Megadeals - What trends are influencing deals in the chemical industry? There are several, according to the latest edition of PricewaterhouseCooper's (PwC)Chemical Compounds report, which analyzes M&A activity in the global chemical industry. The report finds that while the number of M&As dropped during Q3 2011, the proportion of megadeals (deals valued at $1 billion or more) increased.

This also suggests that strategic investors are remaining active. Also, a desire to supplement organic growth and to expand into new markets is driving many companies' M&A efforts. Chemical companies continue to benefit from recent cost cutting and streamlining initiatives, and as cash balances increase, resources are becoming available for larger and more ambitious deals.

The report also shows that deals in China dropped more than 55% in volume and value compared with the previous quarter. However, the analysts weren't surprised: Growth in the slowing Chinese economy - impacted by recent domestic policies and weaker international demand for the country's goods - is expected to fall below double digits for the near term, and China's targeted economic growth rate is 7%, the report states.

2Q & 3Q 2011 Deal Activity and Value Lowest Since Q4 2009

While deal volume continued to decrease in Q3 2011 compared with the previous quarter, deal value improved slightly, to $16 billion. Fewer deals are closing, but they are larger; However, with the exception of Q2 2011, this quarter's deal values are the lowest since fourth-quarter 2009.

The number of deals announced in third-quarter 2011 declined almost 20% from the second quarter, from 286 to 231. However, for the same period, total deal value increased, gaining almost 6.4%, to $16.7 billion. This improvement in deal value was driven in large part by increased deal value for megadeals in the third quarter. While the number of megadeals announced remained steady at four, deal value increased almost 12% to $11.7 billion. Total deal value for medium-sized deals (valued at more than $500 million but less than $1 billion) improved as well, increasing from zero to almost $2 billion.

On the negative side, however, smaller deals (valued at $50 million up to $500 million) declined almost 43%, from $4.2 billion to $2.4 billion this quarter.

The Role of Private Equity

Over the past few years, private equity firms have faced considerable fundraising challenges, deterring their participation in the deal environment. Until recently, their involvement remained weak, as availability of credit and low returns constrained M&A activity. In 2010, financial investors' contribution to M&A activity increased to the highest levels since the recession began, setting the stage for further improvement.

However, that trend reversed this quarter, as financial investments accounted for only 1.25% of deal activity. This is the lowest proportion since PwC began tracking activity by investor group in 2006. This shift may be due to the relative advantage that strategic investors have given their ample cash stockpiles. Although the largest deals announced this quarter were not private equity exits, it seems reasonable that currently high M&A valuations could lead PE investors to seek to divest chemical portfolio holdings to strategic investors. This would seem to be the preferred exit strategy for many PE firms, as compared with initial public offerings, given the recently poor equity market performance.

Four Megadeals in Q3 2011

There were four megadeals in the third quarter, the same as in the second quarter. However, deal value for the third quarter megadeals was $11.7 billion, compared with $10.5 billion in the second quarter. Of the four megadeals announced in the third quarter, three were valued between $1 billion and $5 billion, and the fourth was valued at more than $8 billion. Three of the four were by U.S.-based acquirers, and the fourth involved a U.S.-based target.

The highest valued deal this quarter was the announced $8.11 billion merger in July of U.S.-based cleaning and sanitation products manufacturer Ecolab with water treatment chemical producer Nalco Holdings.

In the second deal, in September, U.S.-based Tronox, the world's third-largest producer and marketer of titanium dioxide pigment, agreed to acquire the mineral sand operations of Exxaro Resources, a South Africa-based iron ore and coal mining company, for approximately $1.3 billion. Exxaro's mineral sands operations produce the key titanium bearing ore feedstock used in the production of titanium dioxide pigment.

In the only mega-deal not involving a U.S.-based acquirer, it was announced in July that Switzerland's Lonza Group will acquire all of the shares of U.S.-based Arch Chemicals. The deal is valued at $1.2 billion. The merger helps Lonza Group diversify its product line, and after completion of the deal, Lonza will have the world's largest microbial control business.