Failed takeover is set to catalyse chemicals

CITY ANALYSTS yesterday predicted that the aborted pounds 1.5bn takeover of the UK speciality chemicals group Laporte by its Swiss rival Clariant would spark a wave of consolidation among undervalued British chemical groups.

The Clariant/Laporte deal foundered on Tuesday after strong opposition from Hoechst, the German life sciences giant which owns a 45 per cent stake in the Swiss group.

However, industry experts believe that the talks between the two companies highlighted the hidden value of several British chemical producers and could herald a series of cross-border mergers.

A number of cash-rich European and US chemical groups are thought to be looking at their British rivals in a bid to exploit the recent slump in share prices across the UK sector. Albright & Wilson, a medium-sized chemical group, is already at the centre of a bid battle between Albemarle of the US and Rhodia of France, which could come to a head in the next few weeks.

ICI, the UK's largest producer, is thought to be close to the sale of over $2.8bn worth of assets to Huntsman of the US, as part of its transformation into a fine chemicals company. Moreover, companies such as PPG of the US and the German groups SKW Trostberg, Degussa-Huels, Bayer and BASF are considered as potential bidders for groups with a good asset base and promising growth prospects, such as Laporte, BTP and Yule Catto.

"It doesn't take a rocket scientist to see all those companies are flirting, and that will probably translate into mergers sooner rather than later," one fund manager said.

The key driver for the latest bout of merger fever is the low valuation of a number of UK producers. Chemical companies' earnings have been hit hard by a combination of the strong pound, slowing demand in the crisis- ridden Far East and a cyclical downturn in the industry. This triple whammy has been compounded by the market's dislike for small and medium cap stocks, which make up a large portion of the chemical sector. These troubles depressed investors' sentiment leading the UK chemical sector index to underperform the market by around 40 per cent over the past eight months.

The low ratings of many UK companies contrast with their good growth prospects. Martin Evans, head of research at the stockbroker Sutherlands, believes that the sector has been oversold.

"The fundamentals of many of these companies are very good. The market has over reacted and the sector has been marked down quite savagely, leaving some companies on some ridiculous price earnings/ratios," he said.

Mr Evans and others point out that companies such as Laporte and BTP are well positioned to take advantage of an upturn in demand. Their key selling point is that they have a strong position in speciality chemicals and have reduced their exposure to commodity chemicals.

Speciality chemicals are high-margin, low-volume products, largely used in high-technology industries such as pharmaceuticals and electronics. Unlike the commodity chemicals supplied to oil and exploration companies, speciality products are cushioned from the industry cycles because they are usually based on long-term contracts with customers. Speciality chemicals are the Holy Grail of the modern chemical industry and several companies are keen to buy their UK rivals in an effort to expand in those areas.

As one analyst said: "Many UK companies have a significant proportion of earnings in those high-growth businesses. Their attraction is that they are fairly small and affordable and could become chewable chunks for an overseas producer."

Given the prospect of activity and the likelihood of a turnaround in trading conditions, this is a good time to buy UK chemical stocks, especially Laporte, BTP and Yule Catto, which are all trading at chunky discounts to the market.