Abu Dhabi closes in on German group that helped ‘invent chemistry’

German chemist Otto Bayer didn’t know what to do with polyurethane foam when he invented it in 1937. Today, the chemical is ubiquitous in household appliances and cars, and is at the center of Abu Dhabi’s state oil group Adnoc’s effort to concludes the largest takeover agreement in Europe. this year.

The target company, Covestro, is a gem of German industry. Spinned out of pharmaceuticals and chemicals conglomerate Bayer in 2015, its headquarters in Leverkusen is in the industrial heart of North Rhine-Westphalia – a state full of potential customers for its products.

But times are not as good as they used to be. High energy prices and sluggish consumer demand have hit German manufacturers, and their suppliers, including Covestro, are feeling the pinch.

“Europe is becoming less and less competitive, especially Germany,” chief executive Markus Steilemann told the Financial Times at Covestro’s latest earnings, when the company cut its full-year profit outlook.

The chemical industry lobby group that Steilemann heads has warned that Europe’s biggest economy is deindustrialising and urgently needs support.

The call has been heeded by Adnoc, which pumps almost three times more crude each day than Shell and has built a team of 50 negotiators led by ex-Morgan Stanley executive Klaus Froehlich to scour the world for acquisitions, particularly in gas and petrochemicals. .

The two sides have been in talks for more than a year as Covestro rejected a number of lower bids and completed due diligence, with Adnoc expected to make a formal offer of around €14.4 billion, including debt .

Sultan Al Jaber, the chief executive of the Abu Dhabi group, was in Germany in the last week of August to finalize negotiations, according to two people familiar with the matter.

If the deal goes through, it will be one of the largest cash deals in the chemical sector and the first time a Dax 40 company has been bought by a Gulf state.

“This is Bayer’s old materials science business, which is one of the few companies globally that basically invented chemistry,” said one person who works on the business.

“Bayer took a different direction and turned it around and has been alone in a very cyclical industry ever since,” they added.

Covestro’s three most important products, all of which it invented, are two types of chemicals, MDI and TDI, which are used to make various forms of polyurethane foam and polycarbonate, the strong but transparent plastic that was popularized in CDs and DVDs, but is now more commonly used for car headlights, sunroofs and electric vehicle interiors.

Many of Covestro’s chemicals are petroleum-based, but the German company is experimenting with using plant and waste alternatives and recycling.

“MDI is used for rigid foam, which is predominantly an insulating material. If you open a refrigerator, you will see rigid foam and that is MDI,” said Sebastian Satz, an analyst at Citi who covers Covestro.

“It’s a relatively consolidated industry with only a few suppliers worldwide and it’s difficult to get into because it has complex chemistry and building a new factory on a global scale would probably cost you close to €2 billion.”

“TDI is used for soft foam. You could be sitting on it as we speak and it’s used for car seats, cushions and mattresses,” he added, noting that the market for TDI has been saturated by Chinese competition.

The person working on the deal said Covestro’s specialization in foams placed it in the middle of a mega trend of energy transition as countries introduce more regulations on insulation and energy efficiency.

Meanwhile, its polycarbonate business will benefit as electric vehicle makers seek to replace metals with lightweight but strong plastics.

Foreign takeovers of German companies, such as the 2016 acquisition of industrial robotics group Kuka by Chinese appliance maker Midea and US-based Carrier’s purchase last year of the Viessmann family’s heat pump business, have raised concern in Berlin about the country’s fate. the industrial edge.

But the attempted takeover of one of Germany’s most innovative chemical groups by a state-owned Gulf company has barely sparked any discussion among politicians.

The federal ministry of economic affairs said it could not comment on “business decisions or negotiations between companies” or “hypothetical considerations regarding investment reviews”.

The economy ministry for the state of North Rhine-Westphalia told the FT it was following the negotiations “closely”, but said “the interest in taking over Covestro shows that the company’s future prospects are viewed positively”.

Satz said the plastics industry was “probably not seen as strategically important” by Berlin.

“I don’t really anticipate that there would be problems, not on antitrust because they don’t have an overlap, but also on German foreign investment policy,” he said.

“Also, because it could put more money into the company, it shouldn’t have a negative impact on employment in Germany, so we wouldn’t expect any material pushback from the unions.”

Satz estimated that the MDI market will continue to grow at about 5% per year, with TDI growing at 3%.

“Covestro has a leadership position with assets at the bottom of the cost curve and in all key regions: Europe, Asia and the Americas. This has allowed them to always generate positive free cash flow, back to the extent we have data,” he said.

He calculated that the cost of building Covestro’s facilities from scratch would be more than €90 per share, well above the €62 per share that Adnoc could offer.

“If someone wants to get into those organic chains, it’s not only very risky, it’s also much more expensive. So you can go in and buy the market leader with large assets at a significant discount and still make the shareholders happy because you’re paying a premium,” he said.

Christian Faitz, analyst at Kepler Cheuvreux, said Covestro was a perfect fit for Adnoc’s ambition to access sustainable technology, as the company’s foams and chemicals were “key enablers to make buildings more energy efficient (and ) the lighter cars’.

But more importantly, a successful deal would give Adnoc access to a global setup – its 17,500 employees are spread across Europe, the US and Asia, with less than a third of production based in Germany – and “a perfect roster of customers”.

Covestro shares have not traded above Adnoc’s likely offer price for the past six years, a time when the chemical industry has suffered through cycles of boom and bust as competitors brought huge new plants online and slashed prices to win orders.

The company’s Ebitda last year was less than a third of what it earned in 2021, and analysts at TD Cowen believe Adnoc’s indicative offer represents a premium of around 50% to its undisturbed share price.

“They’ve had great years, but they’ve also had years where all of a sudden the earnings are a lot lower, which means you have to tighten your belt a little bit, which means even if you want to grow, it might be having to postpone projects when you are listed in comparison. until you are listed,” the person close to the transaction said.

“If you’re in a cyclical industry, you always have to anticipate the next cycle and not casually overextend yourself with the next €2 billion project.”

Having access to Adnoc’s resources, with the company committing to spend $150 billion between 2023 and 2027 on capital expenditures, would be the main advantage of the deal for Covestro, according to Satz.

Faitz also said Covestro, with its cyclical business, could benefit from having an owner with “a long-term asset development plan that gives it the security to make long-term decisions and not be criticized every quarter by analysts for bad numbers. “.