The chemicals industry has faced extraordinary challenges this year. COVID-19 has only added to a substantial to-do list for management teams already grappling with a climate and sustainability ‘mega-trend’ and the global drive to adopt Industry 4.0 technologies and methodologies.

The economic volatility created by the pandemic has posed significant economic challenges for some companies. Complex manufacturing operations mean that chemical producers must contend with high fixed costs related to labour as well as sales, general and administrative (SG&A) activities. In addition, between 60% and 70% of the cost structure of many chemicals companies is comprised of raw material costs.

Although many businesses have seen some benefit from lower oil and gas prices and government support measures, the unprecedented disruption to global supply chains has caused real issues and will force companies and their sponsors to embark on redesigning target operating models. Post-crisis, organisations may also look to leverage opportunities leading from short-time work schemes that have revealed excess capacity across functions, which may not be needed in future or which may be redeployed elsewhere.

It is important for private equity (PE) stakeholders to approach transactions with a robust plan for value creation. Zero-based budgeting (ZBB) is long-established as a valid framework for these activities. Our view is that a targeted Pragmatic-ZBB review can deliver impactful results at pace and can be customised to suit the requirements of either pre-deal diligence phases or post-deal integration and operationalisation.

ZBB and chemicals transactions

Transactions in the chemicals space will differ from subsector to subsector. Our view is that certain subsectors – including healthcare, environmental, agriculture, food and (potentially) construction – are likely to outperform as economies rebuild and respond to COVID-19.

It is also important to understand the types of deal that are foremost in stakeholders’ plans. With large corporations taking stock of their options and considering asset divestments, carve-outs are attracting a high degree of interest at present. A practical ZBB approach has proven to be a valuable tool that can ensure a right-sized target and prevent organisations becoming burdened by non-essential resources.

There is a classic laundry list of cost reduction and value creation opportunities in this context, the majority of which hold true for chemicals companies. There tends to be more limited flexibility for savings in broadly efficient manufacturing functions, and optimising labour costs can require significant capital expenditure. As such, SG&A opportunities are normally prioritised: this might include exploring shared service offerings and footprint management, for instance.

Investors considering carve-outs should be prepared to educate prospective management teams on the need to move faster compared to the pace inside a corporation. Quickly evaluating the cost position and securing alignment with the bigger picture of a target operating model for the new entity is a fundamental priority.

In light of this, when should a chemicals company begin to think about kicking off a zero-based review? A few key trigger events can help guide investors and executives in kicking off Pragmatic-ZBB reviews:

Operating model triggers

• Changing distribution models
• Digitisation of the value chain
• Reducing organisational complexity

Transaction triggers

• Carve-out events where sellers divest assets that are viable but were a neglected part of the portfolio and are in need of a ‘spring-clean’
• Post-merger integration where organisations need to realise synergies and rationalise back-office or shared services functions
• Buy-and-build scenarios where an organisation seeks to ‘roll up’ smaller competitors or firms with adjacent specialties

In the chemicals space and beyond, Pragmatic-ZBB reviews quickly improve transparency and enable closer links between cost transformation and the broader strategic plan, helping move the organisation towards the end goal of a new target operating model. Those interested in learning more about A&M’s Pragmatic-ZBB approach can read our full report here.

A&M: Leadership. Action. Results.

A&M has worked with private equity firms in Europe and globally to stabilise financial performance, transform operations, catapult growth and accelerate results through decisive action. Our senior operators can rapidly assess and respond to challenging situations, delivering value for PE firms and other stakeholders.

Our professionals have extensive experience supporting sellers and buyers through carve-outs and divestments, helping guide businesses through tough, complex situations. To learn more about our expertise and to understand the full scope of our Private Equity Performance Improvement work, contact one of our experts.