Two of the longstanding rules regarding valuations and EBITDA multiples in the chemical industry are:

• the bigger the company, the higher the multiple, and
• specialty chemical companies have higher multiples than commodity chemical companies.

While these two rules may normally hold true, they are by no means always true, or even almost always true.  Thus, there should actually be a third rule:

• Take these 2 rules with a grain of salt.

In the article that follows, we will look at this subject in more detail.

Bigger is better:  The idea that a larger company will have a higher multiple than a smaller one, everything else being equal, is one that is pervasive in the chemical industry.  “Achieving critical mass” and “economies of scale” are often cited as reasons why bigger is better when it comes to valuations.  A look at the trailing 12 month EBITDA multiples of the 75 companies that form the Chemical Week 75 Index, plus a dozen more chemical companies however shows that there is virtually no correlation between size and multiple as of February of this year.  The chart above shows that the median multiple of the 80+ companies surveyed, broken down by size (companies with sales over $5 billion, companies with sales between $1 and $5 billion, and companies with sales less than $1 billion).

Specialty chemicals are better:  The other longstanding assumption in the chemical industry is that specialty chemical businesses are more attractive and command higher multiples than commodity chemical businesses.  Companies will often go to great lengths to portray their business as a “specialty” chemical business in an effort to puff up their value and reputation.  A look at Value Line’s 3 categories of public chemical companies - Basic, Diversified and Specialty – shows however that today, this general rule is also being broken.  The chart above shows that in fact, the median EBITDA multiple of the Basic, or commodity chemical company group is actually higher than the median multiple of the Specialty Chemical group.

So what are we to conclude from all of this?  A few things:

• The valuation of a chemical business is a complex exercise, taking into account numerous factors.
• For example, growth prospects are much more important to a valuation than size or whether the business is a commodity chemical business or a specialty chemical business.
• There are a number of weaknesses in using EBITDA multiples.  For one, EBITDA does not take into account capital spending and therefore does not represent true cash flow.  In addition, using trailing 12 month figures can distort a multiple if the past 12 months have been unusually good or bad.  It also may be misleading if the past 12 months is not an accurate indicator of what the future holds for the company. 

Methodology: EBITDA multiples were calculated in February 2008 and were based on trailing 12 month earnings figures in most cases.  Primary sources were Yahoo Finance and INFINANCIALS. Most companies in the survey are US based, with some in Canada and Europe .