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Bullish Saudi petrochemicals eye M&A

Saudi Arabia's petrochemical industry churned out $7.8bn of profits last year, and is now likely to resume an overseas acquisition and expansion drive interrupted by the financial crisis.

After the local industry's net profits fell by almost two-thirds to $2.8bn in 2009, Saudi chemical companies - led by Saudi Basic Materials Corporation , or Sabic , the state-controlled group with operations from the US to China - roared back to life last year.

"There's a very bullish tone at the moment, as the current petrochemical up-cycle is very strong," says Sebastian Pollems, a managing director and petrochemical specialist at Morgan Stanley in Frankfurt.

"The Gulf petchem companies are perfectly positioned to serve the Asian market, and enjoy low-cost local feedstock," he adds.

Thanks to their domestic market's hydrocarbon production, Gulf petrochemical companies benefit from subsidised energy and cheap access to raw materials such as ethane, used for most petrochemical products, and rising demand from Asia. According to a KPMG report in 2008, the average price of 1m British thermal units of energy was $7-$8 in the US but just 75 cents in Saudi Arabia.

Longer term, analysts expect Saudi petrochemical companies to out-compete US and European rivals and become increasingly dominant in the global market, thanks to their low production costs.

The return to healthy profitability is likely to spur a renewed acquisition drive by Sabic and its other Saudi peers, analysts say.

While sovereign wealth funds have typically garnered the most attention, the largest outbound investment on record in the Gulf is Sabic 's $10.6bn purchase of GE Plastics in 2007.

Sabic is now adding capacity via Yansab and Sharq, two Saudi-based affiliates, and a joint venture with Sinopec in Tianjin, north-east China.

Analysts at Nomura last month reported that Petro Rabigh , a joint venture between Aramco and Sumitomo and another Saudi petrochemical producer, had finally turned a corner after a commissioning period. They described Petro Rabigh 's first-quarter results as "strong" and "better than expected", warranting a re-rating of the publicly traded shares. Muhammed al-Madi, Sabic 's chief executive, last month described the possibility of petrochemical oversupply as "exaggerated".

"The supply today is going to be absorbed by the market in 2011. And there will be shortages also down the road because there is less capacity addition in 2011, '12, '13 and onward.

Sabic , which reported first-quarter profits of $1.4bn, is sitting on a $13.7bn cash pile, and is likely to be the most aggressive expander. However, other companies in Saudi Arabia and elsewhere in the Gulf are also likely to look for potential acquisitions.

Mr Pollems said: "There is also a large group of smaller Gulf petrochemical companies enjoying strong cash flows but [that] they haven't been very active yet in the M&A markets. I wouldn't be surprised to see them become more active in the future."

Acquisitions have usually been made in the US and Europe, but Albert Momdjian, regional head of Calyon, the French investment bank, expects Saudi petrochemicals companies to be more interested in Asia - where most of their clients are.

Saudi petrochemicals do not have the technological edge of many international peers, having traditionally concentrated on low-cost products that take advantage of the country's cheap feedstock, but acquisitions are increasingly likely to focus on proprietary expertise and technology.

"Leading technologies cannot be licensed. Access is often only possible through acquisition of the owner [or] developer," Mr Pollems said

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