Activism and Chemicals – A Fad or an Opportunity?
- Activism in the Chemical space has targeted the right companies – where returns on capital have been lackluster at best and declining at worst, and where there are examples of better business models at different companies.
- However the pillars driving this underperformance have been a function of sub-optimal strategic decisions over a long period of time and/or an unfavorable geographical footprint in terms of both manufacturing centers and head offices.
- Unlocking value will be a complex and time consuming process and the manner in which it occurs may be just as important – spin off versus sales for example, in any decision to separate businesses. In some cases high costs are also a problem and need to be corrected in addition to any business realignment.
- Intransigence of management practices and beliefs have been shown to be major impediments to rapid progress – often fresh thinking is the key but is not often sought out.
- Both APD and DD are struggling with how best to create the maximum shareholder value – we think Dow has a long road ahead to truly satisfy the activist investor. It can be done with the right steps but it will not be easy. At these price levels we would be cautious and would not recommend buying hoping for some big transformation. All three stocks have had a good 12 months partly as a result of the activism and only DD still looks cheap in our view.
It has been a busy six months for US Chemicals, with activists declaring stakes first in Air Products, then DuPont and now Dow Chemical. These are all big companies with complex global businesses, and in each case there is a strong consensus view that value is there to be unlocked; but what are the practical limits? All three companies have underperformed peers over the last decade and in that regard the activists have done a good job of identifying the right names.
Businesses can always be run better than they are today and Air Products watchers can point to Praxair, DuPont watchers can point to Monsanto and 3M, and Dow watchers can point to Lyondell and perhaps Monsanto. These are easy peers to name, but much more difficult peers to emulate. Praxair’s differences to Air Products exist in our view because of strategic decisions and operational practices that began more than a decade ago. Dow and DuPont have each changed strategic direction several times in the last three decades and these moves, right or wrong, have left both companies with product and geographic diversity which has moved well beyond optimal – both are addressing this, but it is either too little or too late in the eyes of the activists.
We look at the success that Monsanto has seen in its share price since 2005 but we forget that the core strategic decisions that created the Monsanto of today were taken in the mid-90s. We applaud the success of PPG and SHW in the coatings business and ARG and PX in US packaged gases, but these are consistent consolidation strategies that the companies have been working on for a decade or more and are only now really beginning to show their true value.
Different strategic decisions and different approaches to managing capital, R&D, overheads and sales and marketing can likely lead to value creation at all three targeted companies. In addition there are some break-up or separation options that could also help. Can these be achieved without major management shake ups? Unlikely in our view. These companies today are a function of decisions made and strategies followed over several years – unravelling decisions and changing strategies generally involves a cultural shift – such as those we have seen at Monsanto, Eastman and Praxair in the last 10-20 years. Nothing is quick and nothing is painless.
Complicating things further; these are not simple businesses – you cannot shutdown some stores or sell off easily carved out pieces:
- Integrated sites contain facilities that might naturally belong in different businesses, but their connectivity with other facilities results in a complex separation, where the value of one business versus another may be more a function of agreed supply and off-take agreements than the assets themselves.
- Shutdowns and business exits are not free. Site clean-up is in some cases prohibitively expensive and some facilities around the world run simply because the cost of shutdown is too high.
- Some businesses only make sense because of their integration – we have already commented that we struggle with the idea of Dow separating its ethylene business from its chlorine business – both, in our view, will be weaker long-term because of the separation.
- People become a major issue. Operations, and even headquarters, are located in towns where the company is the major employer. Where the opportunity to unlock value comes from cost reduction, these complications are not insignificant.
In our view the activists involved have all taken on some big challenges and it is not clear that they will win in a time frame that matters, even if they have a “long-term” view.