The number of activist investors focusing on chemicals is increasing, perhaps due to weaker chemical company profitability and higher cash levels of the past three years, as shown in Figure 11. Activist investors are targeting both US and European chemical companies, often desiring board seats. But the jury is still out on the benefits of activist investors in chemicals.
Let’s compare share prices (including dividends) for a market basket of 83 US and European chemical companies against a group of eight major chemical companies (representing US$106 billion in sales) with activist investor involvement. The results are mixed, as seen in Figure 22. Of this group, most (but not all) activist investors became engaged in the 2012 and 2013 time period.
The outcomes: The shares of active investor target companies performed better than average from 3Q14 to 2Q15, however, they performed worse in the most recent quarter, 3Q15.
The “good” activist investors bring new proposals that are worthy of consideration for adding value. The “bad” activist investors may be those that have simplistic approaches for shorter term financial gain, like share buybacks. The “ugly” may be the activist investors that target companies for their “financial kinetic energy” by splitting them based on short term financial performance. Bad and ugly can impact needed investment and R&D as well.
Common activist levers for increasing shareholder value include splitting off company segments (cash generating parts versus growth areas), cutting costs, buying back shares and increasing dividends. Some of these may be appropriate for some targets at particular points in time, however, sometimes these can run against long term strategic plans upon which the entire asset base of a company was sculpted. For instance, over the past few years, large diversified chemical companies have been aligning their strategies and investment plans towards megatrend growth opportunities (see past blog). Megatrends markets, by definition, are long term prospects. Therefore, abandoning large segments due to short term performance casts doubt on a company’s long term plans.
Jeopardizing innovation cross-pollination
One thing that can be undervalued when splitting a chemical company is the possible distortion of innovation cross-pollination within a company. 3M is a good example as a cross-pollinator. For instance, innovations made in its dental business were successfully leveraged in its collision repair business3.
Our analysis of patents also indicates that some chemical companies have been benefiting from innovation in a similar way. Figure 34 shows an example of a patent filed more than a decade ago. Since then, that original patent had been referenced over 160 times within other patent filings of the same company, benefitting business segments associated with garment production and treatment, electrolytic capacitors, batteries, water treatment and other areas. Breaking up a company may interrupt those cross-pollination streams and limit a company’s innovation strength.
The Good - Positive activist investment
As long as activist investors stick to their traditional ways for increasing shareholder value, they will not bring any new thinking to the business of chemistry. Spin offs, mergers, acquisitions and share buybacks have been done for many years. Real new thinking is needed.
Perhaps activist investors can help to ensure companies are using available cash to transform their business models to enable them to tap megatrends more effectively, such as through the adoption of new business processes, technologies and ways of serving customers.
For instance, to fight ongoing commoditization in specialty chemicals, some diversified specialty chemical producers (which we refer to as “specialty balanced”5) need to differentiate between “commoditized specialties” and solution/service providing chemical segments, which typically have higher margins. Activist investors can launch transformation processes, leveraging tools and services found in consumer products industries, for example, to push customer connectedness to new levels. This may involve the use of digital solutions and collaborative thinking (see some ideas in past M&A blog).
We believe that companies can take some pre-emptive measures to avoid activist investors:
Have a clear story about the synergetic value of their various business components, if it truly exists.
Be clear on how their strategy and organization hinge to megatrend growth prospects.
Take action to rebalance the company portfolio if the synergy and long term strategic links do not exist.
Communicate the above plans and linkages with frequency to investors, including in investor presentations, on company websites and in other media.
Go beyond just portfolio management and revisit current business models, finding ways to lead industry transformation that begins with solving future customer needs.
Co-authored by:Gregg Albert, M&A Strategy Senior Manager, Accenture