Activist investors have been flexing their muscles in the U.S. chemicals sector for some time now, which is a trend we think will likely continue through 2020. Nearly 15% of public U.S. chemical companies rated by S&P Global Ratings currently have activist shareholders (based on regulatory filings) agitating for change. The rise in activism in this sector since the beginning of 2018 is consistent with the upsurge of this phenomenon across various corporate sectors.
Last year was a banner year for corporate shareholder activists (or their nominees) with a record number of board of directors seats held, more capital deployed, and an unprecedented number of campaigns begun (including some by first-time activists). While the merits and risks of activism are up for debate, one thing is clear: There is no shortage of opinions on how a company can improve its short- and long-term value. It's difficult to judge whether an activist going public with his or her opinions directly influences a company's decisions or actions in all cases. For example, if an activist demands the sale of a business segment, it's possible that the sale had already been contemplated by management before the activist spoke out.
Of course, we don't automatically consider any shareholder activism a negative credit factor because there are too many variables. However, given many of the shareholder-friendly policies activists promote, the potential for negative rating actions is somewhat higher than for companies without activist involvement. Since 2018, we haven't downgraded any U.S. chemical company based solely on shareholder agitation. But we believe negative outlook revisions or downgrades are possible if some outstanding activist proposals come to fruition at the expense of debtholders or if activists become more aggressive, potentially threatening a company's credit quality.
Which Companies Are Targeted And Why?
While each situation is different, shareholder activism generally focuses on changing specific company practices or characteristics.
For example, investor activists might target companies that:
- Are sitting on a hoard of cash that could be used for buybacks, dividends, or growth initiatives;
- Possess an underleveraged balance sheet; or
- Have a portfolio ripe for rationalization (e.g., by calling for the divestiture of noncore businesses and even advocating for the sale of an entire company).
We also see activists targeting companies to:
- Increase merger and acquisition (M&A) spending, including boosting existing purchase offers;
- Modify or transform management;
- Obtain seats on the board to expedite preferred changes they hope will enhance shareholder value;
- Reduce costs to bring margins in line with peers;
- Improve the environmental, social, and governance (ESG) profile; or
- Address factors responsible for low share prices or trading multiples that trail peers.
Here we look back at some notable events triggered by activist investors over the past few years, the results of which have no doubt changed the competitive landscape in certain chemical subsectors.
The Dow Chemical Co. and DuPont (E.I.) De Nemours & Co.
Perhaps the two most publicized activist investment events in the industry involved DuPont (Trian Fund Management L.P.) and Dow Chemical (Third Point LLC) in 2014-2015.
In 2014, Third Point publicly targeted Dow with a plan to gain several seats on its board to boost profitability (which lagged certain peers) and split the petrochemical operations from the specialty-chemicals businesses. Toward the end of that year, Dow ended up adding two Third Point nominees to its board while the latter agreed to a one-year standstill agreement.
Trian pushed DuPont to take a hard look at its existing portfolio, cut costs, assess its capital-allocation policies and balance-sheet efficiency, and improve its corporate governance. In 2015, we revised our outlook on DuPont to negative from stable and, later in the year, we lowered our issuer credit rating on the company to 'A-' from 'A' while maintaining the negative outlook. The outlook revision followed a step-up in Trian's efforts to gain influence at the company to achieve its previously stated goal of splitting up DuPont's existing businesses.
The downgrade followed a combination of events including the company's:
- Intention to step up share buybacks through 2016 by at least $4 billion, funded through the announced sale of its specialty chemicals unit;
- Weaker-than-anticipated operating environment leading to the lowering of our expectations for its credit measures; and
- Announcement that the CEO was resigning.
Prior to the end of the standstill agreement with Third Point in December 2015, Dow and DuPont announced their transformational merger. Though both companies claimed they had been thinking about the combination for a while, we believe that activist pressure played at least some role in the desire and pace by which this deal came together.
Air Products and Chemicals Inc.
Pershing Square Capital Management acquired a nearly 10% stake in Air Products in 2013. Since that time, the company changed its CEO, implemented significant cost reductions, improved its EBITDA margins, and rationalized its portfolio. The portfolio rationalization included selling its performance materials segment to Evonik Industries for $3.8 billion and spinning off its electronic chemicals segment into public company Versum Materials Inc. (BB+/Watch Pos/--).
We did not take any rating actions on Air Products because it was able to offset its lost earnings from the divested segments by using the proceeds to repay debt and put cash on its balance sheet to help fund its significant growth initiatives. We did favorably reassess the company's business risk profile to reflect its portfolio transformation to focus exclusively on its more stable and profitable core industrial gas business segment and the significant improvement in its EBITDA margins. This is an example where company actions following activist agitation had a positive impact on credit quality.
Investor Activists Are Still Shaking Up The Chemicals Sector
The U.S. chemicals sector continues to be a hotbed of activist unrest. While the rationales for targeting specific companies remain varied, we're seeing some commonalities within subsectors and industries. For example, the paints and coatings end market remains a focal point for activists. We believe this highly fragmented sector lends itself to consolidation because the top 10 players represent only about 50% of the global market.
This activist-inspired consolidation trend started in 2017 when Elliott Management Corp. took a stake in Akzo Nobel N.V. and pushed for its sale to PPG Industries Inc. After the transaction failed, Akzo sold off its specialty chemicals business and returned €5.5 billion of the €7.5 billion in net proceeds to its shareholders (in addition to €1 billion it distributed in 2017 as a special dividend). Akzo's actions prompted us to downgrade the company by one notch to 'BBB+' from 'A-'.
More broadly, we currently see significantly more activist shareholders in specialty chemical companies than in commodity chemicals. More than 80% of the companies with activists are mostly specialty chemicals players. We believe this stems, in part, from the push in certain cases (such as with Ashland Global Holdings Inc.) to divest noncore commodity chemical businesses and focus on growing the specialty part of their portfolio. Additionally, specialty chemical companies tend to have more predictable and resilient cash flows than commodity players do.
PPG Industries Inc. (A-/Stable/A-2)
In 2017, PPG made several unsuccessful attempts to acquire Akzo Nobel. In 2018, PPG attracted the interest of an activist investor. Trian Fund Management took a stake in PPG and published a white paper in October 2018 with several transformational recommendations (see table below).
Following the publication, PPG publicly stood behind its current CEO. In May 2019, the company completed an extensive review of its portfolio and concluded that the current business portfolio provides the best opportunity to drive long-term shareholder value. In the past, the company tried to remove its staggered board structure but didn't receive the necessary shareholder votes. This measure was on the 2019 proxy and, despite PPG engaging a third party for assistance, it did not receive the necessary shareholder support. We believe that any split of the company would have weakened its scale, scope, and diversity, in addition to leading to significant negative cost synergies and likely deteriorated credit quality.
RPM International Inc. (BBB/Stable/--)
In June 2018, RPM International Inc. announced an agreement with activist investor Elliott Management that focused on improving its operating and financial performance and enhancing shareholder value. We expect that management's financial policies will be more aggressive than they have been historically, as characterized by the company's announcement of a $1 billion share repurchase program that it expects to complete by the end of fiscal year 2021. In comparison, the company had completed an aggregate of about $165 million of share repurchases over the past six years. Nevertheless, the company no longer has asbestos-related outlays to contend with (i.e., roughly $800 million from fiscal year 2015 through fiscal year 2018) and we believe that maintaining an investment-grade rating will remain a key priority for RPM.
RPM's credit metrics are currently weak for the rating and we expect a significant improvement in its fiscal-year 2020 EBITDA and credit measures due, in large part, to its margin-acceleration plan. In our downside scenario, the ratings could come under pressure if this improvement doesn't materialize or if the activist presence (the Elliott cooperation agreement ran through June 2019) leads the company to employ more aggressive financial policies. This could result in RPM undertaking a larger-than-expected debt-funded acquisition or repurchasing a greater-than-anticipated amount of its shares.
Axalta Coating Systems (BB/Stable/--)
Most recently, it was reported that activist Jana Partners had built up a position in Axalta over the past few months. On June 19, Axalta issued a release stating that it "has initiated a comprehensive review of strategic alternatives, including a potential sale of the company, changes in capital allocation, and ongoing execution of our strategic plan." Subsequently, Axalta announced a new chairman of its board of directors. Currently, Axalta's credit measures remain in line with our expectations at the 'BB' rating. However, the ratings could come under pressure if this review led to a meaningful change in the company's business mix or if it were to undertake more aggressive financial policies than we have factored into the ratings.
A Shift In Focus Is Likely But Portfolio Rationalization Remains Key
We believe that activists will continue to focus part of their campaigns on streamlining companies' portfolios and divesting noncore businesses. We expect companies to continue to try to sell off lower-margin, more commodity-type businesses in an effort to boost their overall EBITDA margins and focus on core competencies.
Some past notable examples of this type of portfolio rationalization, several triggered by activist pressure, include:
- Air Products' portfolio-related actions to focus solely on industrial gases;
- PPG Industries' divestiture of its glass, lenses, and chlor-alkali businesses over the years to become a pure-play paints and coatings company;
- FMC Corp., acting as its own activist, sold off its soda ash, lithium, and health and nutrition segments while completing transformational acquisitions in the agricultural chemicals segment; and
- Ashland Global Holdings Inc.'s divestiture of its distribution and water technologies businesses, its spin-off of Valvoline Inc., and its agreement to sell its composites business. Throughout the years, Ashland has focused on supplementing its organic growth by acquiring higher-margin specialty chemical businesses.
Activists Have An Increased ESG Focus
One emerging topic we believe activists will focus more on is ESG. As ESG investing transitions from a niche sector to become more mainstream, we expect rising investor interest in how companies are addressing ESG-related challenges. With millennials continuing to comprise a larger percentage of the workforce, we believe they will be more likely than the rest of the population to incorporate ESG values in their investment choices. As such, we would expect activists to focus some of their campaigns on identifying companies they feel can improve their ESG footprint. For example, activist Jana Partners LLC is looking to launch its Jana Impact Capital Fund, which will focus on socially responsible investing.
We believe companies will continue to increase their disclosure of various ESG-related topics, in part, on their own accord but in some cases driven by activists or regulators. From 2015-2017, we saw a gradual increase in the number of U.S. chemical companies that publish sustainability or corporate-responsibility reports. We expect this number to rise even further as companies make their 2018 reports public. In addition, even companies that don't publish corporate responsibility-type reports are increasing the amount of content available on their websites detailing their ESG-related endeavors.
We believe this uptick in disclosures could, at least partly, be due to activist pressure to increase transparency, particularly as it relates to key topics such as sustainability and climate change. Other key ESG–related characteristics that activists have raised in their campaigns across the various corporate sectors include the environmental impact of a company's products, workplace conditions, board and employee diversity, and compensation.
Activist Involvement Is Here To Stay And Remains A Risk To Ratings
We expect shareholder activism to remain a key ratings risk factor because the results of their action plans often come at the expense of debtholders. The magnitude of any potential rating action would depend on a combination of factors, including our assessment of the impact on a company's business risk profile (e.g., upon the completion of a divestiture). We would also re-assess a company's financial policies, including the potential for increased leverage to support growth or shareholder-friendly initiatives. A company's financial risk and credit measures would also come under scrutiny. Will an action plan have a significant impact on a company's liquidity position? How might these activist-inspired plans alter our assessment of management and governance?
While there are some instances where activist involvement had a positive influence on a company, we continue to expect a greater potential for negative rating actions triggered by company decisions stemming from activist ownership and agitation.
This report does not constitute a rating action.
|Primary Credit Analyst:||Daniel S Krauss, CFA, New York (1) 212-438-2641;|
|Research Assistant:||Julie M Tsang, New York|
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