By John Richardson
This is a question raised by this excellent Insight article, from the blog’s ICIS colleague Joe Chang, which revisits the issue of hedge fund Third Point’s interest in carving out commodities from the Dow Chemical commodities-specialities business.
“To get a clue as to whether diversification itself is the culprit, it’s worthwhile comparing the performance of Dow and DuPont to Germany’s BASF – the largest and arguably the most diversified chemical company in the world. BASF’s Verbund strategy is synonymous with integration,” writes Joe.
“BASF has consistently beaten both Dow and DuPont, as well as the S&P 500 – in the past five years, 10 years, and since 2000. BASF itself has made significant acquisitions and divestments through the years. Yet none could be called disastrous. None stretched the balance sheet to troubling levels.
“It’s a fair question to ask whether a chemical company focused on commodities and specialities is inherently misallocating capital, reducing the growth potential of the specialities businesses. That analysis should be done for each company and each business segment.”
In this context, Joe was referring both to widespread claims that Dow overpaid for its Rohm & Haas specialities acquisition in 2009 – when the global financial crisis was in full swing – and the success of BASF’s oft-cited Verbund , or integration, strategy.
Here we’ll focus on the issue of effective integration – something that is a great deal easier said than done, and something that, in the case of commodities-specialities, goes much beyond advantaged feedstock supply from commodities to specialities. Perhaps we are talking more here of a corporate culture that takes time to evolve?
- The job of a commodity chemicals and polymers company, such as a Dow, is to find ways of selling all the volume from, say, a 400,000 tonnes/year linear low-density polyethylene ((LLDPE) reactor. Therefore, whilst high value applications are important, these might only ever consume 10-15% of that reactor’s volume. Thus, most of the sales and marketing focus has to be on “sell, sell, sell” into often price-sensitive commodity applications. Getting all of that volume out of the door and into customers’ silos, warehouses and tanks is crucial, especially during up-cycles when supply and demand is tight. You sometimes have only a few months to make so much money that you can pay-back your 1m tonnes/year cracker and derivatives project. The same applies, to a lesser or greater extent, to other parts of the Dow portfolio –for instance, PE elastomers and polyurethanes (PU). Whilst some PU applications are either specialities, or are almost specialities, other segments of PUs are highly commoditised and under a lot of downward price pressure in China.
- The job of a speciality producer is instead to follow the motto, “less equals more”. Output is often just a few tonnes, or even a few kilograms a year. Because turnover is small, selling out a plant is not the challenge. Instead, everything is about lots of finding lots of niche applications that deliver excellent margins per tonne or kilogram. This means a lot of expenditure on R&D, product development and sales and marketing. These efforts, also, often take years to reach fruition and often result in failure. Somebody brought up on commodities might feel that this is a terrible waste of money.
- This obviously means that you need separate R&D, product development and sales and marketing teams – one for commodities and other for specialities. But in a big company, with lots of bureaucracy, how do you get everyone to communicate with each other effectively? For instance, how do you leverage on the breadth and depth of expertise so someone in specialities knows the ideal people to contact in commodities who could help with a problem?
- And how do you get one side to understand the other – i.e. commodities to understand the needs of specialities and vice versa, especially right now when the opportunities for commodities are so huge, given the shale-derived ethane advantage?
- How do you therefore ensure that investments are allocated in the optimum way in a commodities-specialities company?
- Might the Japanese model work better when you have one big parent holding company i.e. a Keiretsu – and almost entirely stand-alone commodity and specialities entities with just a few shared corporate functions?
- Or might the best approach be to spin-off commodities from specialities altogether?
None of this, of course, is insurmountable as proved by integrated and successful commodities-specialities players.
Perhaps the answer is time, but, of course, Wall Street can sometimes have different objectives than waiting for long-term value to emerge.