Last of the Big Spenders

How 2008 panned out for one of the M&A boom's most transformative deals — and what 2009 has in store.
Tim BurkeDecember 8, 2008

What do a bank, a health-care products retailer and a chemicals conglomerate have in common? Each is responsible for orchestrating some of the biggest and most transformative deals during the recent M&A boom, and has subsequently spent the past year handling the aftermath. But that’s where the similarities end. Of the three, one has hit a wall: Royal Bank of Scotland’s ambitious consortium break-up of Dutch rival ABN Amro has proven to be an overpriced dud. In contrast, the second dealmaker is bouncing along, with Alliance Boots announcing a 20% rise in profits after becoming the first FTSE-100 company bought by private equity. But it’s the third, AkzoNobel, that warrants attention now — the jury is still out on its bid to shed its conglomerate status, hinging on a major divestment and acquisition strategy. The Dutch industrial group’s performance during 2009 could decide whether the move works or came too late.

Much of the pressure falls on Keith Nichols. CFO since May 2008, he earned his stripes at AkzoNobel over the previous two-and-a-half years as senior vice-president for finance, following a 20-year finance career that included time at Anglo-Dutch steelmaker Corus and TNT. The 48-year-old Briton knows that he’s “not immune to difficult environments or change.” But demonstrating the value of the new AkzoNobel could prove a baptism of fire in his current role.

Indeed, there are three tests ahead for AkzoNobel, all of which call into question the timing of its transformation. First, it needs to integrate ICI, a once-iconic UK company that had lost its way over recent years and which AkzoNobel bought for £8 billion (then €11.5 billion) in 2007. With 29,000 employees across 50 countries, compared with AkzoNobel’s 43,000 across 80 countries, ICI was smaller but nonetheless a sprawling business to integrate. Second, it must drive through a critical divestment plan during one of the most severe economic downturns in recent history. Finally, there will be pressure to demonstrate that its greater reliance on emerging markets — a crucial part of its rationale for buying ICI — is still sensible despite those economies beginning to show signs of slowing down. If AkzoNobel succeeds on these three fronts, it could be a textbook example of how to change the course of a company, regardless of the rocky conditions. If it doesn’t, it could join the likes of ICI as proof of how ill-advised deals can scupper the most well-meaning restructuring strategies.

The Get-Together

Timing aside, few would argue that AkzoNobel’s restructuring was unnecessary. The company had operated in pharmaceuticals, chemicals and coatings since the merger of Dutch company Akzo and Swedish firm Nobel Industrier in 1994. But when Hans Wijers took over as CEO in 2003, economic and operational woes had driven the company’s share price down to 1996 levels. Analysts presumed that Wijers, a former management consultant, would spin off the pharmaceuticals or chemicals division and refocus the group on the remaining businesses. Many of its peers had already done so. German chemicals rival BASF, for example, sold its pharmaceuticals businesses to Abbott Laboratories in 2001. ICI had spun off its drugs business as Zeneca back in 1993.

But when Wijers announced a €500m chemicals disposal programme and a plan to fix the pharma unit by cutting costs, he came under fire. As a newswire journalist put it at the time, “AkzoNobel should hurry up and restructure so investors stop using words such as ‘conglomerate’ or ‘hybrid’ to describe what this Dutch company actually does.” Wijers ultimately heeded such calls. In late 2005, just as Nichols joined the group’s finance team, AkzoNobel decided to offload the pharma division, first planning an IPO but eventually accepting an offer from Schering-Plough in the spring of 2007. The company then hunted for targets to bolster its chemicals and coatings businesses, confirming in June 2007 that it had approached ICI.

There were big risks in AkzoNobel’s plan, as ICI’s executives would know. The British company’s £5 billion takeover of Unilever’s speciality chemicals division in 1997 was accompanied by the sale of some of its bulk chemicals businesses at a knock-down price. By the time CEO John McAdam arrived in 2003, ICI needed a fast turnaround: revenues had fallen to £5 billion, from £9 billion five years earlier. In 2007 it offloaded chemicals business Uniquema to Croda for £410m and sold Quest, a flavours and fragrance business, for £1.2 billion.

But because of its well-known brands, including Dulux and Glidden paints, ICI was still attractive to AkzoNobel. By taking it over, the Dutch company would become a market leader in the decorative paints business, while ICI’s strength in emerging markets would help it increase the percentage of its paints business’s revenue in Asia from 1% to 10%.

Sealing a deal wasn’t easy. AkzoNobel had to increase its offer twice before it was accepted in August 2007. Adding to the intricacies, Henkel, a German chemicals company, agreed to buy ICI’s electronics materials and adhesives units as part of the takeover. But for Nichols, it was the complexity that made the transaction a career highlight. “You don’t do this magnitude of strategic change very often,” he says. “This was reshaping the future of this company.” And reshaping his own career. In November 2007, Rob Frohn announced that he would leave as finance chief to run the chemicals business, and the board offered Nichols the empty seat.

Now for the Hard Part

It’s now that AkzoNobel’s major challenges begin. Although the company couldn’t have foreseen the extent of the economic downturn, it’s clear that there may have been more opportune circumstances in which to overhaul the business.

On the surface, the integration process is going well — in April the company increased the cost savings it expects from synergies in raw-materials procurement, overheads and the like from €280m to €340m. It also brought forward the deadline for achieving these by a year, to 2010. Nichols says there is still “loads left to do” at what he calls the “heavy end” of optimising manufacturing sites and supply and distribution channels. Most of the work will be in mature western markets, he adds, and should generate more cash that can be invested in emerging markets.

Though no strangers to M&A, integration on this scale is unfamiliar territory for AkzoNobel’s current executive team. Indeed, during the six months that he stayed with the company after the takeover, Alan Brown, former CFO of ICI and now CEO of UK business-services group Rentokil Initial, says the AkzoNobel team seemed to be “learning as they went along,” handling issues as they arose rather than “working to a masterplan.”

Nichols agrees that the integration has been a learning curve. “We’re continuously finding bits and pieces where we’re adopting what we see as best practice, be it ours or ICI’s,” he says. For example, when the takeover was announced, analysts commented that AkzoNobel could learn a thing or two from ICI’s strong working capital discipline. “The key difference was that ICI made working capital efficiency a top priority and incentivised people accordingly, whereas we included working capital within EVA [economic value added],” Nichols says. “We’ve learned from this and are putting more focus on working capital specifically, but without letting go of our EVA disciplines.”

Integration aside, the downturn leads to two other tests for AkzoNobel. The first is the slump in M&A activity. AkzoNobel hasn’t sold, as originally planned, ICI’s National Starch, a business which serves the food industry. As Nichols points out, AkzoNobel doesn’t bring “a core competence or scale to manage [National Starch] effectively.” But in October, during an M&A drought and with no buyer in sight, the company announced that the business would stay with AkzoNobel until the dealmaking outlook picked up.

Nichols plays down the move. “In this market, we’re not desperate to sell it,” the CFO says. “For the time being, it gives me more cash flow and additional profitability. We’re not in a distressed, firesale situation.” Maybe so, but given that the point of AkzoNobel’s restructuring was to streamline the company, hanging on to a business it had no intention of running clearly bogs down the plan.

So does the spread of the downturn to emerging markets. Like so many western companies, AkzoNobel has been at pains to point out that its wide geographic spread — emerging markets now account for 35% of revenue and nearly 40% of profits — will help it weather the downturn. But its focus on emerging markets looks shakey now that concerns are being raised about the strength of those economies. For its part, the International Monetary Fund predicts growth in emerging Asia slowing to 7.75% in 2008 and 7% in 2009, from 9.25% in 2007.

Still, Nichols maintains that the emerging markets are “where the real growth will come from” in the long term. Although growth forecasts for China and India are now much lower than they were a year ago, the CFO says that those economies still have an “unstoppable level of internal growth over the medium term,” with “huge infrastructure projects and strong internal demand for some of the chemicals and coatings products we’re producing.” In November the company opened a new manufacturing plant for its coatings division near Bangalore to help increase annual revenue from the region, from €200m currently.

When Flat Is Fine

AkzoNobel has created a lot of work for itself by buying ICI. The irony is that if the company still had the sprawling structure of a few years ago, it might have been better placed to handle the current climate. Philip Bowman, CEO of Smiths Group, a UK industrial conglomerate, recently told reporters he was happy that a delayed restructuring plan meant he was entering the downturn “knowing that not all my eggs are in one basket,” adding that “our mix of businesses makes Smiths better placed than most to resist the pressures of the downturn.” The group’s 2008 revenues and profits both rose from 2007 levels.

But AkzoNobel appears to be rising to the challenge. Its third-quarter results showed that despite a 23% drop in net income due to “one-off” hits, including a loss from selling certain ICI assets to meet antitrust rulings, revenues were up 8% from the same period in 2007. The company expects profits for 2008 to be close to the 2007 pro forma level of €1.87 billion. In a downturn, that kind of flat performance doesn’t look so bad.

Next year will be tougher. As equity analysts at UBS point out, downturns tend to hit the chemicals sector with a delay of up to six months, so 2009 is the “key concern.” A slump in housing markets in countries such as the UK, for example, could limit growth in the paints business. Nichols acknowledges that “signals are very difficult to read at the moment” around growth prospects. “At this stage, the potential severity of the economic cycle is unclear,” he told investors at the last results presentation, adding that AkzoNobel will nonetheless focus on its targets of an Ebitda margin of 14% by 2011 and cost savings of €100m.

Elsewhere, trouble in the financial markets has led the company to put some corporate-finance plans on hold. The board has deferred the final €1.6 billion of a share buyback programme until after it refinances €1.8 billion of bonds that mature by May 2009. “We could never have predicted how this banking crisis has evolved and how paralysed the financial markets would become in late summer,” Nichols says. “You would have thought for a strong investment-grade company this [refinancing] should have just been a routine event.” Instead, with debt markets largely closed, AkzoNobel wants the safety of its own cash to fall back on, although Nichols adds that he is “encouraged” by recent developments in the bond market and is “not too concerned” about the impending maturity.

Muddy Waters

Not all investors share Nichols’ confidence. By late November, AkzoNobel’s share price was at its lowest in more than five years. To what extent the company’s new structure has affected its stockmarket performance is questionable, although Nichols thinks the upheaval of the restructuring and reliance on pro-forma revenues have made it a difficult business to value. “We’ve undergone huge change that has made it complicated for analysts to keep up with and understand,” he says. The CFO hoped a September investor day was “a big step” in giving the market a clearer picture of AkzoNobel. But in an October research note, Credit Suisse said that accounting effects from the acquisition, disposals and restructuring would make “the waters somewhat muddy” and that “market commentators may need some time to analyse [AkzoNobel’s] numbers properly.”

While ICI is integrated and the investment community gets its collective head around the new AkzoNobel, Nichols faces the same uncertain outlook as his fellow CFOs across myriad industries amid the downturn. “The real unknown here is how this is going to develop, so we have to be even better prepared than usual to react and adapt quickly,” he says. “We have experienced people across the three business areas, and their knowledge and understanding, together with our leading positions, strong brands and customer relationships, give us at least a headstart in managing our way through here.” Nichols seems to have convinced himself — now he needs to make sure investors are on board too.

Tim Burke is senior editor at CFO Europe.