PPG Industries, Inc. (NYSE:PPG)’ decision to keep itself together at the conclusion of a strategic review has raised the question of whether Trian Partners, which advocated a breakup, will become more aggressive in pursuing its demands. Trian decided to hold fire at the beginning of the year after the company committed to corporate governance changes, a review of a breakup, and operational targets such as sales growth of 3%-5% and adjusted earnings per share growth of 7%-10%, connected to CEO pay.
In addition to a split, Trian sought the replacement of current CEO Michael McGarry with former chief Chuck Bunch, an improvement in PPG’s capital structure efficiency, and an enhancement of its governance profile. None of these recommendations have been implemented hitherto. PPG prefers gradual adjustments instead of abrupt change.
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The "nothing sacred" portfolio evaluation conducted separately by Morgan Stanley and Goldman Sachs concluded that a split of the architectural and industrial coatings businesses will "likely create potential meaningful dissynergies, incremental costs, and potential tax leakage." McGarry later clarified the chief reason for the decision was the loss of synergies. However, the company did say that it will divest smaller businesses that do not meet its "profitability objectives" and unveiled a new cost-cutting program aimed at delivering $125 million in savings.
On a subsequent conference call, McGarry said "zero" shareholders were informed about the company’s decision prior to the official announcement, meaning that it came as a surprise to Nelson Peltz’s Trian. The results of the review contradict the activist’s thesis, which said two separate pure-play businesses would have more focus and the ability to pursue consolidation in their fields, leading to an increase in earnings per share. Trian said the current synergies could be dwarfed by improved operational performance as a result of the breakup.
Yet there is reason to believe Trian may have changed its mind. Frank Mitsch, an analyst at Fermium Research, wrote in a note to clients that the review concluded as "expected." Mitsch said PPG’s current strategic configuration is craved by its competitors, noting that Sherwin-Williams’ acquisition of Valspar for $11.3 billion in 2016 was "an attempt to look more like PPG." Similarly, Akzo Nobel’s 2017 failed pursuit of U.S.-based Axalta would have created a combined entity with a strategic configuration akin to PPG, Mitsch contended.
The company also said no other global industry players separated architectural from industrial coatings, noting that it only saw "evidence of increasing participation in both." Indeed, consolidation seems to be the main theme in the global coatings industry. Charlie Shaver, former Axalta CEO and the current CEO of Akzo’s specialty chemicals business, said in August 2018 that the industry will see mega-deals over the coming years, while the leading players will continue to make medium-sized acquisitions.
McGarry seems to have a similar belief and continues to long for a big deal, after he was spurned by Akzo in 2017 in a highly contentious hostile takeover in which he had the support of Elliott Management, the Paul Singer-led hedge fund that invested heavily in Akzo and fiercely pushed for a combination. If it had been successful, the Akzo combination would have made PPG the number one global coatings player again after it lost the crown to Sherwin-Williams in 2016. On the call, McGarry said he has not ruled out a large merger, saying he would be willing to "stretch" the company’s balance sheet capacity for a "really good acquisition." Otherwise, he said he would like to keep the company’s indebtedness low to maintain its credit rating.
Any large transaction will likely have to be approved by Trian, which may not endorse one at any cost. McGarry’s hostile bid on Akzo, as part of which PPG increased its offer three times, has put off the activist, which described the move as "ill-advised" and blamed the pursuit of the Netherlands-based company for the loss of Lowe’s as a key customer.
PPG’s leverage may be a point of contention. Although PPG’s long-term debt has increased in 2018 from $3.9 billion to $4.6 billion in the first quarter of 2019, its leverage is still well below peers. PPG’s current debt is less than two times its EBITDA, compared with Sherwin-Williams’ four times. Trian hailed an increase in leverage closer to peers as a potential avenue for value creation.
Nor has Trian received any concessions on corporate governance yet. Management put forward proposals to declassify the board and remove the supermajority voting standard, but the 80% of outstanding shares approval threshold has proved an insuperable hiccup for years (around 99% of the shares cast voted for the resolutions in 2019), in what appears to be a Catch-22 situation. PPG has hired a proxy solicitor to improve the turnout next year.
The next event to watch is PPG’s second-quarter earnings, likely to be announced in mid-July. Pressure on management to deliver on earnings-per-share growth is high, after in the first quarter it reported a drop of nearly 3% compared to the same period last year, although it beat expectations. Trian is likely waiting on the sidelines.
Gatemore Capital Management disclosed a 3.8% stake in U.K. wine specialist Majestic Wine, and is pushing for a breakup behind the scenes, Activist Insight Online understands. Gatemore, the Liad Meidar-led fund known for its campaigns at DX Group and French Connection, believes the company should separate its subscription-based wine retailer from its classic retailing operations consisting of roughly 200 stores, contending there are few synergies between the two units, according to a source. On May 21, the company confirmed press speculation that it is considering a sale of its traditional retail business, earning Gatemore’s applause. The news represented a marked shift in strategy, after in March the company said it planned to transfer resources from its retail operations to the subscription service Naked Wines, a plan that was not supported by Gatemore.
Quote of the week comes from the investor group consisting of Legion Partners Asset Management, Macellum Advisors and Ancora Advisors, which settled with Bed Bath & Beyond for four seats following an intense campaign. The agreement comes after the company dismissed its CEO and replaced five directors, which together with the new additions resulted in wholesale change.
"We are pleased to have reached this resolution with Bed Bath & Beyond, which is the result of collaborative dialogue and intensive engagement with the company. Together with the existing board members, these four new independent directors will help the company navigate the current omnichannel retail environment and pursue our shared goal of enhancing shareholder value. We are optimistic about the company's efforts to find a best-in-class CEO to drive shareholder value and applaud the board's commitment to building an even stronger future for shareholders, customers, associates and other stakeholders."