Trian Fund Management LP won’t stay quiet any longer. After investing over a billion dollars in E I Du Pont De Nemours And Co (NYSE:DD) in early 2013, the fund now holds a roughly $1.6 billion stake in the 212-year old chemical giant based in Delaware. That stake represents roughly 3% of the company’s stock and has Trian firmly entrenched as a top-10 stockholder.
Trian is one of Wall Street’s most successful activist interests and has been calling on the company privately to split-up its seven major business lines that it believes are suffering from a an overly complex corporate structure. Now, Trian is promising to to take its fight with the DuPont hierarchy public while seeking support of other investors according to a letter that it sent to to DuPont’s board on Tuesday. The letter was confirmed and reviewed by David Benoit of The Wall Street Journal.
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Dupont – Be smart, be two companies
Trian likes to throw its weight around and has successfully done so with Ingersoll-Rand and Kraft Foods. The fund’s argument with DuPont is similar to the one it had with the aforementioned companies; it simply wants to see DuPont to create a single public company comprised of its faster-growing segments and another that generates strong cash flows. In the case of DuPont, that would mean one company made up of its agriculture and nutrition businesses and another led by specialty-chemical products, namely its Tyvek construction materials and Kevlar body armor.
DuPont claim it has a “constructive dialogue with Trian” and that it wishes to “enhance value for all DuPont shareholders,” that however doesn’t jibe with Tuesday’s letter that Trian sent to its board.
Trian presently enjoys the support of the California State Teachers’ Retirement System, or Calstrs, who has cosigned other letters to DuPont’s board and holds a $250 million stake in the company.
Last October, DuPont agreed to spin-off of its “performance chemicals” division but that’s not enough for Trian. “These actions are not moving the needle,” Trian co-founder Nelson Peltz said in an interview. “It’s not dealing with the problem.”
Dupont – Potential proxy battle for representation?
Trian continues to argue that DuPont is a dinosaur and overburdened with corporate red tape and is looking to cut somewhere between $2 billion and $4 billion in annual costs while allowing the separated units to excel on their own. Ed Garden, co-founder of Trian and chief investment officer has called DuPont’s portfolio “overly complex.”
Despite claims that DuPont listens to Trian, the company has repeatedly declined to grant the fund board representation. The latest instance of the fund being rebuffed came in June when DuPont lowered its full-year guidance.
While Trian execs suggest that the company is not afraid of a proxy battle for board representation, it will face an uphill battle to win over major shareholders. Since Chief Executive Ellen Kullman took over the chemical giant in 2009, the stock is up roughly 160%, a gain that outpaced the S&P 500 stock index over the same time period.
Dupont – Deutsceh Bank
In a September 17th 2014 research note, analysts from Deutsche Bank lend merit to both sides, noting:
We believe Trian has a strong case with respect to its break-up proposal as DuPont has, in our view, done a poor job of quantifying the benefits / synergies of having its Ag, Nutrion & Health, Industrial BioSciences businesses in the same portfolio as its Materials businesses. That said, we believe Trian faces an uphill battle in getting its plan approved. In DuPont’s favor are a number of actions over the past 3 years that have substantially improved the company and the share price.
The full letter from Trian has been posted by WSJ, readers can find it below.
TRIAN PARTNERS DELIVERS LETTER AND WHITE PAPER SUMMARY
TO DUPONT BOARD
Says Conglomerate Structure Is Destroying Shareholder Value;
Suggests Initiatives It Believes Can Double Share Value In Three Years;
Plans To Meet With DuPont Shareholders
NEW YORK, September 17, 2014 – Trian Fund Management, L.P. (“Trian”), whose investment funds beneficially own approximately $1.6 billion of the outstanding shares of E. I. du Pont de Nemours and Company (NYSE: DD), today said it has sent a letter to DuPont’s Board of Directors analyzing how DuPont’s conglomerate structure is destroying shareholder value. The letter and accompanying White Paper Summary also detail initiatives DuPont should take that Trian believes could significantly improve DuPont’s financial performance and double the value of its common stock within three years. Trian plans to meet with DuPont shareholders to present its analysis and strongly recommends that the DuPont Board meet shareholders without management present to hear their views.
Trian’s letter to the DuPont Board is below (Dupont has already responded and their response can be found here).
September 16, 2014
By Federal Express and email c/o [email protected] The Board of Directors
c/o Corporate Secretary DuPont Company 1007 Market Street D-9058
Wilmington, DE 19898
Dear Members of the Board:
Investment funds managed by Trian Fund Management, L.P. (collectively, “Trian”) currently beneficially own approximately $1.6 billion of the outstanding shares of E. I. du Pont de Nemours and Company
(“DuPont” or the “Company”), making Trian one of DuPont’s largest shareholders.
As you know, Trian has engaged in a private dialogue for more than a year with DuPont’s management and the Lead Director regarding specific initiatives we believe can significantly improve the Company’s financial performance. While we applaud the announced spin-off of Performance Chemicals, the Fresh Start initiative and the $5 billion share buyback authorization, we believe strongly that, by themselves, these moves are not enough to optimize shareholder value. We would have preferred to continue working privately with management and the Board, but it is now clear that the Board is not willing to hold management accountable for continuing underperformance and repeated failures to deliver promised revenue and earnings targets. Therefore, we can no longer be silent as DuPont continues to struggle to execute what we are convinced is a flawed business plan, especially as we have a solution that we believe could double the value of DuPont’s shares over the next three years.
Trian believes the reason for DuPont’s persistent underperformance is very simple: DuPont’s conglomerate structure is destroying value. Even after the spin-off of Performance Chemicals, which is expected to be completed in mid-2015, DuPont will remain an inefficient conglomerate characterized by:
- Excessive holding company costs – we estimate $2 to $4 billion of excess corporate costs including $1
billion of publicly disclosed unallocated corporate expenses (corporate expenses include the maintenance of a country club, a 1,252-seat theatre and a 217-room hotel).1
- Disparate businesses and overwhelming complexity have rendered the management team incapable of meeting its own guidance.
- Bureaucracy and a lack of accountability have led to below-peer organic revenue growth and margins in most segments.
- An inefficient capital structure limits total shareholder returns (TSR) over time.
- A persistent conglomerate discount because it is neither a pure-play growth company, nor a cyclical recovery play nor a capital return story. Importantly, it fails to deliver low EPS volatility and strong EPS growth, the fundamental rationale for a conglomerate.
The conglomerate structure and resulting inefficiencies have led to subpar financial performance and low management credibility. Listed below are just some of the major missteps shareholders have endured:
- In 2012, DuPont announced the sale of its Coatings business to private equity. At the time, Coatings generated $339 million of EBITDA (earnings before interest, taxes, depreciation and amortization).
Today, that same business (now called Axalta) generates $813 million of EBITDA, an improvement of 140% as the private equity owners have reduced unnecessary costs.2
- In August 2014, Axalta’s private equity owners filed an S-1 to take the company public. The Axalta S-1
discloses that pro forma EBITDA in 2011 was $568 million, $229 million (or 67%) higher than the $339 million originally reported by DuPont in the same year.3 This implies that DuPont burdened the Coatings
segment with $229 million of excess corporate costs in 2011 (representing over 5% of Coatings sales at the time).4
- DuPont transferred wealth to private equity owners by selling Coatings instead of spinning it off to
shareholders tax-free. In 2013, DuPont received after-tax cash proceeds of $4 billion, or $4.37 per share, for the Coatings business.5 Trian believes a standalone Coatings business would be worth $11.79 per
share if Coatings had been spun-off tax-free, achieved the same operating improvements that private equity has executed (i.e. was run efficiently), and traded at a peer multiple.6 In effect, DuPont transferred $7.42 per share or $6.8 billion to private equity investors at the expense of its shareholders.
- In 2011, DuPont paid 12.2x EBITDA for Danisco which was intended to provide more growth to the portfolio.7 Since the acquisition, Danisco’s organic revenue growth has declined by one-third and
margins are approximately half of what they were in 2010 (pro forma for claimed synergy realization of $130 million and portfolio composition).8
- Since 1998, DuPont has been in a state of perpetual transformation – having divested or separated
businesses generating more than $40 billion of revenue and acquired businesses generating nearly $12 billion of revenue – yet 16 years later, the stock price has declined 21% from its 1998 peak.9
- Earnings are down since 2011. 2014 earnings per share (EPS) are now expected to be $4.05, down from
$4.32 in 2011, despite spending ~$11.6 billion on net investments during the same timeframe excluding net capital invested in mergers and acquisitions (M&A) of $1.7 billion.10 Management has failed to achieve its target of 12% long-term EPS growth.11
- Management is unable to forecast the results of the business. In June 2014, DuPont lowered and/or missed earnings guidance for the third consecutive year.12
- After failing to achieve long-term operating targets presented at its 2011 Investor Day, DuPont lowered targets in six of seven segments at its 2013 Investor Day.13
- DuPont’s organic revenue growth and margins, the operating metrics that ultimately determine success or failure, trail peers in five of seven segments.14
- DuPont management has resorted to “manufacturing” earnings to meet guidance. In 2013, non-operating
benefits contributed 27 cents of headline EPS. Such benefits include a pull-forward of seed sales, one-time investment gains and lower-than-expected taxes.15
- During current management’s tenure (since 2009), “significant items” (defined as one-time earnings
“addbacks” according to the Company) have totaled $2.3 billion, increasing headline EPS by ~8% per annum on average.16 Addbacks, which are not extraordinary when they occur every year, have averaged $663 million annually over the past three years (2011-13).
- DuPont has significantly underperformed diversified chemical companies and industrial conglomerates in TSR and EPS growth over virtually all time frames.17
As we have discussed, we believe DuPont should implement the following strategic and operating initiatives
(the “Trian Initiatives”) to optimize long-term value for shareholders:
- Separate DuPont into GrowthCo (Agriculture, Nutrition and Health, Industrial Biosciences) and CyclicalCo/CashCo (Performance Materials, Safety and Protection, Electronics and Communications), in addition to the announced separation of Performance Chemicals
- Commit to the elimination of unnecessary holding company costs, the implementation of zero-based budgeting, and a timeframe for best-in-class revenue growth and margins in each business, by segment
- Commit to a shareholder-friendly capital allocation policy at the low-growth and highly cash generative CyclicalCo/CashCo and a prioritization of high return on invested capital (ROIC) organic growth initiatives at GrowthCo
- Implement the following corporate governance initiatives:
- Put an end to extraordinary charges (or “significant items”)
- Commit to best-in-class transparency and consistency of reporting
The Trian Initiatives will eliminate the inefficient holding company structure by creating two autonomously-managed businesses (three including Performance Chemicals). The separation is a means to an end as we believe it will significantly increase the probability that the individual businesses eliminate the significant operational performance gap versus peers (see a detailed explanation in the attached summary of our White Paper) and achieve a valuation multiple re-rating. The Coatings case study shows us the profit potential of DuPont if it was managed efficiently. Accordingly, the primary driver of value creation in our financial model is operational improvement, not a simplistic sum-of-the-parts. We believe the Trian Initiatives have the potential to double the value of DuPont’s stock over the next three years.
DuPont represents one of the largest positions in our portfolio and we have recently increased our position. Trian has a strong vested interest in the future of the Company’s businesses. We take pride in our reputation as a long-term shareholder with a proven history of working constructively with boards and management teams to implement value added strategic and operating initiatives. We have discussed adding a Trian
representative and an industry-insider to the Board with you to ensure that shareholder perspectives are adequately represented, yet that idea has been summarily rejected. Therefore, we will begin to meet with other shareholders to present our White Paper and discuss our views. Ultimately, the shareholders will decide the right path forward for DuPont. In addition, we will continue to closely monitor DuPont’s performance – and we strongly recommend that instead of dismissing our initiatives, Board members meet shareholders without management present to learn their views. We believe such a dialogue would be enlightening and provide the Board with a valuable new perspective.
At many underperforming companies, the management team has an “information advantage” and board members are apt to unknowingly defer to management’s rhetoric. We have reviewed DuPont’s presentation titled “Leveraging Good Governance and Strategic Vision to Build a Sustainable Future” dated September 2014 which claims the leadership team “outperformed peer firms in total shareholder return, operating EPS growth,” “exceeded management’s financial targets,“ “achieved operational and cost productivity objectives,” improved margins “by 540 basis points” and “successfully integrated Danisco.” In order to assist you in discerning rhetoric from reality, we are attaching a summary of our White Paper which provides more information regarding our analysis of DuPont’s value-creation potential. We remain willing to engage in discussions with you at any time.
Very truly yours,
|Nelson Peltz||Peter May||Ed Garden|
|Founding Partner &||Founding Partner &||Founding Partner &|
|Chief Executive Officer||President||Chief Investment Officer|
Matt Peltz Brian Jacoby
Partner & Senior Analyst Partner & Senior Analyst