How DuPont Spinoff Chemours Came Back from the Brink
When industrial giant DuPont (DD) spun off its performance chemicals division in July 2015, few gave the orphaned appendage much hope. Loaded up with debt and stuffed full of potentially toxic assets—on multiple levels—the new company, re-branded as Chemours (CC), was seen by many investors as a listing garbage scow locked on a one-way course to the bottom of the ocean.
By February, the company’s share price was off as much as 85% from its July listing price. Short sellers were crowing that it was just a matter of time before Chemours was, well, “no mores.”
That didn’t happen.
Chemours’ stock is up nearly 250% since those dark days in February and it looks set to go even higher as the year progresses. The company just beat on its earnings, reporting a profit for the first quarter of the year. It even managed to eke out a dividend, albeit a small one. Analysts who had once written the company off have changed their tune, as have many fund managers.
So what happened? And why was Chemours discounted in the first place? It suffered no Enron-like financial scandal, BP-like industrial accident, or VW-like public relations disaster. No, Chemours, which is a portmanteau of the words “chemistry” and “Nemours” (a reference to DuPont’s full name, E. I. du Pont de Nemours), seems to have fallen victim to bad timing, which led to unrealistic expectations. It was dealt a weak hand by its former parent right from the start, immediately putting its management into an awkward and confrontational position with investors, many of whom had no idea what the company did or where it was going.
While the wind is clearly on its back today, Chemours still faces obstacles, any of which could blow the company off course. But it is safe to say that the company won’t be keeling over anytime soon.
When DuPont’s then-chief executive, Ellen Kullman, announced in late 2013 that the company was spinning off its titanium dioxide (TiO2) and performance chemical divisions from the rest of DuPont, she promised Wall Street that the split would create “two strong, highly competitive companies.” TiO2 is used in everything, from paint to food coloring, to turn a product white. It’s what makes the cream in your Oreo cookie so bright and what gives your toothpaste that almost neon-white color.
DuPont had recently come under fire from activist investor Nelson Peltz, who argued that the company was in need of a shakeup after years of lackluster growth. His entrance on the scene probably had something to do with Kullman’s move to hive off performance chemicals, but it was hardly Peltz’s idea. Analysts like David Begleiter from Deutsche Bank and Mark Gulley from BGC Partners had argued for over a year at that point that DuPont should make the split, as they believed the volatility of the TiO2 market caused DuPont’s stock to trade at a discount to many of its rivals, especially those in the growing agricultural space, like Monsanto and BASF.
But while TiO2 prices were volatile, when business was good, it was very good. Indeed, TiO2 was a cash cow for DuPont in 2013, accounting for around 20% of the massive conglomerate’s bottom line. DuPont was the world’s largest manufacturer of the stuff and was arguably the best at making it as well. Its proprietary TiO2 refining process was more efficient than any of its competitors, allowing for fatter profit margins and stronger pricing power.
Nevertheless, Kullman was determined to smooth out DuPont’s earnings, so the volatile performance chemicals unit had to go. It was decided that it would be spun off to DuPont’s current shareholders in a tax-free deal sometime in 2015. Kullman and her management team at the time noted that no job cuts were in the works for the unit’s 7,500 employees and that it would only be taking on a commensurate share of DuPont’s debts and liabilities, ensuring an investment-grade credit rating. In addition, the new company would pay DuPont a “modest” one-time dividend to compensate it for the split and would be expected to maintain a fat dividend for its own investors of around $100 million a quarter.
All these promises weren’t completely off base when they were proposed at the end of 2013. But 18 months later, when Chemours was set to be spun off, the situation had changed. Thanks to a sluggish economy and cheap Chinese competition, the price of TiO2 had spiraled down to earth.
“The intention at the spin was that TiO2 prices would start migrating back to its midpoint, which, as you know, didn’t happen,” Mark Vergnano, Chemours’ chief executive, told Fortune. “So, right out of the gate, we had some very serious challenges.”
But DuPont moved forward with the spinoff as if nothing had changed. It went ahead and dumped around $4 billion in debt on the new company and then loaded it up with a bunch of legal liabilities—far more than was initially expected. So while Chemours products made up around a fifth of DuPont’s overall sales when it was spun off, it ended up inheriting nearly two-thirds of its environmental liabilities. Pending lawsuits linked to a chemical used in making Teflon, one of Chemours’ biggest products, now sits on its balance sheet like a ticking time bomb, threatening to wipe out millions of dollars from the company’s coffers over the next few years.
And if all that wasn’t bad enough, DuPont also obliged Chemours to pay out that huge $100 million dividend at the conclusion of its first quarter as a public company. This created the expectation that Chemours would continue paying a huge dividend every quarter thereafter, which was basically impossible given the continued weakness in the TiO2 market.
DuPont declined to offer a comment concerning Chemours and the events surrounding the spinoff.
This was what Vergnano inherited when he officially took over as CEO of Chemours last summer. Largely unknown outside of the performance chemical world, few investors predicted Vergnano could keep Chemours afloat. He not only had to fight the perception that the company was unsalvageable, he also had to give the market hope that he could actually grow the company’s earnings, even if TiO2 prices remained depressed for some time.
So, it’s no wonder that Chemours had a rough start. Its stock tumbled right out of the gate as analysts immediately said there was no way the company could keep its dividend in the face of weakening TiO2 prices, which continued to fall throughout 2015. The weakness in the TiO2 market hit Chemours’ earnings badly, sending the company’s leverage ratio to around 5.5 times revenue and later to 6.5 times revenue. The company, which was promised an investor grade credit rating, was immediately junked by the credit rating agencies. Those risk-averse and dividend-loving DuPont investors who had inherited Chemours stock began to dump it, accelerating the decline in the company’s share price.
“You had this high dividend put on us as well as all this debt while TiO2 prices were coming down, and the high-yield market was dead,” Vergnano said. “So I think investors were worried if we were going to be solvent – were we going to make it through this or not?
“We immediately went out to explain our transformation plan to investors and while I think people ‘got it,’ they still were going to wait for at least one quarter to see if we [the new management] could really deliver. They wanted to know if these were the old DuPont guys, who made promises but didn’t keep them, or if this was a team who could really deliver what they say, when they said it.”
Vergnano and his team had to stabilize the situation before it spun further out of control. But given how dependent Chemours was on TiO2, it meant that the company would need to slash costs and ditch its dividend so it could calm any solvency fears.
“So right from the start we put together what we called our ‘five-point transformation plan,’ which was all about getting the company de-levered as quickly as possible,” Vergnano said. “We immediately set out to reduce our $2.4 billion cost base by $350 million. At the same time, we would be growing our market share across all our business lines and divesting assets that we inherited from DuPont but which really didn’t fit for us.”
Chemours delivered, and then some. Vergnano and his team moved quickly, performing more like private equity turnaround specialists trying to close a deal as opposed to staid corporate executives – especially those working in sleepy Wilmington, Delaware. Since it was spun off, Chemours has slashed expenses, reduced headcount, renegotiated supply contracts, and sold off non-essential business lines – all while meeting the company’s debt obligations and winning market share for its refrigerant and TiO2 business lines. It sold off its clean and disinfect unit to LANXESS for around $240 million and essentially returned its aniline business to DuPont, when it sold it for $140 million to Dow Chemical, which is now acquiring its former parent. They also put the company’s sulfur business on the block and shut down its unprofitable reactive metals unit.
Chemours achieved $100 million in cost savings in 2015 alone and expects double that in 2016. And despite the continued weakness in the TiO2 market, the company was able to raise the price of its TiO2 product this year, not once, but twice, proving that it still yielded considerable pricing power in the market. Vergnano also convinced DuPont to agree to cancel certain payments Chemours was required to make as part of the breakup agreement, reducing the size of its liabilities by $250 million. He also got DuPont to advance Chemours $190 million for goods and services set to come due over the next 15 months.
Vergnano said that while DuPont may have hastily tossed Chemours into the deep end of the pool, it wasn’t going to let it drown. The quick footwork by Vergnano, combined with DuPont’s support, has put to rest concerns over the company’s solvency. which has allowed its stock to bounce back from its lows. To be sure, it isn’t all sunny in Wilmington. Chemours was still forced to slash its dividend – announcing a 3 cent per share payout in the fourth quarter, down significantly from the 55 cents per share mandated payout in the preceding quarter. Chemours says it is determined to boost the dividend in the future, but it has been cagey about when that might happen.
The austerity measures have kept the ship afloat, but Chemours has to do more if it wants to set sail. It needs to grow. With TiO2 prices still in the dumps, Vergnano acknowledges that Chemours’ growth will need to come from elsewhere. Earlier this month, the company announced that it was investing nearly a quarter-of-a-billion dollars to triple production of its new refrigerant, Opteon. It cools similarly to Freon but does it without emitting greenhouse gases, giving it a much lower global warming potential (GWP). Chemours and Honeywell are the only two companies with the license to make low GWP refrigerants, giving them both significant pricing power in the years to come. The auto industry will be the first to use Opteon on a large scale. New, stricter emission standards are now being mandated in Europe, forcing automakers to switch refrigerants to one with a low GWP, which Vergnano claims will be a boon for Chemours.
“In 2017, this will be worth $100 million in earnings for us, just from this one refrigerant,” Vergnano said. “Most TiO2 producers are one-trick ponies, but we have another whole other side of our company that is in growth mode.”
Vergnano says Chemours has secured contracts with all major car manufacturers around the world and that its Opteon production is sold out over the next two years. The company estimates that 40 million cars will be using Opteon by the end of 2017, growing to 140 million by the end of 2020. Low GWP refrigerants will be mandatory for vehicles in the U.S. starting in 2021, opening up a huge new market for Opteon. But the big growth will come if (or when) regulators force appliance makers to follow suit and switch to a low GWP refrigerant, like Opteon. The market for refrigerators and air-conditioners is eight times what it is for the auto market, so there is big potential. The company predicts that 1,000 supermarket and commercial refrigeration systems worldwide will be using Opteon by the end of 2016, growing to as many as 10,000 systems by the end of 2020.
Vergnano will continue hitting the road and speaking with fund managers and analysts about the company’s growth plans, helping to assuage any leftover fears or misconceptions about Chemours. But he seems relieved, as if the worst is behind the company now.
“With TiO2 prices stabilizing, investors are now feeling that the bottom is behind us,” Vergnano said. “It’s not clear how high this can go, but … we are expecting some good things.”
The company’s stock trades at around $10 a share. While that is still 50% below where it traded when it was first spun off last summer, it is still a significant comeback from its lows this winter.
The market no longer values Chemours as if it is going under, but it still trades at a discount to its peers, creating an entry into the stock for those who missed the recent rally. But investors will have to move quickly. If Vergnano and his team continue firing on all cylinders, that value gap will surely vanish soon.