Alcoa Seen Unlocking 63% Gain by Separating: Real M&A
Alcoa Inc. (AA), the aluminum producer dragged down by the metal’s price decline, stands to unlock 63 percent in added value for shareholders by splitting itself up.
Alcoa, the 124-year-old seller of metals for use in beer cans and airplanes that plans to release third-quarter results after the U.S. market closes today, slumped about 50 percent in the past 18 months as aluminum prices dropped to an almost three-year low. That left the New York-based company trading at a lower multiple to book value than 94 percent of peers in the aluminum industry, and at a 60 percent discount to its sales, according to data compiled by Bloomberg.
With analysts projecting average aluminum prices during the next three years won’t surpass 2011’s level, Davenport & Co. said Alcoa could boost value by untethering its specialized products such as aerospace studs from its commodity-driven mining and smelting operations. By valuing Alcoa’s four divisions separately, the combined entity would be worth $14.82 a share, 63 percent more than yesterday, according to the average of four analysts’ estimates compiled by Bloomberg. The units that make flat-rolled aluminum sheets and engineered products are together worth more than Alcoa’s entire $9.73 billion market value, said Dahlman Rose & Co.
“The commodity side is what keeps punishing them,” John Stephenson, a fund manager at First Asset Investment Management Inc. in Toronto, who oversees about $2.7 billion including Alcoa shares, said in a telephone interview. Without aluminum processing, the specialized-products business would be a more “profitable company. You have less of a drag on earnings, you have less earnings volatility. That, to me, would be a more sensible approach.”
Libby Archell, a spokeswoman for Alcoa, declined to comment on the company’s valuation and earnings.
Founded in 1888, Alcoa was the first metals producer to develop the process for turning bauxite ore into aluminum, a lightweight metal used in the aerospace, construction, electronics and packaging industries.
Alcoa, formerly known as Aluminum Company of America, is organized into four segments: alumina, which mines bauxite and processes it into the precursor to aluminum; primary metals, which smelts aluminum; flat-rolled products, which makes sheets used in beverage cans as well as airplane wings and car parts; and engineered products and solutions, which makes aerospace fasteners, turbine blades and truck wheels.
Alcoa’s stock lost half its value since its peak last year on April 6, making it the second-worst performer in the Dow Jones Industrial Average (INDU), as aluminum prices declined to a 34-month low in mid-August. Aluminum for delivery in three months on the London Metal Exchange averaged $1,950 per metric ton during the third quarter, the lowest in three years.
The company, typically the first member of the Dow to announce earnings results, is projected by analysts to announce a second straight quarterly net loss after the close of the market today, with breakeven earnings per share. It had net profit of $172 million, or 15 cents a share, in the year-earlier period, data compiled by Bloomberg show.
“The company has done a very good job of operating the business, of controlling the costs,” David Katz, who oversees about $850 million including Alcoa shares as chief investment officer at New York-based Matrix Asset Advisors Inc., said in a phone interview. “Cash flow has been overwhelmed by the weak commodity prices and as a result, their earnings are weak compared to a year ago.”
While falling aluminum prices have hurt results at Alcoa’s alumina and primary metals units this year, profits at the company’s flat-rolled and engineered products businesses have helped offset the declines. These so-called downstream businesses have benefitted from demand by planemakers such as Boeing Co. (BA) as well as automakers, and the units’ earnings power isn’t reflected in the company’s stock price, said Lloyd O’Carroll, a Richmond, Virginia-based analyst for Davenport.
Aluminum prices may average $2,400 per metric ton in 2015, according to the median of analysts’ estimates compiled by Bloomberg, compared with an average of $2,421.20 in 2011.
Alcoa traded yesterday at 0.72 times its book value, 36 percent less than the median multiple among aluminum companies with a market value of more than $1 billion, according to data compiled by Bloomberg. Only Aluminum Corp. of China Ltd. had a lower valuation, the data show. At 0.4 times its revenue in the past 12 months, Alcoa’s price-sales multiple is less than half the median of the group.
With Alcoa’s stock languishing, shareholders may gain more if the company separated its specialized-products divisions from its mining and smelting businesses, according to Jorge Beristain, a Greenwich, Connecticut-based analyst with Deutsche Bank AG.
“Different parts of the business take their turns at underperforming and so the overall holding company doesn’t produce good results,” Beristain said in a phone interview. Given the potential value of the engineered-products division, “why wouldn’t you spin it off and liberate that value?”
Based on the sum of its parts, Alcoa is worth about $14.82 a share, compared with yesterday’s closing price of $9.12, according to the average of four analysts’ estimates compiled by Bloomberg that account for corporate overhead costs while excluding the potential impact of pension liabilities. The lowest of the estimates at $10, from First Asset’s Stephenson, still values Alcoa at an almost 10 percent premium.
Today, Alcoa shares rose 4 cents to $9.16 at 11 a.m. in New York.
Davenport’s O’Carroll, whose sum of the parts values the company at $21.72 a share based in part on his assumption for long-term aluminum prices, said Alcoa could choose to either sever the company into two parts or spin off the flat-rolled aluminum sheets and engineered-products businesses into a separate public entity in which Alcoa retains a majority stake.
Either of these two options would boost transparency and “allow the market to independently value those assets,” O’Carroll said in a phone interview. “It’s simple. It meets market tests.”
Alcan Inc., which was the third-largest aluminum company before it was bought by Rio Tinto Group, spun off its aluminum sheet unit in 2005 to form Novelis Inc. That unit was purchased by Hindalco Industries Ltd. in 2007, the same year that the parent company was taken over by Rio Tinto.
The spinoff helped position Alcan for a sale, and the same strategy could be adopted by Alcoa, O’Carroll said.
If the company were broken up, Alcoa’s smelting and mining businesses may lure bids from commodity companies such as Glencore International Plc (GLEN), O’Carroll said. The engineered-products division is more likely to attract aerospace companies such as Precision Castparts Corp. (PCP) and Boeing or an industrial company such as General Electric Co., O’Carroll said.
Representatives for Precision Castparts, Boeing, GE and Glencore declined to comment when asked whether the companies would consider acquiring one of Alcoa’s divisions or had held conversations with the aluminum producer about a deal.
Alcoa Chief Executive Officer Klaus Kleinfeld said on a Nov. 9 conference call that it makes sense to keep the company integrated because the specialized-products businesses can benefit from being part of a global company with a large and sophisticated purchasing structure, the world’s biggest aluminum technology research center and established customer relationships.
While Beristain at Deutsche Bank said a breakup of Alcoa could unlock value for shareholders, unfunded pension liabilities might make a split more complicated and could undercut the benefit to shareholders. Using a sum-of-the-parts valuation, Beristain estimates that Alcoa is worth $14.22 a share. Taking into account unfunded pension liabilities, that valuation drops to $11.46.
Pension liabilities are “a big overhang on Alcoa’s value,” Beristain said.
Still, even after taking those costs into account, Beristain’s sum-of-the-parts analysis values Alcoa 26 percent higher than its current stock price.
Dahlman Rose analysts Anthony Rizzuto and Joseph Giordano estimated in a Sept. 27 note that Alcoa’s flat-rolled aluminum sheets and engineered products businesses are worth a combined equity value of about $13.9 billion. The analysts wrote that while their analysis “clearly shows the significance of Alcoa’s downstream segments,” the full value of the units is unlikely to be realized in the company’s current form.
“Investors think of Alcoa as a commodity company,” Davenport’s O’Carroll said. “The company’s downstream businesses are growing, profitability is rising rapidly, and they are not being priced properly by the market. So you’re losing value.”
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