WR Grace Diversification Case



When Grace “tried scores of businesses” they were seeking value through which diversification scheme from exhibit 6.2 on page 182?
Why are conglomerates valued at a 10% discount to single business firms?
What are some of the minuses to splitting up, in value chain terms?
What data does the case offer about the cost of individual diversification vs the cost of company diversification?
Grace is claiming which of the three objectives for divestment?
What managerial motive was eroding value creation for WR Grace?
W.R. Grace: The End of an Empire

Activists Want Their Companies Smaller and Smaller; The Final Break-Up for a Conglomerate of Yore

James R. Hagerty

Feb. 11, 2015

Founded in 1854, W.R. Grace & Co. took more than a century to find its place in the business world.

Grace and its predecessor companies tried scores of businesses—grinding bones and oyster shells into fertilizer, operating steam ships, banking, breeding cattle, and running kidney-dialysis centers—before concentrating on chemicals over the past two decades.

Now the Columbia, Md.-based company has settled on a strategy with an even narrower focus. Last Thursday, it announced a spinoff plan that would split Grace into two firms—one making catalysts used in oil and chemical refining and the other producing chemicals used in cement and concrete.

The change put Grace in tune with investors’ current preference for purer plays. “The time is right to create two strong, independent companies,” Grace’s chief executive, Fred Festa, said Thursday, and the share price closed up about 12%.

Over the past few years, companies including BHP Billiton PLC, Hewlett-Packard Co. and DuPont Co. have announced plans to narrow their focus by shedding assets in various ways. ITT Corp. split off two businesses in 2011, and shareholders have generally done well as a result. Shares of the surviving ITT and one of the new companies, Exelis Inc., more than doubled in the three years through 2014, while the third company, Xylem Inc., was up 48%. The S&P 500 index rose 64% in that period. On Friday, Exelis shares jumped 36% after Harris Corp. agreed to buy the company for $4.56 billion.

‘The time is right to create two strong, independent companies,’ says Fred Festa, CEO of W.R. Grace.

In many cases, activist investors have pushed breakups. Trian Fund Management LP, for instance, is prodding DuPont to split itself into three firms. But Grace’s Mr. Festa said he hasn’t had such pressure.

On a global basis, conglomerates last year were valued at an average 10% discount to single-industry firms, compared with a 5% discount three years earlier, according to Citigroup’s financial-strategy group.

Old-style conglomerates are unlikely to return to favor, but there are limits to how narrowly a firm should focus, said Peter Tague, co-head of global mergers and acquisitions at Citigroup in New York. A slump in the one niche served by a company could spell big trouble. “Diversification among closely related businesses makes sense,” Mr. Tague added.

John Roberts, an analyst at UBS in New York, estimates Grace’s separated catalyst firm should trade at about 22 times earnings and the construction-materials firm at 19 times. When they were together, Mr. Roberts said, investors missed some of the potential. Before the announcement, Grace shares were trading at 17.5 times forecast earnings for 2015.

The 55-year-old Mr. Festa began his career with 12 years at General Electric Co. and later was an executive at AlliedSignal Inc. From those experiences, he got used to the power that comes from large scale. But he has also worked for a private-equity firm, and he ran a company with just one line of business, providing outsourced procurement services. He liked being able to make decisions fast, he said.

Mr. Festa, who plays hockey in a league for players over 50 and owns a minor-league hockey team in Greenville, S.C., said in an interview that his latest strategic move shows Grace is back at full strength after a long spell in the penalty box.

When Mr. Festa joined Grace in 2003, the company was two years into a 13-year purgatory in Chapter 11 forced by asbestos liabilities. He had no thoughts then of a breakup. “We had to be strong,” he said. “We had to demonstrate the financial prowess we had.”

After Grace emerged from Chapter 11 a year ago, he began to rethink his strategy. He noticed that 75% of the questions during analyst calls were about the catalyst specialty-chemical business. No one seemed much interested in the packaging sealants, cement additives and other construction-related products, so he figured the market might be undervaluing them.

He was also frustrated when the company was choosing new software to process orders from customers. Different parts of the business wanted different types of software. The process dragged on, heading toward a compromise that pleased no one.

“I went back to my office and said, ‘My gosh, if each one could pick their own, we’d have it done by now.’”

Last summer, Mr. Festa began sounding out colleagues about the possibility of a split. He recalls thinking: “Am I crazy? Am I thinking about this right? You get a lot of blank stares and other reactions.”

One obstacle to overcome was ego, he said: “You challenge yourself and say, ‘Why can’t I just keep these two businesses together and run them both?’” On the other hand, splitting allowed him to keep the top job at the core catalyst business and give his No. 2, Gregory Poling, a 38-year Grace veteran, the CEO post at the spinout.

Other possible minuses are some loss of the benefits from scale in purchasing and less bulk to attract the attention of analysts and investors. But Mr. Festa doesn’t expect those to be real problems.

In October, he took the split idea to the board and got an agreement to proceed.

There could be some downside ahead. If credit becomes scarce again, companies with more financial heft and diversity may have an advantage shielding themselves against downturns. The two newly focused companies may also have choppier results because they are tied to fewer markets.

Citing the potential for “slightly higher” earnings volatility, Standard & Poor’s Rating Services cut Grace’s credit rating Friday by one notch to BB-plus, just below investment grade.

The construction side will be subject to a market known for causing whiplash. Partly to deal with that, Grace is preserving a bit of the old diversity: Construction-related chemicals have been combined with a steadier, unrelated business making sealants and coatings for metal cans.

So far, Mr. Festa has run into only one sign of discontent. His son, Kyle, a student at the Naval Academy in Annapolis, called to say, “Dad, why did you split up the company and give up your power?”


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