By James R. Hagerty
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.
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?"
Write to James R. Hagerty at bob.hagerty@wsj.com
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