D.E. Shaw, Mantle Ridge zero in on key fixes to build shareholder value at Air Products

Enterprise: Air Merchandise and Chemical substances is an industrial gases firm. It is targeted on serving power, environmental and rising markets. Its base enterprise supplies important industrial gases, associated tools and purposes experience to clients in dozens of industries, together with refining, chemical substances, metals, electronics, manufacturing and meals. Air Merchandise additionally develops, engineers, builds, owns and operates clear hydrogen tasks supporting the transition to low- and zero-carbon power within the heavy-duty transportation and industrial sectors. As well as, it supplies turbomachinery, membrane methods and cryogenic containers globally. Air Merchandise has operations in roughly 50 international locations.

Inventory Market Worth: $73.83B ($332.10 per share)

Share Possession: n/a

Common Price: n/a

Activist Commentary: D.E. Shaw is a big multi-strategy fund that’s not traditionally recognized for activism. The agency is not an activist investor, but it surely makes use of activism as an opportunistic instrument in conditions the place it thinks it might be helpful. D.E. Shaw seeks out strong companies in good industries, and if the agency identifies underperformance that’s inside administration’s management, it is going to take an lively function. The investor locations a premium on personal, constructive engagement with administration. Because of this, it usually involves an settlement with the corporate earlier than its place is even public.

D.E. Shaw has reached out to Air Merchandise’ board. The agency proposed that the corporate take varied steps to boost shareholder worth, together with bettering capital allocation, refreshing the board and restructuring govt compensation.

Air Merchandise supplies industrial gases and associated tools in end-markets resembling refining, chemical substances, metals, electronics, manufacturing and meals. The corporate’s industrial gasoline enterprise is extraordinarily steady and low threat, functionally a risk-free, inflation-protected, senior secured bond when the enterprise is saved pure. The character of the enterprise is that the corporate enters into long-term 15- to 20-year “take or pay” contracts with clients which have very excessive renewal charges exceeding 95%. The enterprise is principally resistant to financial cycles, contracts are inflation-protected, and the oligopolistic trade has large obstacles to entry. These long-term contracts functionally assure an unlevered double-digit return earlier than Air Merchandise even must put a greenback into the bottom. When unadulterated and dedicated purely to its core enterprise, this can be a fantastically steady and well-valued enterprise.

Nonetheless, whereas the corporate was targeted by itself operations, it missed out on a wave of consolidation within the trade. In 2016, Air Liquide finalized its buy of Airgas. In 2018, Linde and Praxair accomplished a merger of equals. Earlier than Air Merchandise knew it, the corporate was the odd man standing, and it was standing on their own. CEO Seifi Ghasemi’s enlargement answer, having missed out on combos with pure-play friends, has been to pursue non-core enterprise enlargement. Departing from its longstanding technique within the conventional industrial gasoline enterprise mannequin that generates reliable capital returns, the corporate has moved up alongside the chance curve in direction of extra speculative investments with out locked-in income by means of a number of clear hydrogen mission investments. Throughout 5 investments — probably the most notable of which being the Air Merchandise’ NEOM Saudi Arabia inexperienced hydrogen mission and its Louisiana blue hydrogen mission — the corporate expects to spend almost $12 billion of capex. When initially deliberate, Air Merchandise didn’t have offtake agreements — agreements with patrons to buy its future choices — for 4 of the 5 tasks (solely 6% of capability had offtake agreements). At this time, over 80% of mission capability stays uncontracted.

This can be a good instance of “di-worsification.” Traders recognize corporations like Air Merchandise for his or her low-risk and extremely steady cash-flowing operations. Whatever the efficacy of those non-core companies, the everyday risk-averse buyers which were traditionally interested in corporations like Air Merchandise are going to flee when the chance profile modifications. Furthermore, buyers with a bigger urge for food for threat who is likely to be interested in companies like NEOM or the Louisiana mission, are much less more likely to put money into it when it’s diluted by a low-risk, steady enterprise like Air Merchandise’ core industrial gasoline companies. Additional, issues aren’t helped by the truth that friends Linde and Air Liquide have been capable of execute on hydrogen tasks with secured offtake agreements in place pre-construction and have targeted on partnerships according to its low-risk conventional enterprise mannequin.

On account of its funding in these speculative tasks, Air Merchandise’ capex as a p.c of gross sales has greater than doubled over the previous 5 years and is roughly four-times increased than its peer common. The corporate’s free money circulate conversion has turned unfavourable whereas friends are averaging 92% since 2016. Additional, its return on capital employed is shifting inversely in comparison with friends. Whereas administration thinks that being a primary mover in inexperienced and blue hydrogen and shifting up the chance curve ought to be rewarded with the next a number of and inventory worth, buyers clearly disagree. Air Merchandise has underperformed its friends and related benchmarks over functionally each related time-frame previously ten years and is buying and selling at a 20% low cost.

Now, D.E. Shaw has taken an approximate $1 billion stake in Air Merchandise and has taken its engagement public after initially reaching out to the corporate over a month in the past and presenting its value-enhancing plan to administration on Oct. 2. D.E. Shaw will sometimes go public with a marketing campaign after a decision has been reached with the corporate, however the agency has encountered some resistance to engagement right here. It put ahead a seven-point plan to enhance worth on the firm, targeted on a revised capital allocation framework and company governance. Starting with capital allocation, D.E. Shaw is urging the corporate to de-risk its current massive mission commitments by signing offtake agreements at cheap return hurdles, as their friends have been capable of do. As well as, in gentle of Air Merchandise finalizing one other massive hydrogen mission in Texas with out current offtake agreements in place, the agency calls for that the corporate decide to tying future capital funding to offtake settlement milestones. Moreover, D.E. Shaw needs the corporate to restrict annual capex to $2 billion to $2.5 billion past 2026, with a particular goal of capex to not exceed the mid-teens as a p.c of Air Merchandise’ income. The agency additionally argues that the corporate ought to instantly repurchase its discounted shares as much as its three-times goal web leverage ratio in fiscal 12 months 2025 and direct future extra free money towards extra repurchases.

The second a part of D.E. Shaw’s marketing campaign pertains to company governance, particularly, succession planning for CEO Seifi Ghasemi. At about 80 years outdated, he has been serving within the function for a decade. Ghasemi was given a five-year extension in 2020 and it was renewed in 2023 on an evergreen foundation. There seems to be no formal succession plan in place, solely obscure commitments to a seek for an skilled former CEO of a public firm. Air Merchandise’ COO Samir Serhan formally left the corporate on the finish of September, eradicating a high quality inner candidate. There are questions on what viable candidate would wish to be a part of the corporate if Ghasemi primarily has an indefinite contract. To not point out, his compensation over the previous 5 years of $87 million is much larger than each the corporate’s peer common ($78.5 million) and S&P 500 common ($67.2 million), regardless of underperforming each. D.E. Shaw is demanding that the corporate talk a transparent, credible, and clear CEO succession plan. It needs the corporate to refresh the board with extremely certified unbiased administrators, and to restructure govt compensation to enhance alignment with technique and efficiency (i.e. the introduction of return on fairness/return on capital employed metrics for the long-term incentive plan as friends have). The agency can be calling for the formation of a number of advert hoc board committees to supervise these initiatives.

D.E. Shaw is a big multi-strategy fund that’s more and more embracing activism as a instrument to create shareholder worth and has an skilled group that has had success in its activist engagements. Because the starting of 2022, it has commenced six activist campaigns, settling for board seats in 5 (L3Harris Applied sciences, Corpay, Constancy Nationwide Info Companies, FedEx and Verisk Analytics) and efficiently opposing a merger on the sixth (Diversified Healthcare Belief). The agency is understood for its deep quantitative and technical analysis. That is exemplified in its Oct. 2 presentation on Air Merchandise. D.E. Shaw completely outlines the corporate’s points and provides proposed fixes.

It’s not unusual to see a number of activists in the identical inventory, particularly at an organization with such a robust underlying enterprise paired with relative underperformance, capital allocation missteps and company governance purple flags. On Oct. 4, Mantle Ridge introduced a greater than $1 billion place in Air Merchandise, and echoed an identical sentiment and recognized related points as D.E. Shaw. The principle distinction between the 2 is that D.E. Shaw traditionally provides a minority of administrators to the board and customarily not a principal of the agency. Mantle Ridge has traditionally reconstituted a majority of boards with the inclusion of its founder, Paul Hilal. Whereas sure buyers and CEOs could have a look at the activist principal being on the board as a unfavourable, we see it a big constructive in that it indicators long-term engagement, and the activist investor is usually probably the most ready and assertive unbiased director at board conferences. It must also be famous that in three prior campaigns, Mantle Ridge by no means positioned a couple of of its personal insiders on the board, and the agency all the time had a slate of spectacular, unbiased administrators.

D.E. Shaw is barely searching for three seats on Air Merchandise’ nine-person board, together with one for Scott Sutton, the previous CEO of Olin, who oversaw a inventory appreciation of 379.2% as CEO from Sept. 1, 2020 to March 18, 2024, versus 28.3% for the Russell 2000 over the identical interval. The 2 others will doubtless be spectacular public firm executives with a monitor document of making shareholder worth. Whereas D.E. Shaw’s funding thesis has loads of overlap with Mantle Ridge’s plan, there are two evident points that each buyers prioritize: CEO succession planning and capital allocation refocus. We strongly count on that lots of Air Merchandise’ different shareholders are involved about the identical concern. So, the query right here shouldn’t be whether or not there shall be change, however what’s going to that seem like. Having two totally different activists offers the corporate some optionality to settle with the one it thinks shall be a greater match. D.E. Shaw doubtless means fewer new administrators and no activist principal. However Mantle Ridge has a pre-existing relationship with the corporate, in addition to a few of the present administrators and CEO Ghasemi, going again greater than ten years, and it has a repute of working effectively with administration. As each activists will insist on higher capital allocation and a agency succession plan, both means it ought to be a win for shareholders.

Ken Squire is the founder and president of 13D Monitor, an institutional analysis service on shareholder activism, and the founder and portfolio supervisor of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments.