Elementis in war of words with investor
Speciality chemicals company Elementis has come under pressure after an investor, Franklin Mutual Advisers, published an open letter to board chairman John O’Higgins, calling for it to put itself up for sale before its Q3 results on 31 October. Elementis has responded by saying it did not think this to be in shareholders’ best interests.
Elementis mainly supplies the personal care sector, notably cosmetic and antiperspirant actives – it is the world market leader in the latter field. 85% of its products are of natural origin. In 1H 2023, personal care accounted for 44% of adjusted operating profit before central costs.
The letter, dated 20 September and signed by portfolio managers Steve Raineri and Chris Meeker, states that when Franklin first invested in Elementis in December 2020, it was impressed with Elementis’ “healthy market position in its personal care and coatings businesses”. It now has a 9.8% stake. “As value investors, we were also attracted to a stock that had declined more than 50% since 2016, an inexpensive valuation relative to history and peers, the potential for upside in earnings from a cyclical recovery in the company’s end markets and publicly stated commitment to operational improvement.”
Franklin accused the company of “a shocking amount of shareholder value destruction”, mainly from buying SummitReheis and Mondo Minerals in 2017 and 2018 respectively. It has since incurred over $200 million in impairments associated with Mondo, and its market value is less than the $860 million amount it spent to acquire the two companies.
In addition, Franklin said, Elementis' 1H operating margins of 14.4% are “far short” of the 17% goal set at its 2019 Capital Markets Day, despite the sale of the lower margin Chromium business in January. The invested capital base more than doubled to $1.1 billion between December 2016 and June 2023, while return on capital and the stock price have both declined by more than 50%.
Elementis rejected offers £1.30/share and £1.60/share from Minerals Technologies in December 2020 and Innospec three months later, claiming that £1.98-2.25 would be fair value. However, Franklin said, since then the share price has averaged £1.23, 38% below the low end. “In our opinion, this indicates a significant lack of confidence by shareholders (and the market) in management's ability to unlock the substantial value inherent in the business,” they said.
In Franklin’s view, Elementis is too small, at about one quarter of the median size of its peers, to achieve its targets or transactions that would significantly boost its scale. It would do better as part of a larger entity. “Under these circumstances, a strategic merger seems necessary and, ultimately, inevitable.”
The letter concluded by saying that Franklin had discussed its concerns privately with the management but had made no progress. It has therefore “reluctantly decided to make this letter public” to alert shareholders to these issues and encourage them to share their concerns with the board, we hope these issues might finally be properly addressed. The company’s shares saw a 9% rise after the letter was published, while analysts from Schroders and Odyssean came out in support.
However, the Elementis board replied that it did not consider an immediate sale to be in the best interests of its shareholders. “The board notes and agrees with Franklin's comments about Elementis' attractive assets,” they said. “In particular, the comments about our healthy market positions, strong gross margins that demonstrate the premium nature of our products and potential for upside in a cyclical recovery alongside substantial operational improvement initiatives.”
Since the divestment of the Chromium business, they added “Elementis is a pure play specialty chemicals business focused on adding value by making our customers’ formulations look, feel, and perform better. [It] is now a higher growth, higher margin, less cyclical and less carbon-intensive business,” able to deliver higher earnings and margins, with lower volatility. Elementis, the board claimed, is making progress to the 17% adjusted operating margin target and towards a <1.5x net debt/EBITDA ratio. In addition, its 2023 interim results have been “resilient … in challenging macro-economic conditions that have seen many other specialty chemicals companies downgrade expectations for 2023”.