D.E. Shaw, Mantle Ridge zero in on key fixes to construct shareholder worth at Air Merchandise

Enterprise: Air Merchandise and Chemical substances is an industrial gases firm. It is targeted on serving vitality, environmental and rising markets. Its base enterprise gives important industrial gases, associated tools and functions experience to clients in dozens of industries, together with refining, chemical compounds, 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 vitality within the heavy-duty transportation and industrial sectors. As well as, it gives turbomachinery, membrane methods and cryogenic containers globally. Air Merchandise has operations in roughly 50 nations.

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 isn’t traditionally recognized for activism. The agency is not an activist investor, nevertheless it makes use of activism as an opportunistic software in conditions the place it thinks it could 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’s going to take an lively position. The investor locations a premium on non-public, constructive engagement with administration. In consequence, 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 government compensation.

Air Merchandise gives industrial gases and associated tools in end-markets reminiscent of refining, chemical compounds, metals, electronics, manufacturing and meals. The corporate’s industrial gasoline enterprise is extraordinarily secure and low threat, functionally a risk-free, inflation-protected, senior secured bond when the enterprise is stored 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 mainly resistant to financial cycles, contracts are inflation-protected, and the oligopolistic business has big boundaries 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 secure and well-valued enterprise.

Nonetheless, whereas the corporate was targeted by itself operations, it missed out on a wave of consolidation within the business. 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 lonesome. CEO Seifi Ghasemi’s enlargement answer, having missed out on mixtures 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 way of a number of clear hydrogen undertaking investments. Throughout 5 investments — essentially the most notable of which being the Air Merchandise’ NEOM Saudi Arabia inexperienced hydrogen undertaking and its Louisiana blue hydrogen undertaking — 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 the moment, over 80% of undertaking capability stays uncontracted.

It is a excellent instance of “di-worsification.” Traders admire corporations like Air Merchandise for his or her low-risk and extremely secure cash-flowing operations. Whatever the efficacy of those non-core companies, the standard risk-averse buyers which were traditionally interested in corporations like Air Merchandise are going to flee when the chance profile adjustments. Furthermore, buyers with a bigger urge for food for threat who could be interested in companies like NEOM or the Louisiana undertaking, are much less prone to spend money on it when it’s diluted by a low-risk, secure enterprise like Air Merchandise’ core industrial gasoline companies. Additional, issues usually are not 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 greater than its peer common. The corporate’s free money stream 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 timeframe up to now 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 present giant undertaking commitments by signing offtake agreements at cheap return hurdles, as their friends have been capable of do. As well as, in mild of Air Merchandise finalizing one other giant hydrogen undertaking in Texas with out present 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 yr 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 previous, he has been serving within the position 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 imprecise 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 top quality inside candidate. There are questions on what viable candidate would need to be a part of the corporate if Ghasemi basically has an indefinite contract. To not point out, his compensation over the previous 5 years of $87 million is way higher 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 impartial administrators, and to restructure government 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 software to create shareholder worth and has an skilled crew 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 Data Companies, FedEx and Verisk Analytics) and efficiently opposing a merger on the sixth (Diversified Healthcare Belief). The agency is thought for its deep quantitative and technical analysis. That is exemplified in its Oct. 2 presentation on Air Merchandise. D.E. Shaw totally outlines the corporate’s points and gives proposed fixes.

It’s not unusual to see a number of activists in the identical inventory, particularly at an organization with such a powerful underlying enterprise paired with relative underperformance, capital allocation missteps and company governance crimson flags. On Oct. 4, Mantle Ridge introduced a greater than $1 billion place in Air Merchandise, and echoed an analogous 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 might have a look at the activist principal being on the board as a unfavourable, we see it a major optimistic in that it alerts long-term engagement, and the activist investor is usually essentially the most ready and assertive impartial director at board conferences. It also needs to 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 at all times had a slate of spectacular, impartial 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 observe file of making shareholder worth. Whereas D.E. Shaw’s funding thesis has loads of overlap with Mantle Ridge’s plan, there are two obtrusive 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 subject. So, the query right here just isn’t whether or not there will likely be change, however what is going to that appear like. Having two completely different activists provides the corporate some optionality to settle with the one it thinks will likely 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 fame of working effectively with administration. As each activists will insist on higher capital allocation and a agency succession plan, both method 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.