What we can learn about the future of global capitalism by looking at “Old Economy” Companies
Much of the commentary about business strategy on Medium is dedicated to those few highly-valued companies, mostly in information technology, who have executed on long-term growth strategies that have disrupted existing markets and are seen as impacting our future in a profound way. But most businesses are not like the IT and Internet giants: the Apples, Amazons, Facebooks and Googles or the “unicorns” that hope to follow in their wake. Although perhaps not as sexy and transformative, companies that produce tangible products or mine or harvest raw materials, ship them around the globe and sell them to other manufacturers and to retailers (like Amazon) are much more representative of the global economy and collectively still matter more, at least in terms of revenue and employment, than the IT giants and the disruptive unicorn darlings of the media. These companies are also going to have to get on board if we are going to address climate change. I would submit, therefore, that the strategies of these businesses still matter a lot and what you don’t know about their business strategies will hurt you.
To keep current on how manufacturing and mining businesses are faring and how they are approaching strategy, I listened in to investor conference calls reporting 2nd quarter results and revising estimates for the second half of the year. As a veteran of the chemical industry, I concentrated on companies in that space: DuPont, Dow, Chemours, FMC, Livent and Tronox. Listening to investor conference calls and reading their quarterly earnings information confirms that while executives continue to tout their long- and medium-term strategic priorities, the focus of these calls remains short-term.
Several things are apparent from these calls:
- The world economy is quite weak and has been quietly weakening for some time.
- Investors and top managers of corporations reliant on global supply chains complain about tariff wars and trade “uncertainty” but that doesn’t yet translate into any shifts of strategy.
- Companies with products that can help with climate change are largely silent about the headwinds created by political opposition in the US and elsewhere to a robust international efforts; rather they choose to tamp down high-expectations and investor impatience, explaining that the “future is coming, but it is not here yet.”
- The latest merger and spin-off wave in chemicals raises big issues about the US model of corporate governance.
- Chemours’ challenges are particularly interesting and can serve as a bell-weather for many trends.
Of those who sell into industries whose demand growth tracks global GDP, they report lower revenues in first half 2019 than in first half 2018, attributable to a mix of lower volumes and prices. Economic headwinds, weak demand, excess capacity and persistently high inventories are widely mentioned. Weakness in global manufacturing, especially the auto and electronic sectors are mentioned, with weak conditions in Europe and Asia mentioned in call after call. Guidance was adjusted downward in many cases, with “economic uncertainty” stemming from “trade tensions” mentioned again and again.
At one level, managements are hoping to survive this current period of uncertainty and preserve the ability to execute on longer-term plans when reasonable prospects for future growth return. They are taking pains to defend current maintenance capital expenditures against skeptical investor questions. The largest diversified chemical manufacturers, a greater share of whose products are used in slower-growing or contracting industries are focusing on reducing debt and repurchasing stock. To the extent they sell into end-markets predicted to grow faster than GDP, management is defending longer-term plans to add capacity and invest in R&D, albeit with caveats to reassure analysts that cash discipline will be maintained and investors not forgotten. What you do not hear is any confidence that public policies that negatively impact the bottom line or future growth prospects can be reversed or modified to improve future prospects.
What is striking is the extent to which current management is steering a ship that they didn’t design. The portfolio of products they sell and the assets they own are dictated by past decisions of activist shareholders or existing management preemptively to take the wind out of the activist’s sails. DuPont, Dow and FMC have spun-off slower growing business lines and DuPont and Dow have combined their other businesses to maximize scale and to rationalize costs, creating three new surviving companies, one in agricultural sciences, one in basic materials and one in specialty businesses. Chemours and Tronox were earlier spun-off to shareholders, from DuPont and Kerr-McGee, respectively, and are essentially managing businesses cast off as too slow-growing or liability-laden in previous waves of corporate reorganization. FMC has already sold its industrial chemicals businesses in private transactions, spun its higher-growing Lithium business to create Livent and traded its food-ingredients and pharmaceutical excipients business to DuPont for the part of its Ag business it was not allowed to contribute into the DuPont/Dow spin-off Corteva. This is the same FMC since 2001 that itself had to generate growth from chemical businesses spun from the larger conglomerate of the same name. Meanwhile, the spun titanium dioxide producers, Tronox and Chemours, are each trying to gain strategic depth, Tronox by recently acquiring global competitor Cristal and Chemours by buying a Georgia-based miner of titanium ore.
This wave of corporate reorganization has inspired new worries about whether the US model of “shareholder capitalism” needs fixing. Leo Strine, the retiring Chief Justice of the Delaware Supreme Court published in 2017 a stinging indictment of Wall Street “short-termism” in the Yale Law Journal. Jay Clayton, the chair of the SEC has stated that he is worried about short-termism as well and encouraged public comment on whether the quarterly schedule of earnings reporting encourages too much short-term thinking. The SEC meanwhile has not acted on a request to open rule-making to mandate sustainability, environmental and governance (SEG) disclosure, but recently included new items in Regulation S-K requiring issuers to report on their strategy for managing “human capital” to the extent material. The degree to which chemical company management has prioritized using cash flow to buy-back stock and maintain dividends is testimony to the continued influence of short-term thinking in corporate board-rooms. Whether reforms such as those proposed by Elizabeth Warren would improve things has to be judged against the reality that if the world is to de-carbonize and address human-generated climate change, it is the global chemical companies that will have to execute on the strategies to produce the materials necessary to effect this transition. On the evidence of the most recent earnings season calls, management will need more encouragement than the incentives offered within current governance rules to make the long-term bets necessary. We will need to decide the extent to which the public policy environment around the firm be put into place to give corporate executives the confidence in stable public policies and rising demand for new products or the extent to which we will need to reform the corporate governance system directly to encourage greater corporate risk taking and long-term thinking.
Finally, some thoughts about Chemours. Chemours has a number of features that makes it a fascinating test case. First, it is challenging its former parent DuPont Dow in a lawsuit, complaining (as much as we know since the complaint is secret) that the environmental and toxic tort liabilities it was saddled with in the spin cannot be unbounded and infinite. This is another chapter in the long history of lawsuits brought by spun companies against their former parents (Tronox successfully sued Anadarko Petroleum who had bought the energy business of its parent Kerr-McGee and Solutia Inc. sued its former parent, Monsanto). Board of directors and their advisors should follow this closely to see the contours of what is permissible when you wish to spin off your old-economy problems with your old-economy businesses. Also Chemours is pushing European Union member states to enforce European rules phasing out old refrigerants. Chemours sells a new class of HFOs that replace the old CFC-based compounds. It believes its sales of HFOs are being hurt by the illegal importation of non-compliant materials using legacy chemistries that cause global warming. Finally, Chemours’ President and CEO Mark Vergnano will become the Chair of the Board of the American Chemistry Council. His chairmanship coincides with a host of challenges for Chemours and for the chemical industry as a whole.
