Friday, December 15, 2006

Early Christmas Bonuses for Ashland's Board of Directors



In the last two years, specialty chemicals distributor Ashland Inc. (ASH-$68.86) has sold two subsidiaries for an aggregate balance of about $5.0 billion.

“Capital as such is not evil; it is its wrong use that is evil. Capital in some form or other will always be needed.” – Mohandas Gandhi

Unfortunately, Ashland has displayed both fiscal prudence and exacting pretense for using the $5.0 billion to remake itself as a global player in the chemical and adhesives material markets.

On June 30, 2005, Ashland transferred its 38% interest in Marathon Ashland Petroleum LLC (MAP) to Marathon Oil Corp. for the consideration of $3.7 billion in cash and stock.

Ashland used a substantial portion of the proceeds of the MAP Transaction to strengthen its balance sheet, retiring most of its debt and certain other financial obligations. In addition to the repurchase of accounts receivable previously sold under its sale of receivables facility and the purchase of $101 million of assets that were formerly rented under operating leases, Ashland retired approximately $1.6 billion of balance sheet debt as of September 30, 2005 (incurring a loss on the early retirement of debt—repayment premium penalties and issuance fees—of $145 million).

During 2006, Ashland continued with its focus to redefine itself as more than the owner of the automotive lubricant, Valvoline, a branded motor oil (and other appearance products, including antifreeze, filters and automotive fragrances).

On August 28, 2006, Ashland sold its paving and construction business (APAC) to Old Castle Materials, Inc. for $1.3 billion. [Ed. note. Prior to the sale of APAC, the subsidiary was producing about 30 percent of the Company’s annual revenue.]

Shareholders were rewarded by this sale when the Company declared a special cash dividend of $10.20 per share, which was payable on October. 25,2006.

Even with the cash distributions to shareholders, management said that money left over from the sale of the paving business and other businesses would enable it to make more than $2 billion in purchases—including up to 7.0 million in share buybacks—without increasing debt beyond two times its earnings before taxes.

[Ed. note. For the fiscal year ended September 30, 2006, EBITDA was about $220.0 million.]

Ashland repurchased 6.7 million shares for $405 million during fiscal year 2006. Following the completion of the current share repurchase program Ashland estimates it will have purchased approximately 18% of the shares outstanding on June 30, 2005. [Ed. note. The stock repurchase actions are consistent with certain representations of intent made to the Internal Revenue Service with respect to the transfer of MAP.]

Last month, in keeping with its promise to promote growth, the Company signed an agreement to purchase Northwest Coatings, cutting-edge adhesives and coatings company that uses ultraviolet and electron beam technology, for $72 million.

Unfortunately, we did the math—followed the money trail—and could not find the $2.0 billion that the Company said was available for future purchases:

1. Saying that cash inflows to the Company were $5.0 billion would be misleading; the MAP transaction only resulted in a non-taxable gain to Ashland of about $1.29 billion and Ashland recorded an after-tax gain on the sale of APAC of $110 million in 2006.
2. $1.40 billion (revised cash inflows) - $1.60 billion (debt retirement) - $674.0 million (special cash dividends) - $405.0 million (2006 share repurchase program) - $100.0 million (additional share repurchases in 2H:05) - $101.0 million (proceeds from the MAP Transaction to purchase Construction Equipment assets) = $(1.48) billion deficit
3. OOPS! Less $72.0 million (for the Northwest Coatings acquisition) = $(1.55) billion deficit. Five Billion just doesn’t buy what it used to?

Valuation Analysis

The common stock of Ashland has climbed 21.08% in the past 52-weeks, as investors anticipate that the recent sale of the pavement and construction business represents an important strategic step in transforming the Company into a diversified chemical company, better positioned to benefit from continued global economic growth (especially in Europe and China).

[Ed. note. Now that the monies from the two subsidiaries have been spent, any future acquisitions will have to come from borrowings. Albeit we do admit that the company does sit in good financial health, with about $33.75 per share in cash and a Total-Debt/Equity ratio of only 2.6 percent.]

In our view, the rise in the price of Ashland’s stock already reflects an optimistic scenario. Long-term, we remain (fundamentally) unimpressed with a company generating a ROA and a ROE of 1.59% and 5.36%, respectively.

Corporate Governance Issues

As we demonstrated earlier, Ashland forgot to turn off the money spigot.

To further illustrate our point:

Pursuant to Ashland’s 2005 incentive plans, upon election to the Board of Directors, a new director received 1,000 restricted shares of Ashland Common Stock. Each director received, too, an annual retainer of $65,000 (for attending nine meetings of the Board of Directors).

In addition to the annual retainer, non-employee directors received $1,500 for each Board of Directors and Committee meeting attended. The Lead Independent Director also received three $5,000 quarterly installments of a $20,000 annual fee approved by the Governance Committee in January 2006. The Committee Chairs also received a $5,000 annual fee. Members of the Audit Committee, including the Chairman, also received a $1,500 fee for attendance at each quarterly Audit Committee financial review with Ashland’s management. All such fees could be paid in cash, shares of Ashland Common Stock or deferred into any investment alternative available under the Directors’ Deferral Plan.

Flush—with what they thought—were all these new billions in the Company’s coffer—the directors voted to themselves more than a 38 percent raise in their annual retainer. Effective January 26, 2007, the revised compensation program provides that non-employee directors will receive (a) an annual retainer of $90,000; (b) an additional annual retainer of $20,000 for the Lead Independent Director; (c) an additional annual retainer of $15,000 for the Chair of the Audit Committee and $7,500 for Audit Committee members; and (d) an additional annual retainer of $7,500 for other Committee Chairs.

In addition, pursuant to the revised non-employee director compensation program, effective January 26, 2007, each director will receive an annual award of deferred restricted stock units with a grant date value of $100,000! The restricted stock units will vest one year after date of grant and will be payable in stock or cash, at the director’s election upon termination of service. Under the revised director compensation program, however, annual stock option grants will no longer be made to non-employee directors.

Truth or dare—Do any investors truly believe that this new compensation package for non-employee directors will “create a stronger linkage and alignment with the long-term interests of Ashland and its shareholders?”

By contrast, CEO James J O’Brien received a base increase of only 10.8%, or $95,000, (to $983,258), during fiscal 2006. Lest we forget, however, Messer. O’Brien, was awarded a bonus of $1.16 million for fiscal 2006—and a long-term compensation payout of $1.29 million (representing fiscal years 2004 – 2006).

[Ed. note. In fiscal 2005, Ashland settled a shareholder derivative lawsuit brought in 2002. In settling the action, Ashland agreed, among other things, to solicit from its major shareholders director candidates and to nominate a qualified candidate for election to the Board of Directors.]

Certain Relationships and Transactions

Mannie L. Jackson, a director of Ashland, is Chairman of the Board and Chief Executive Officer of the Harlem Globetrotters. During fiscal 2006, Ashland paid the Harlem Globetrotters approximately $31,000 for certain promotional tie-ins.

Michael J. Ward, a director of Ashland, is Chairman of the Board and Chief Executive Officer of CSX Corporation (“CSX”). In fiscal 2006, Ashland paid CSX and its subsidiaries approximately $13.6 million for transportation services, and CSX paid Ashland approximately $114,000 for certain products and/or services.

Investment Risks and Considerations

Many of Ashland’s businesses are cyclical in nature and economic downturns or declines in demand may negatively impact the Company’s financial performance. The profitability of Ashland is susceptible to downturns in the economy, particularly in those segments related to durable goods, including the housing, construction, automotive, and marine industries. Both overall demand for Ashland's products and services and its profitability will likely change as a direct result of an economic recession, inflation, changes in hydrocarbon (and its derivatives) and other raw materials prices, or changes in governmental monetary or fiscal policies.

Ashland has been undergoing a major process initiative designed to optimize its supply chain function. By integrating the supply chain function and creating more efficient, customer responsive processes including source-to-pay, plan-to-deliver and order-to-cash, Ashland is looking to lower costs, while increasing service levels and customer satisfaction. The implementation of the Supply Chain Optimization Project carries substantial risk, including the potential for business interruption and associated adverse impacts on operating results.

Editor David J Phillips does not hold financial interests in any of the companies mentioned in this posting. The 10Q Detective has a Full Disclosure policy.

3 comments:

Tweakie said...

Another piece of high quality forensics research from 10Q Detective.

The Sound said...

David,

Do you ever go long...?

David J. Phillips said...

A list of my long positions is located in the right-hand margin under the title: CURRENT HOLDINGS.

THE 10Q DETECTIVE HAS A FULL DISCLUSURE POLICY