“The board has concluded that separating American Standard into three focused, better understood companies will create greater shareowner value than the current structure,” said Fred Poses, the company’s chairman and CEO, in a press release announcing the plan. “The businesses have the size, global reach, industry leadership and organizational talent to succeed as separate companies.”
American Standard’s decision got early approval from Wall Street when the stock reached an all-time high on the same day. The stock peaked as high as $53.70, up 7% to its highest level since the company went public in 1995.
Broken UpThe company said the separation would allow management to focus on air-conditioning systems and services, its biggest business with $6.8 billion in 2006 sales. The new Trane Co. will remain publicly traded and keep its headquarters in Piscataway, NJ. Trane will still be able to use the American Standard name for some of its HVAC equipment.
Meanwhile, the vehicle control business, with $2 billion in 2006 sales, will be spun off through a stock swap with current American Standard shareholders. The independent, publicly traded company will be likely named WABCO, after its signature brand of antilock brakes and electronic suspension systems for heavy trucks and luxury cars.
That leaves the bath-and-kitchen business with 2006 sales of $2.4 billion up for sale. Who will buy? We’ve read everything from the Chinese to Home Depot, plus the usual suspects, plumbing manufacturers - American, European and Asian - and investment bankers.
“I do think it will be a valuable property,” Poses said in a conference call with stock analysts to announce the breakup. He added that he’s already received interest, but would not name names.
But the sale price of the ailing plumbing business may be less than Poses wants to think, according to analysts who regularly follow the company for investors. A.G. Edwards analyst Christopher Kotowicz told the Reuters news agency a day after the announcement that American Standard “would be lucky to take in gross proceeds of $1.5 billion” for the business because of “lackluster profitability.” Deutsche Bank’s Nigel Coe gave the business a $1.2 billion price tag. Keith Humphrey, SunTrust Robinson Humphrey, wouldn’t give an estimate, but said it would be “well below” its 2006 sales.
Financial ChallengesJudging from Wall Street’s perspective, the company could have changed its name to Trane years ago.
“The continuous underperformance of the bath-and-kitchen business has overshadowed top-tier performances from Trane and WABCO,” said Deutsche Bank’s Coe, in a note to investors. “As such, it is difficult to argue with the strategic logic of this move.”
And it is difficult to argue with Coe’s logic. Wall Street didn’t just applaud the breakup. American Standard also reported a 77% leap in fourth-quarter profits.
“We had a good year,” Poses said of the fourth quarter. By “good,” he means double-digit income increases from Trane and Webco that were “powerful enough to overcome lower earnings in our bath-and-kitchen business.”
It was just the latest in a string of disappointing quarterly results. By the time of the breakup announcement, the business synonymous with plumbing had lost $18.4 million for 2006, steadily drained the company’s otherwise solid financials and even seen a double-digit sales decline in the United States.
It’s impossible to page through the company’s annual reports from 2000 onward without seeing tens of millions of dollars in restructuring charges taken as result of layoffs, plant closures and other operational issues.
The same situations applied in some years to the other two divisions, but none more so than the kitchen-and-bath group. Maybe the best way to sum it up is to consider that in 2001, the bath-and-kitchen group employed 28,000 people in 66 plants around the world. As of 2006, the group employed 26,000 people in 54 plants.
The moves seemed to help the division turn a corner in 2004 when its annual sales increased by 9% and earnings grew 41%. Operating margin grew to 8.1%, up from 6.2% the previous year.
However, sales and earnings failed to keep up that trend in 2005. The bottom really dropped out by that October when the company announced its third-quarter results. While sales and earnings for the overall company increased, bath-and-kitchen sales dropped 2% and earnings fell by 61%. The company also dropped its own earnings-per-share estimate for the rest of that year.
Wall Street hammered the stock on the bad news. By the end of the day, American Standard’s stock lost 17% of its value.
“The most significant issues included the loss of volume due to production problems, unavailability of some new luxury products, increases of 10-15 percent in energy costs and unfavorable exchange rates,” Poses later wrote in the 2005 annual report.
Wholesale, Retail DropsThe division suffered that year from drops in both its retail and wholesale markets in the “Americas,” a sales territory largely made up by the United States.
By 2005, sales through home centers represented 45% of bath-and-kitchen sales in the Americas. The company, however, blamed a 1.5% sales decrease for the region, in part, to “a reduction in inventory and lower volume at a major retail customer.” Sales volume in the Americas was “also unfavorably impacted by reduced sales in the wholesale channel.”
By the end of the year, the group reported a 48% decrease in income. Operating margin was cut in half to 4%.
The problems didn’t let up in 2006. First quarter - sales up slightly, but posts a loss of $500,000, down from a profit of $44.8 million. Second quarter - sales drop 4%, largely as a result of continued weakness in the Americas, and income falls to $4.7 million, down from $35.6 million.
Another Awful 3QThird quarter - sales increase 5%, but income, which included operational expenses of $25 million, represents a loss of $19 million. Meanwhile, the Trane and Webco businesses turn in third-quarter sales and income records, and the company, again, trims its earnings estimates for the year.
Poses went on Jim Cramer’s CNBC “Mad Money,” program the next day and agreed with most analysts’ judgments that his bath-and-kitchen business was much worse than anyone had expected.
“It was a good business before,” he said, “and it’s taken longer to fix than we thought. But that doesn’t mean that the business couldn’t be good in the future.” Poses labeled much of the problems as “executive-driven.” All three global businesses have shared the same market-driven problems lately, namely increased raw material and energy costs combined with a construction slowdown.
While Poses wasn’t specific on the program, some of the executive-driven problems the bath-and-kitchen division continues to contend with are productivity lags, product mix and inventory problems.
During a conference call with analysts last month to discuss the breakup, Poses added another problem that’s probably driven by a little bit of both: Fourth-quarter sales for the bath-and-kitchen division fell 12% in the Americas and were down 5% for the year.
The company keeps on its attempts at right-sizing its plumbing operations. On the heels of the breakup news, for example, American Standard said it would take a $29 million charge in 2007 for costs associated with eliminating jobs in Europe, discontinuing production of cast-iron tubs at a French factory and streamlining other European operations. More than half of the group’s sales in 2006 are in Europe, where the brand name is sold as Ideal Standard.
While the latest restructuring might be just what the company needs, we can’t help but spot a common refrain appearing in the annual reports to explain why other restructuring attempts failed: “These costs exceeded benefits from improved volume, pricing and previous operational consolidations.”
Whatever price the company receives for the plumbing operations will be used to pay down debt and buy back what will be Trane stock. No part of the breakup requires shareholder approval. The company expects both the sale of kitchen-and-bath operations and the spin-off of WABCO to be completed by September.
Current executives of the three units are expected to stay on in their respective roles - all except for one. Poses will remain chairman and CEO, but is expected to retire at the end of this year. A search is already under way to name his successor.By Steve Smith
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