business
A MODERN-DAY HERCULES BULKS UP Having pared Hercules back to its most profitable lines, Chairman and CEO R. Keith Elliott nearly doubled the company's size in 1998 Marc S. Reisch C&EN Northeast News Bureau
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in difficult times," after the Asian financial crisis hit. Although Hercules lost a bid for England-based Allied Colloids to Ciba Specialty Chemicals at the beginning of 1998, thefivesuccessful acquisitions followed swiftly thereafter. Elliott says, "I see 1998 as a monumental year in the life of this company. It surely wasn't fun for shareholders, of which I am one. But three or four years out, we will look back and say that 1998 was a turning point." From 1991 until his retirement in 1997, former Chairman Gossage relentlessly pursued a strategy to divest poorly performing businesses and reduce costs. Hercules sold a number of businesses— including its aerospace, composites and carbonfiber,flavorsandfragrances,and electronics and printing businesses. R&D spending slipped from $86 million in 1991 to $53 million in 1997. And paradoxically, during the years that Hercules' sales and research spending were shrinking, its share price soared, peaking at more than $60 in early 1996. But more recently Hercules' shares have traded at less than $30. Hercules had no further divestitures in 1998, and economic conditions for specialty chemi-
hen R. Keith Elliott succeeded Thomas L. Gossage as chairman and chief executive officer of Hercules in 1997, the company's annual sales were $1.9 billion. That's a far cry from the $2.9 billion in sales the company recorded in 1991 when Elliott joined the company as senior vice president and chief financial officer from a similar position at catalyst and pigment maker Engelhard. But withfiveswift acquisitions in 1998, Elliott, 57, has nearly doubled Hercules' size by making a determined effort to enlarge what was until recently a shrinking chemical producer. If the company had owned BetzDearborn for the full calendar year along with the four other businesses it bought, Hercules' sales would have totaled $3.3 billion last year instead of the $2.1 billion it did report. Hercules added paper chemicals producer Houghton International and pectin maker Citrus Colloids early in 1998. In July, it bought the 49% of polypropylene fiber producer FiberVisions it did not already own from Danish partner Jacob Holm & Sons. And following the BetzDearborn acquisition in Octo- — ber, Hercules added a small, EnAcquisitions have doubled gland-based rosin manufacturer, AlHercules' sales potential liance Technical Products. For those businesses, Hercules spent $3.6 bilHercules' Other3 continuing lion, of which $3.1 billion went for 2 the purchase of water treatment FiberVisions \ Jesses X 8% '51/0 chemicals producer BetzDearborn. "We realized at the end of 1995 that with what we were doing, we weren't going to be able to grow organically at the rate we thought we wanted or that we thought people BetzDearborn who invested in our shares want39% ed," Elliott says. "We started this ef1998 sales = $3,308 billion" fort to grow in good times, and it a Houghton, Citrus Colloids, and Alliance Technical Products. turned out the business combinab Based on full-year sales for acquired businesses. tion part of our plan came to fruition
Elliott: 1998 was a turning point
cal producers deteriorated throughout the year. For the last quarter of 1998, in particular, Elliott notes, "results suffered from the soft market conditions in the basic manufacturing sector, particularly in the U.S., where a record level of downtime was incurred in the paper industry," a major customer of Hercules, papermaking and water treatment chemicals. And then, too, as Herculesfilledits shopping cart with so many promising additions, it also acquired an enormous debt $3.1 billion at the end of 1998, upfrom$419 million at the end of 1997. Elliott, an economist by training, says Hercules will excel again once it fully incorporates BetzDearborn into the corporation, contemplates selling or "partnering" its poorly performing nitrocellulose business, and considers offering its FiberVisions business in an initial public offering sometime in the near future. 'We said in the past that our ultimate intent on FiberVisions was an initial public offering, and that is still a real possibility. That business is doing exceedingly well, and its future is very bright. And so it is a good time to have the marketplace recognize what its value is. We will be reviewing our options regularly." Although Elliott says "we don't have anything on the block to sell," he admits that "nitrocellulose is a business that is having a tough time because of worldwide excess capacity. It's not a very big business. And the pain we are taking from it is not big either. But it takes a fair amount of management time. I think if we could find a sensible way to venture that business, we would surely consider it, and we are working on that." APRIL 5,1999 C&EN
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business Generally speaking, Elliott says, "we would not want to part with any of our six major franchise businesses. On the other hand, I'd be foolish to say nothing is for sale, because if someone wanted to pay a very fair price, then we have an obligation to think it through and determine if it was the right thing for us." For BetzDearbom, Elliott targeted $125 million per year in cost savings by 2000 through synergies from the combination of the two companies, and he has suggested the actual savings could be more. Those synergies will include eliminating at least 700 jobs, shuttering six to eight major facilities and a number of offices, and achieving savings through pooled raw materials purchasing and tax planning initiatives. And Elliott says he is changing the way the old BetzDearbom has done business. BetzDearbom had an operating profit margin of about 15% of sales in 1997; however, Hercules targets return closer to 20%. 'We couldn't allow the new franchise to go on as it had in the past because the cost structure was simply too high," Elliott says. "We did an analysis that indicated [BetzDearbom was] spending 78% of its gross profit dollar getting the product to the customer. Its number-one competitor, Nalco, was spending 70%." In other words, BetzDearborn's operating costs were higher as a percentage of sales than were Nalco's. So, Elliott says, "I challenged [BetzDearbom management] to get the costs down to two-thirds of gross profit dollar. They actually adopted a goal of 68%. And they committed in their last business plan to be at a run rate of 68% by the end of the fourth quarter of 1999. I thought that was tremendous progress." Given the absorption of FiberVisions and BetzDearbom in 1998, Elliott says Hercules' operating profit margins have fallen to about 17%. In 1997, before those acquisitions and before the impact of the Asian economic crisis set in, Hercules achieved margins in the 20 to 21% range, Elliott says. The synergies Hercules hopes to achieve with the integration of BetzDearbom along with Betz's renewed focus on the bottom line should bring Hercules up to the 18 to 20% range, Elliott says, which "is about the right area." "In our business, I think that if we were earning 30% operating margins, it would clearly be an indication that we had not made the R&D investments that we need to make to have the future be what it has to be. And if we were making 13 to 14% as a corporation, it is a clear 14 APRIL 5,1999 C&EN
Hercules at a glance Headquarters: Wilmington, Del. Sales: $2.1 billion in 1998 Operating income: $459 million R&D spending: $61 million Capital expenditures: $ 1 5 7 million Employees: more than 12,000 Production facilities: 79 worldwide
leum refining, chemical processing, and food and beverage processing Aqualon—Water-soluble polymers, organosoluble polymers, and specialties such as pentaerythritol and sodium formate Food gums—Pectin, carrageenan, and agar used to stabilize and gel foods such as jams, jellies, processed meats, and cultured dairy products
Major products (six divisions): Pulp and paper—Performance and pro- Resins—Hydrocarbon resins; wood-, cess chemicals such as sizing agents, gum-, and tall oil rosin-based resins; perantimicrobial agents, dispersants, and oxides; and specialty terpene chemicals defoamers, as well as water treatment FiberVisions—Polypropylene thermal BetzDearbom—Chemical treatment pro- bond fiber for disposable diaper cover grams for water systems such as boiler, material as well as polypropylene fiber cooling towers, and wastewater; and in- for upholstered, automotive, industrial, dustrial process systems such as petro- and agricultural fabrics
indication that we have got too much expense and that we need to be a lot more tidy around the house," he explains. Hercules spent about $61 million on R&D in 1998 based on the "pure" definition of the activity the Securities & Exchange Commission (SEC) requires. The SEC definition of R&D restricts it to product development and formulation and specifically excludes technical assistance to users of a company's products. That puts Hercules spending on R&D as a percent of sales at about 3%-—fairly consistent with other chemical companies. "Our total technology spending, which includes things outside the strict SEC definition, is just a little less than 5%," Elliott says. "I think those kinds of numbers for our kind of company are about right. And that is about where we will be with the combined businesses." But more important than the amount of money Hercules devotes to R&D is the renewed importance R&D has at Hercules, Elliott says. "In the early '90s, we took a lot of cost out of research. We focused the people on research that generated close-in results. And what happens in that environment is that you lose a lot of innovation because you are focusing on something else. At the time, that was proper and correct, but the consequence clearly was a reduction in the innovative atmosphere, spirit, and results." Hercules decided it had to renew its R&D effort in 1995. Vincent J. Corbo, now the company's president and chief operating officer, "was asked to reignite our research efforts. And he went at it as you would expect an engineer to go at it,"
Elliott recalls. "He did so by asking What do we need?' and What do we have?'" Once Corbo determined where the gap was, he determined how he was going to fill it in. "By the second half of 1996, we decided we were going to absolutely fund an expansion in R&D and we were going to find the people to do it," Elliott says. "We started a hiring effort. I think we had about 100 vacancies tofillfor the particular kind of talent we wanted." In both 1997 and 1998, Hercules hired close to 50 people tofillvacancies in R&D "until we put a freeze in when we announced the BetzDearbom transaction." Elliott says the company now has about 1,100 scientists, technicians, and their assistants employed in research and technology efforts. For the most part, "we got all those competencies we wanted, and that put a huge amount of spirit back into the research folk." Although a few people have been lost through attrition, and a few more may leave as Hercules integrates with BetzDearbom, Elliott says research will fuel a good deal of internal growth at Hercules. R&D should help Hercules get manufacturing cost improvements of 5% per year and should also help the company get 30% of its sales from products less than five years old by 2000, according to Elliott. That is up from 14% of sales from new products in 1996. Last year, the company was up to 16%. Both the quantity and quality of new product launches are on the upswing, he says. In 1994 and 1995, the company was launching about 30 new products per year. In 1998, that number was up to 83. Those numbers do not in-
elude the new products from recent ac- sources, because it will be a few years quisitions. Counting them in should put before Hercules can consider more sizeable acquisitions. Elliott says he is interHercules even closer to its goal. So given those R&D targets and Her- ested in what biotechnology can do for cules' successful acquisition of promis- the company's businesses. 'We've taring businesses, Elliott muses, "Hercules geted biotransformation as the one area should again be a darling on Wall Street. that we are paying for as a corporation. Right? Don't we wish. Instead, we've But [our efforts are] very focused. Biofound that the investment community is transformation is a huge continuum. We have no interest in doing anything other taking a wait-and-see attitude." Among those taking that attitude is than focusing on our products and trychemicals analyst William R. Young at ing to understand whether or not there the New York City-based investment is a way enzymatically to significantly banking firm Donaldson Lufkin & Jen- improve what can be done." rette. Although Young figures Hercules Hercules has already conducted bioshould be able to achieve its synergy tar- transformation research on a paper gets for the BetzDearborn acquisition, chemical product it expects to introduce and should also succeed in paying down commercially next year, oxidized guar debt, he believes "BetzDearborn doesn't gum. Elliott believes that biotechnology add much to Hercules' growth rate." research may also help Hercules improve Hercules is ahead now in cutting other paper chemicals as well as the comcosts, but the company "is doing the pany's lines of resins, cellulosics, and easy things first," Young says. Will Her- food gums. It recently formed a partnercules gain enough from cross selling ship to develop proprietary industrial proBetzDeaborn products to current Her- cess and product enzymes with biotechcules customers and vice versa? Will nology research firm Kairos Scientific they achieve significant savings from based in Santa Clara, Calif. material management efforts? "They Hercules is also directing expansion swear they will do it. If they can, the efforts at overseas markets. The compastock price will go up," he predicts. ny currently derives 44% of sales from But chemical analyst and first vice U.S. customers, 37% from Europe, 12% president of investment banker Merrill from Canada and South America, and Lynch in New York City, John E. Rob- 7% from the Asia-Pacific region. erts, says Hercules is in a better position "Latin America is clearly on our to compete since it made its recent ac- screen as a growth opportunity," he quisitions. Refiners are merging, paper says. Markets in Argentina, Brazil, chemical customers are merging, and Peru, and Chile are particularly ripe for that puts pressure on suppliers to Hercules' polypropylene fiber and water merge and offer lower costs, he says. treatment sales, according to Elliott. Hercules' actions are therefore a "logi- And "Asia is a geographic expansion cal response." The cost savings Hercules promises to achieve, and the company's excellent record of cutting back and managing costs in the early '90s, means Hercules has a lot of credibility Producing a fast-growing chemical that as far as Roberts is concerned. costs $2,500 per kg and is made by only Analyst Leslie C. Ravitz with New one other company would seem like the York City stock broker Morgan Stanley ideal business to enter, but so far comDean Witter is even more bullish than petitors seeking to challenge HoffmannRoberts. Although he says he recogniz- La Roche in the astaxanthin market es that "earnings have not grown in the aren't having much luck. past two years and that this is the issue Astaxanthin is a pigment in the carowith the stock," he thinks the recent ac- tenoid family that is added to the food of quisitions will bring about some positive farm-raised salmon, trout, and shrimp. changes. Ravitz says he sees "a few It gives their flesh and skin the desirmore bumpy quarters, but Hercules' able pink hue that in the wild would be earnings should begin to accelerate as acquired from eating algae. expected cost savings push margins upRoche, for years a producer of the ward. Hercules is one of a few compa- vitamin-like substance beta-carotene, nies where I see a good chance of up- started large-scale production of astaside earnings surprises in mid-1999." xanthin in 1990 in Sisseln, Switzerland. Hercules continues to look for ways The company says its plant has enough to expand the company with internal re- capacity to supply twice the current glo-
point for us, too," he adds, citing a new carrageenan facility in the Philippines put into production in 1998. The carrageenan plant partly replaces a plant the company shut down in Denmark. It produces carrageenan through the gel press method, "which is different and less expensive than alcohol precipitation—the process used in Denmark. The cost difference between those two technologies was on the order of 25 to 28%," Elliott says. Other expansion efforts are also under way in China, where the company recently opened a paper chemicals facility near Shanghai that "sold out almost immediately. On the day that we formally opened the plant, we also approved an expansion. There have been lots of new modern paper plants in that part of the world and in China. Those paper mills need our higher technology," he says. Hercules also has plans to build a hydrocarbon resins plant near Beijing with partner Beijing Yanshan Petrochemical Group, and it may soon expand polypropylene fiber production at an existing facility in China. Although Elliott declares 1998 a pivotal year, he knows that in 1999 Hercules will have to make things happen. 'The job of 1999 is execute, execute, execute. That is what we have to do. We have to make sure the balance sheet is in good shape, and then we can do some other things," Elliott says, eyeing other potential acquisitions. "But that will be two or three years from now." Surely enlarging a company is at least as difficult as reducing a company to its most profitable parts.^
Astaxanthin market a ha d one to crack bal demand for the pigment. Roche doesn't disclose sales or production capacity, but others estimate the world astaxanthin market at about $175 million last year, and growing quickly. Not surprisingly, several other firms want to break Roche's astaxanthin monopoly and are trying to enter the market. In a twist, they are pursuing three different technologies for making the pigment. Similar to Roche is fellow betacarotene producer BASF. The company started pilot astaxanthin operations at its Ludwigshafen, Germany, site in mid1998, and it opened a commercial plant early this year. BASF claims all major aquaculture players are now customers, although others say BASF has yet to supply significant amounts. APRIL 5,1999 C&EN
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