Shareholders in Alcoa (AA +0.00%) haven't seen great returns on their investment recently, but the company has nevertheless taken steps to try to unlock value by tapping into many different trends at the same time. An emphasis on its value-add capacity for building custom premium components for key customers has been a huge success, but Alcoa has also worked hard to get its primary metals business into better shape by cutting costs to address rock-bottom commodity prices. Now, Alcoa has decided to break itself into two pieces, and CEO Klaus Kleinfeld hopes that the move will unlock shareholder value and be generally positive for the company as a whole. Let's look at what Kleinfeld had to say to investors about the split and what it means for shareholders going forward.
Why now is the right time for Alcoa's split
The potential for Alcoa to break itself into multiple parts has existed for a long time, raising the question of why Alcoa chose to move forward now. As Kleinfeld sees it, Alcoa's recent acquisitions of Firth Rixson as well as key players in the titanium business such as Tital and RTI International have made its value-add capacity much larger than it was when the company focused solely on aluminum, giving Alcoa the ability to deliver more of what its aerospace customers need from different materials. The value-add business will also include rolled products, where Alcoa has done well serving the automotive industry.
At the same time, the upstream side of the business, which includes mining, refining, smelting, and casting capability, has also taken huge strides recently. In the past, Alcoa's internal costs were fairly high, but the company has worked hard to replace high-cost facilities with lower-cost alternatives. The result has been a better ability to survive low aluminum prices, and low costs will continue to pay dividends even when aluminum prices recover.
What will happen to Alcoa's debt?
Whenever a company breaks apart, it has to figure out how to allocate its debt. Kleinfeld said that he expects the value-add business to have an investment grade debt rating, which would be a big improvement over the overall company's current rating at the highest notch of the high-yield debt spectrum. The upstream business will probably get more of Alcoa's current debt, but Kleinfeld still expects it to have a strong noninvestment grade rating even after the split.
Alcoa will also specifically have to address pension liabilities. The pension is currently underfunded by about $3.3 billion, and CFO Bill Oplinger said that it will have to add future pension liability into the overall consideration of debt in order to make likely bond ratings work going forward.
Did Alcoa just lose a key competitive advantage?
One of the reasons that Alcoa has cited in the past for its decisions not to break up the company was that it saw advantages in having a vertically integrated operation. Some critics of the deal now believe that the synergy within the organization will now disappear, offsetting some of its expected benefits.
Kleinfeld noted that by structuring the split the way that it did, many of its customers will continue to see their needs served by one particular division. Moreover, Alcoa expects that being able to focus on growth opportunities, especially in the value-add space, will more than compensate for any synergy issues that the company hasn't already solved.
When will the split happen?
Alcoa needs to go through plenty of steps before it can complete its planned split. Although the businesses themselves are in a position to move forward, Alcoa will need final approval from its board of directors, and it will have to get approval from the SEC. The key financial elements of how to allocate assets and liabilities will take some time to work out, and in addition to the debt considerations, Alcoa has to be certain that its split will be a tax-free event for existing shareholders, with the ability to defer gains and allocate tax basis between the two new publicly traded divisions going forward. In all, though, Alcoa thinks it can get the deal done by the second half of 2016.
With so many successful initiatives in recent years, Alcoa's move to break itself into two pieces reflects the direction it thinks will bring it the most opportunities going forward. Investors will likely have the better part of a year to assess the deal and decide for themselves whether they want to hold onto both parts of Alcoa's current business in the future.
