WSJ - Markets

Activist Paints Bleak Picture of DuPont’s Paint-Unit Sale

When DuPont Co. agreed to sell its paint-making unit to private-equity firm Carlyle Group LP two years ago, the chemicals giant was lauded by deal makers and analysts for fetching a rich price.

But not everybody looks fondly on the $ 4.9 billion deal. Last month, activist investor Trian Fund Management LP lambasted DuPont’s handling of the paint division as an example of corporate flab at DuPont and criticized its sale as a gift to Carlyle at the expense of DuPont shareholders.

The business “is a current and real-life example of the intrinsic profit potential of a DuPont subsidiary being overwhelmed by the costs imposed on it by the conglomerate structure,” Trian wrote to DuPont’s board.

DuPont has said it has had “constructive dialogue” with Trian and points to the sale of the paint business as progress on its own plan to slim down. Since the sale, DuPont said, it has trimmed corporate expenses equal to the amount of cash it had received from the paint unit each year and then some.

Other investors will soon get a chance to weigh in. Carlyle is readying an initial public offering for the unit, since renamed Axalta Coating Systems Ltd., according to regulatory filings. The stock-market debut of the new company will help determine whether DuPont gave the unit away or extracted a good price for a business it no longer wanted. On Thursday the company said in a filing that Carlyle hopes to sell about $ 1 billion worth of Axalta stock, or about 20% of its stake.

The issue is bigger than Axalta. As ever more powerful activist investors call for companies to break up or narrow their focus by shedding divisions, corporate boards are also under pressure not to be seen as selling off the family heirloom on the cheap.

Companies need to keep emotion out of such decisions, focus on economic analysis and convey their choices clearly to investors, said Gregg Feinstein, head of mergers and acquisitions at advisory firm Houlihan Lokey, who advises activist investors as well as companies. “For example, how much are you going to get after tax and what are you going to do with the proceeds? And will your share price over the short and long term be higher or lower as a result?” said Mr. Feinstein, who wasn’t involved in the DuPont deal.

DuPont Performance Coatings, the paint unit’s previous name, dates to 1923, when DuPont invented a fast-drying finish that cut the time to paint cars to a couple of days from weeks, helping to speed mass production. DuPont’s logo—and paint—adorned the Chevrolet of race-car driver Jeff Gordon, which is now emblazoned with Axalta’s A-shaped insignia.

When DuPont decided that the division was growing too slowly and put it up for auction in 2012, several private-equity firms answered the call. Big buyout funds often pursue corporate “carve-outs” in which they use debt to buy unwanted business units and then retool their operations and finances with a view to selling at a hefty profit.

Before the auction, in a sign of the deal’s importance to Carlyle, it sent David Rubenstein, one of the firm’s founders and its public face, to DuPont’s headquarters in Wilmington, Del., to meet with Chief Executive Ellen Kullman .

Competition was fierce. Carlyle outbid competitors including KKR & Co. and Apollo Global Management LLC, agreeing to pay $ 4.9 billion and take on $ 250 million of worker pension costs. Other bids were closer to $ 4 billion, according to people familiar with the matter. Rivals and deal makers scoffed among themselves at the price, saying Carlyle had lost its discipline.

But Carlyle executives were elated. “They have 80,000 customers in 120 countries. We love the geographic diversity,” Greg Ledford, who leads Carlyle’s transportation and industrial deals, told The Wall Street Journal when the deal was announced.

After the deal closed in February 2013, the tedious work of a carve-out began. Carlyle spent more than a year separating Axalta’s computer system from DuPont’s, according to people familiar with the matter. Of 17 top executives, 12 were replaced, including the CEO and chief financial officer. Carlyle boosted the company’s sales force in emerging markets and launched $ 153 million of expansion projects at factories in Germany, Mexico, China and Brazil.

Revenue has increased modestly, though the volume of paint sold has declined, Axalta said in regulatory filings.

Those filings, made in August, gave a glimpse into the business’s performance before and after the sale, and with and without the corporate costs DuPont extracted from the business when it still owned it.

The figures grabbed Trian’s eye. Trian, run by Nelson Peltz , Peter May and Ed Garden, first invested more than $ 1 billion in DuPont in early 2013 but concluded the conglomerate wasn’t doing enough in response to its suggestions to boost shareholder value. When Trian went public with its arguments, it zoned in partly on Axalta.

About $ 230 million of the business’s annual sales had been used to help fund DuPont’s corporate overhead. Trian notes that without that cash drain, Axalta’s earnings before interest, taxes, depreciation and amortization—or Ebitda—in 2011 amounted to $ 568 million. Including the payments to its corporate parent, Trian estimates, the paint unit’s Ebitda that year was $ 339 million.

Trian argues that DuPont should have spun off the paint business to its shareholders. That would have avoided taxes on a sale, which amounted to about $ 900 million in the Carlyle deal. DuPont executives decided that if the business was a bad fit for DuPont, its shareholders probably wouldn’t prize the stock, according to a person familiar with the company’s thinking.

Trian credited Carlyle with cutting other costs that helped boost profit margins. It separately criticized the overhead the business had to carry under DuPont, arguing that DuPont could have made the same cuts as Carlyle. DuPont this week said that the quest to trim expenses after the sale has led to cuts of about $ 1 billion.

For potential investors in the IPO, the results may not be as glorious as Trian paints them.

In the buyout, Axalta took on about $ 3.9 billion of debt to go with $ 1.35 billion of cash that Carlyle put into the deal. Last year, Axalta paid about $ 211 million in interest on that debt, according to the IPO filings. That debt isn’t reflected in Ebitda, which measures profit before interest payments and other expenses.

With expenses such as buyout debt included, Axalta’s bottom line looks worse after the deal: Its net income fell from $ 243 million in 2012 to a loss of nearly $ 90 million last year.

Write to Ryan Dezember at Markets

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