Air Products: D.E. Shaw and Mantle Ridge focus on critical improvements to boost shareholder value

Company: Air Products and Chemicals (APD)

Air Products is an industrial gases company that serves energy, environmental, and emerging markets. Its core business provides customers in various industries, including refining, chemicals, metals, electronics, manufacturing, and food, with essential industrial gases, related equipment, and applications expertise. Additionally, Air Products develops, engineers, builds, owns, and operates clean hydrogen projects to support the transition to low- and zero-carbon energy in heavy-duty transportation and industrial sectors. The company also provides turbomachinery, membrane systems, and cryogenic containers globally. Air Products has operations in approximately 50 countries.

Stock Market Value: $73.83B ($332.10 per share)

Activist: D.E. Shaw & Co

Percentage Ownership: n/a

Average Cost: n/a

D.E. Shaw is a large multi-strategy fund that is not traditionally known for activism. Despite not being an activist investor, the firm uses activism as an opportunistic tool when it believes it may be beneficial. D.E. Shaw focuses on identifying solid businesses in good industries and, if it identifies underperformance that is within management's control, it takes an active role. The investor values private, constructive engagement with management and often reaches an agreement with the company before its position is made public.

What's happening

Air Products' board has received a proposal from D.E. Shaw to enhance shareholder value by implementing measures such as improving capital allocation, refreshing the board, and restructuring executive compensation.

Behind the scenes

Air Products specializes in industrial gases and equipment for various end-markets, including refining, chemicals, metals, electronics, manufacturing, and food. The company's industrial gas business is highly stable and low risk, with a functional risk-free, inflation-protected, senior secured bond status when kept pure. The nature of the business involves long-term "take or pay" contracts with customers that have high renewal rates exceeding 95%. The industry has significant barriers to entry, and the contracts are inflation-protected. These long-term contracts effectively guarantee an unlevered double-digit return before Air Products needs to invest any money. When committed solely to its core business, this enterprise is highly stable and well-valued.

In 2016, Air Liquide finalized its purchase of Airgas, and in 2018, Linde and Praxair completed a merger of equals. Before Air Products knew it, the company was the odd man standing, and it was standing all alone. CEO Seifi Ghasemi's expansion solution, having missed out on combinations with pure-play peers, has been to pursue non-core business expansion. Departing from its longstanding strategy in the traditional industrial gas business model that generates dependable capital returns, the company has moved up along the risk curve towards more speculative investments without locked-in revenue through several clean hydrogen project investments. Across five investments — the most notable of which being the Air Products' NEOM Saudi Arabia green hydrogen project and its Louisiana blue hydrogen project — the company expects to spend nearly $12 billion of capex. When initially planned, Air Products did not have offtake agreements — agreements with buyers to purchase its future offerings — for four of the five projects (only 6% of capacity had offtake agreements). Today, over 80% of project capacity remains uncontracted.

Air Products' low-risk and stable cash-flowing operations are highly appreciated by investors. However, when the risk profile changes, risk-averse investors who have historically been attracted to companies like Air Products are likely to flee. On the other hand, investors with a larger appetite for risk may be less likely to invest in Air Products when it is diluted by a low-risk, stable business like its core industrial gas businesses. Additionally, peers Linde and Air Liquide have been able to execute on hydrogen projects with secured offtake agreements in place pre-construction and have focused on partnerships in line with their low-risk traditional business model.

Over the past five years, Air Products' capital expenditures as a percentage of sales have more than doubled, which is significantly higher than its peer average. Additionally, the company's free cash flow conversion has turned negative, while peers are averaging 92% since 2016. Furthermore, Air Products' return on capital employed is moving in the opposite direction of its peers. Despite management's belief that being a first mover in green and blue hydrogen and taking on higher risk should be rewarded with a higher multiple and stock price, investors disagree. As a result, Air Products has underperformed its peers and relevant benchmarks over the past ten years and is trading at a 20% discount.

D.E. Shaw has invested approximately $1 billion in Air Products and has made its engagement public after reaching out to the company over a month ago and presenting its value-enhancing plan to management on Oct. 2. However, the firm has encountered some resistance to engagement. D.E. Shaw has put forward a seven-point plan to improve value at the company, which includes a revised capital allocation framework and corporate governance. The plan focuses on de-risking existing large project commitments by signing offtake agreements at reasonable return hurdles, as peers have been able to do. Additionally, D.E. Shaw demands that the company commit to tying future capital investment to offtake agreement milestones. The firm also wants the company to limit annual capex to $2 billion to $2.5 billion beyond 2026, with a specific target of capex not exceeding the mid-teens as a percent of Air Products' revenue. D.E. Shaw argues that the company should immediately repurchase its discounted shares up to its three-times target net leverage ratio in fiscal year 2025 and direct future excess free cash toward additional repurchases.

D.E. Shaw has raised concerns about the lack of a formal succession plan for CEO Seifi Ghasemi, who has been serving in the role for a decade and has an indefinite contract. The company has not communicated a clear, credible, and transparent CEO succession plan, despite Ghasemi's compensation being far greater than both the company's peer average and S&P 500 average. D.E. Shaw is demanding that the company refresh the board with highly qualified independent directors, restructure executive compensation to improve alignment with strategy and performance, and form one or more ad hoc board committees to oversee these initiatives.

D.E. Shaw is a prominent multi-strategy fund that has recently become more active in using activism as a means to increase shareholder value. The fund has a skilled team with a track record of success in its activist engagements. Since the beginning of 2022, D.E. Shaw has launched six activist campaigns, securing board seats in five of them (L3Harris Technologies, Corpay, Fidelity National Information Services, FedEx, and Verisk Analytics) and successfully opposing a merger at the sixth (Diversified Healthcare Trust). The firm is renowned for its in-depth quantitative and technical research, which is demonstrated in its Oct. 2 presentation on Air Products. In this presentation, D.E. Shaw thoroughly analyzes the company's problems and presents proposed solutions.

Activists are frequently found in the same stock, especially at companies with strong underlying businesses but underperformance, missteps in capital allocation, and governance issues. On October 4th, Mantle Ridge announced a $1 billion investment in Air Products and echoed the sentiment of D.E. Shaw, identifying similar problems. While D.E. Shaw typically adds a minority of directors to the board and does not appoint a principal of the firm, Mantle Ridge historically reconstitutes a majority of boards with its founder, Paul Hilal. While some investors and CEOs may view the activist principal on the board as negative, we see it as a positive signal of long-term engagement and the activist investor's preparedness and assertiveness at board meetings. It is worth noting that in three previous campaigns, Mantle Ridge never placed more than one of its own insiders on the board and always had a slate of impressive, independent directors.

D.E. Shaw is seeking three seats on Air Products' nine-person board, including one for Scott Sutton, the former CEO of Olin, who oversaw a stock appreciation of 379.2% as CEO from Sept. 1, 2020 to March 18, 2024, versus 28.3% for the Russell 2000 over the same period. The two other seats will likely be impressive public company executives with a track record of creating shareholder value. While D.E. Shaw's investment thesis has some overlap with Mantle Ridge's plan, there are two glaring issues that both investors prioritize: CEO succession planning and capital allocation refocus. We strongly expect that many of Air Products' other shareholders are concerned about the same issue. So, the question here is not whether there will be change, but what will that look like. Having two different activists gives the company some optionality to settle with the one it thinks will be a better fit. D.E. Shaw likely means fewer new directors and no activist principal. But Mantle Ridge has a pre-existing relationship with the company, as well as some of

Ken Squire is both the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments.