in this issue
Dow Advanced Materials: Building a specialties franchise
2:45 PM MDT | July 15, 2013 | —Vincent Valk in Philadelphia
Dow Chemical’s advanced materials business aims to combine the scale of Dow with the customer intimacy of Rohm and Haas, its landmark 2009 acquisition.
Dow Chemical’s $18.8-billion purchase of Rohm and Haas in 2009 repositioned the company and created what Dow CEO Andrew Liveris and senior executives hoped would become an advanced materials and specialty chemicals powerhouse. At the forefront of that hoped-for powerhouse would be the company’s advanced materials segment, which consists of R&H’s legacy coatings and electronics businesses; functional materials, a hybrid of water, oilfield, and personal-care chemicals businesses that were legacies of both Dow and R&H; and Dow’s monomers and epoxies business. Advanced materials—which reports mostly within two segments, electronic and functional materials and coatings and infrastructure solutions—houses most of Dow’s specialty chemicals operations and is a major growth driver for the whole company.
“Our big competitive advantage is that we are able to tap into the big back end of Dow, the downstream molecules and the scientific understanding,” says Howard Ungerleider executive v.p./advanced materials. “We have 12,000 employees who wake up every day thinking about coatings, electronics, water, construction, home care, personal care, and food and pharma. [Our competitive advantage is] that combined with Dow’s big capabilities in science, technology, and scale.”
Advanced materials’ sales totaled about $13 billion during 2012, about 22.9% of Dow’s total sales, of $56.8 billion. Electronic and functional materials sales totaled $4.48 billion, coatings and infrastructure solutions sales totaled $6.9 billion, and monomers and epoxies accounted for the rest. For the first quarter of 2013, the most recently available data, electronic and functional materials sales totaled $1.14 billion, while coatings and infrastructure solutions sales totaled $1.67 billion. Electronics and functional materials generated $273 million in Ebitda during the first quarter, while coatings and infrastructure solutions generated $186 million in Ebitda.
“In electronic and functional materials, our goal is to grow 2 times (x) GDP, and in coatings and infrastructure we’re aiming for 1.5x GDP,” Ungerleider says. Dow is also aiming for a 25% Ebitda margin in electronic and functional materials and a 20% Ebitda margin for coatings and infrastructure solutions. “We have some work to do in coatings and infrastructure, but in electronics and functional materials we are pretty much there,” Ungerleider says.
Bridging the gaps
Getting to—and, Dow hopes, eventually exceeding—those targets required bringing an entirely new company with a long history into Dow’s fold. Headquartered at Philadelphia, R&H had built a specialty chemicals powerhouse on strong franchises in electronic chemicals and coatings. “In an integration of this magnitude, we had the full range, from irrational exuberance to abject fear to everything you can envision in between,” says Carol Eicher, business president/coating materials and building and construction and a 10-year veteran of R&H prior to the Dow acquisition.
“There’s nothing really magical to this,” Neil Carr, business president/functional materials, says of integrating two large companies. “You have to go through the process and allow yourself a certain amount of time.” Carr, a veteran of private equity, the pharmaceuticals sector, and cross-border M&A prior to joining R&H in 2006, says the cultural gap between Dow and R&H was not insurmountable. “Even allowing for different corporate cultures, there are a lot more similarities than both parties necessarily would have thought at first,” he says.
Probably the most important thing Dow did, executives in the advanced materials division say, was to leave the crown jewels of R&H alone. “We’ve been … left to manage our business,” says Dominic Yang, business president/electronic materials and another R&H veteran. “The coatings business structure stayed as it was for the most part,” Eicher says. Dow established the advanced materials headquarters at the former R&H building in the Center City neighborhood of Philadelphia, some 700 miles from Midland, MI. Ungerleider, as head of advanced materials and a member of Dow’s executive committee, regularly commutes by Dow shuttle flights between both locations.
Some businesses can illustrate both the differences and the similarities between Dow and R&H; Ungerleider cites water as an example. “At integration, we compared notes and both businesses were what management considered good businesses, but how they get there was very different,” he says. “The Dow water business before the merger went after large-volume applications.” Strong operational efficiency meant that, although these large-volume products had low prices, margins were strong. R&H “went after smaller, niche applications … [and] the prices were much higher [and] the cost to operate manufacturing facilities was higher,” Ungerleider says. However, “[t]he profit margins were within a percentage point of each other. The income statement looked different because of the way we went to market, but when you brought those two businesses together you get the best of both worlds.”
Getting employees to buy into an acquisition is always a challenge, but it’s largely been resolved, advanced materials’ executives say. People who were uncomfortable with the change have by now mostly left, according to Carr. “We’ve gone through that,” he says. “The integration, in my view, has been successfully completed, and I think the people who left are people who want to be here.”
The functional materials business—which focuses on microbial control, water, and home and personal care—has something of an enigmatic name, Carr admits. “When I talk to analysts, I don’t talk about the name; I talk about the business and end use markets.” The business is driven by two “strategic imperatives,” according to Carr. One is energy and water, which is led by microbial control and water treatment activities, and the other is consumer, which is focused on food, pharmaceuticals, and home and personal cares. “You have microbial control, pharma, and food, which is based on our cellulosics platform, and consumer and industrial solutions, which is our home- and personal-care franchise,” Carr says.
Functional materials is aiming to “aggressively grow” in five markets, Carr says. These markets are energy, water, food, pharmaceuticals, and personal care. “These five segments represent about 40–45% of our portfolio,” according to Carr. Most of the rest of functional materials sells into industrial markets, such as coatings or industrial facilities, which are “about profit and not necessarily [market] share. They fund the growth.”
All of functional materials’ businesses participate in the energy, water, food, pharmaceuticals, or personal-care markets at some point, tying the disparate strands of the business together. “In oil extraction, you might have microbial control; you might have water in waste treatment; you might have a polyacrylic acid in the antiscalant in the water during the extraction process; you might have cellulosics as a flow chemical in drilling,” Carr says. Energy—which plays into water treatment and microbial control—is functional materials’ fastest-growing business line. “Obviously hydraulic fracturing is a big driver,” Carr says.
The business will try to compete for major accounts, even in commoditized product lines, to establish relationships that can lead to innovation and higher-value product development down the road. For example, Dow provides Procter & Gamble (P&G) with a low-cost formulation for powdered laundry, helping to establish Dow as a trusted, reliable supplier that P&G can work with on laundry pods, which are more technically demanding. “We are going to come up with an agreement with margin that we can both live with and treat it like the commodity it is in how they buy it. We guarantee them the volume, we’re a strategic supplier, and now we get to innovate,” Carr says. “You can’t have all the nice, choice, sexy stuff if you don’t take care of [your customers].”
Communication is key
Customer relationships are a key priority for Dow’s electronic materials business as well. “Some people look at this as a technology business, but before technology it is a relationship business,” Yang says. “If you can get information from your customers more quickly and accurately than your competitors and share it within your organization, then you can be successful.”
Customer intimacy is crucial because of the fast-changing nature and quick cycles of the electronics business and because of electronic materials’ highly specialized products. “If our products are not successful for that customer for that layer, then we don’t sell the stuff to anyone else” because it is tailored to specific applications for specific customers, Yang says. Electronics customers also stress reliability, he adds. “Once you’ve proven yourself in your technical performance and quality, it’s insurance [for customers],” Yang says. “They don’t want to stop the operations of a $7-billion [fabrication plant], so they go back to the trusted partner.”
Such fabrication plants, which manufacture semiconductor chips, constitute the largest portion of electronic materials’ business: About half of annual revenues are derived from lithography and chemical mechanical planarization process technologies, according to Yang. The remaining half is split about evenly between interconnect technologies, which makes metallization products for circuit board manufacturing, and display technologies. About 80% of electronic materials sales are in Asia, Yang adds.
When Dow acquired R&H, Yang’s goal “was to land electronic materials’ customer focus within Dow,” and he thinks “we have done that fairly well.” The business focused on customers to the extent that “if, in a presentation, the name of a customer or the word customer didn’t come up by the third or fourth slide, you heard about it. It was very natural for us, but if someone outside the business came in [he/she] saw it and pointed it out,” Yang says. The short cycles and the intense customer focus were aspects of the business that were new to Dow—but Dow adapted to them. “I think Dow was at first surprised by the intensity and the shorter cycles, but it has learned that this is how we work,” Yang says.
A new cycle
In contrast to electronic materials, coatings and construction sales cycles tend to be long. The construction business “is risk averse and slow to change,” Eicher says. “So when you bring out new products, they must be compelling—but they are sticky.”
Nevertheless, customer intimacy is important for other reasons, since building and houses contain far more variety across the world than semiconductor plants. “It is a very regional, almost local, business,” Eicher says. Building code differences and consumer preferences, both in terms of different kinds of paints and construction materials and different levels of consumption, mean that the business must have a strong presence where customers are located. Dow’s coating materials and construction materials business has 37 manufacturing sites worldwide, Eicher says. The coatings business also has R&D operations that test the performances of paints in different climates around the world.
Another unique aspect of the coatings business is its level of back-integration. While all of advanced materials’ business source some raw materials from other parts of Dow, the level of raw material integration in coatings far surpasses that of the other businesses. ”We have a much stronger network for raw materials and a broader range of tools,” Eicher says. Although R&H operated one large propylene monomers plants at Deer Park, TX, Dow can source monomers from locations in most regions.
Integration and growth
Dow’s performance monomers and epoxies business, which supplies coatings, among others, is near the center of the company’s raw materials integration. About 50–70% of the business’s products are consumed for internal production, according to business president Pat Gottschalk.
Integration has also been a boon to advanced materials’ R&D efforts. Dow’s research chemists have access to a “critical mass” of research data, including Dow and R&H experiments going back decades, says A.N. Sreeram, v.p./R&D at advanced materials. Such “high-throughput” frees up chemists to perform a larger number of higher-quality experiments, with the benefit of access to reams of relevant data, Sreeram adds.
Looking ahead, the fastest growth for all of advanced materials is expected to come from the smartphone and tablet end markets, in electronic materials. Revenue growth for Dow in those markets was around 40% for the past year, according to Ungerleider. “The long-term trend is less, of course, but still around 20%/year or more for the next several years,” he adds. The water and process solutions business—which is reported under coatings and infrastructure but organized within functional materials—operates in a market posting 10% annual growth, making it another big focus for expansion. “This is driven by population growth, urbanization, health and wellness trends, and the need for more process water in industrial applications,” Ungerleider says. The coatings business, which has suffered in recent years because of the weak US construction market, is expected to pick up as that market improves and also as paint consumption rises in emerging economies.
Advanced materials, like the rest of Dow, is focused on organic growth and helping the company pay down debt. The business is interested in small, technology-focused M&A, such as the 2012 purchase of Lightscape Materials, a research firm with phosphors intellectual property in the display space, says Ungerleider. Similar, technology-focused deals in water have been completed, and advanced materials will look at other acquisitions in those areas, he adds. However, M&A is a small component of advanced materials’ overall plans.
Electronics and functional materials right now have a higher return on investment than coatings, meaning they will be targets for growth capital, Ungerleider says. The coatings business is still facing a headwind from the weak European construction market. Dow is in the process of closing six facilities in Europe.
Advanced materials is trying to grow and adjust its portfolio while maintaining Dow’s traditional focus on operational efficiency and R&H’s traditional focus on customer intimacy. “In today’s world, you have to be operationally excellent just to have a seat at the table,” Ungerleider notes. “Dow does this well. But what is special about advanced materials is bringing that while also maintaining customer application expertise.”