Cytec's Diamonds in the Rough

Until a few weeks ago, Cytec Industries seemed to be the sort of company that minded its knitting, working off its environmental liabilities, and, for the first time, paying a dividend this year. But that view changed earlier this month.

On Oct. 1, David Lilley, Cytec’s chairman, president, and chief executive officer, announced an agreement to acquire Belgium-based UCB Group’s Surface Specialties business for $1.8 billion. When it is completed at the end of this year, the deal will nearly double Cytec’s annual sales to $2.7 billion. And because of the heavy concentration of Surface Specialties’ sales in Europe and Asia, the acquisition will boost Cytec’s sales outside North America from 54% of its total to 65% and set it on the path for faster sales growth overseas.

The acquisition “will add a second jewel to our crown and better balance our portfolio,” Lilley, a chemical engineer with a degree from Cambridge University, told investors in a conference call following the announcement. The first jewel is the firm’s engineering materials business, which makes carbon-fiber composites for military and commercial aerospace use.

The deal with UCB made Cytec investors sit up, take notice, and get a little nervous. Cytec’s shares closed down $3.34 to $45.61 the day the deal was announced. But Lilley, 57, has acquired businesses for Cytec before. He tells C&EN that since 1997, when he joined Cytec as president and chief operating officer, the firm has made about 12 acquisitions-mostly small bolt-on businesses-and has prospered along the way.

This acquisition is more than five times the size of the largest of Cytec’s previous acquisitions, and it will make Cytec a force in the coatings business. Fiberite, bought in 1997 and the largest acquisition made by Cytec until now, made Cytec a significant composites maker.

As Lilley sees it, the Surface Specialties acquisition will not only enlarge international sales but will also be a “springboard to enlarge our presence in Asia.” While Cytec has only one plant in Asia now, the six additional plants from UCB will place it in a sweet spot where its other businesses also can take advantage of high-growth markets, Lilley says.

Cytec itself was spun off from American Cyanamid in December 1993. Since then, it has divested many nonstrategic businesses and nurtured internal R&D to develop new products. Lilley, who spent 19 years in a variety of positions with Cyanamid and its successor, Wyeth, helped Cytec’s first CEO, Darryl D. Fry, set up the company but then remained with Cyanamid. Cytec not only survived the wrenching ordeal of separation from its parent, but it also tamed what 10 years ago seemed nearly insurmountable environmental and retiree health care obligations.

UNLIKE THE seven-year-old Monsanto spin-off Solutia, which sought court protection from creditors last December, Cytec has prospered. Solutia had large environmental and retiree obligations, too. However, Cytec started life at a time when commodity and raw materials prices were not squeezing margins. And as Cytec concentrated on profitable business lines and sold others, it had the cash flow and the time to remediate many of the same liabilities that helped force Solutia into bankruptcy.

Right now, Cytec is on a roll, and is unlikely to stop its acquisitive habits with coatings. Once Cytec has absorbed Surface Specialties, Lilley suggests that the firm will be ready to consider adding to existing businesses in mining chemicals, phosphine chemicals, and polymer additives.

The UCB business will add $1.2 billion in annual sales and 2,900 people to Cytec, which now has $1.5 billion in sales and 4,500 employees. The acquisition gives Cytec facilities in Asian countries such as Malaysia, Thailand, South Korea, and Singapore, where it previously only had one in Japan.

It also gives the firm new positions in fast-growing powder and radiation-curable coatings. When the dust settles, coatings-related business will increase from 24% of Cytec’s sales to 55%. To head off potential regulatory concerns and also to reduce debt, Cytec said it would keep its own amino cross-linker business but sell UCB’s cross-linker business, which has sales of $140 million.

As part of the deal, UCB will accept a 12% stake in Cytec in partial lieu of payment. But analysts expect that UCB will eventually sell that stake as it concentrates on its remaining pharmaceuticals business.

“In the past, we’ve done smaller transactions. The largest were mostly under $100 million,” Lilley says. “Basically, we want to stick to market areas where we have focus today. And we want to avoid diversification into areas where we have no idea what’s going on.”

Cytec has shown a talent for making acquisitions that have enlarged existing business franchises. Seven years ago when it bought Fiberite-its first acquisition-it did a deal that in some respects parallels its latest one.

Early in its development, Cytec had identified advanced fiber composites used in aerospace applications as a growth area. In 1997 when competitor Hexcel ran into regulatory troubles in its attempt to acquire Fiberite, Cytec stepped in and bought Fiberite for $344 million. The new business, with about $250 million in sales, dwarfed Cytec’s own composites business with about $60 million in sales at the time.

Lilley points out that Fiberite, like the UCB acquisition, not only significantly enlarged Cytec’s composites business but gave it important technology positions, too. “We took over a business that was more than four times our size and added it to our existing engineering materials business. It was a significant leap forward and created this strong market position in good technology.”

In some respects, the Fiberite purchase was as significant a purchase for Cytec at the time as the coatings deal it just arranged. Aerospace composites went from being a tiny 5% of Cytec’s overall sales of $1.3 billion in 1996-the year before the Fiberite purchase-to more than 25% of sales of $1.4 billion in 1998.

In 1998, Cytec reinforced its composites position with the acquisition of aerospace composites maker American Materials & Technologies. In 2001, it acquired 3M’s composite business and BP Amoco’s carbon-fiber business.

INTERNALLY, the firm refined its technology to supply the carbon, aramid, and glass fabrics impregnated with epoxy, bismaleimide, and phenolic resins. Today, it sells those “prepregs” to military and commercial airplane builders for the advanced tactical fighter jets and fuel-efficient airliners coming into the market. “We had organic growth and acquisitions leading to this excellent market position,” Lilley says.

Cytec has also followed the same philosophy with its other businesses. For instance, last year it acquired Avecia’s metal extractant products business to strengthen its own mining chemicals operations with products for copper ore processing. On their own, Cytec’s researchers have come up with what they say is a breakthrough in processing technology for alumina-the feedstock for aluminum production-that will save energy and improve alumina processing efficiency.

“We’ve got the wherewithal to grow organically,” Lilley says. “We are looking for 6% sales growth every year. About 2% would come from new products out of R&D, 2% would come from geographic expansions into the Asia-Pacific region, and another 2% would come from growth in the economy. And that should yield earnings growth per share of 10%.”

Through the first six months of this year, Cytec has prospered. Sales of $837 million were 13% higher than for the same period in 2003. Income rose 11% to $60 million. Greenwich Consultants analyst Michael Judd pointed out in a report earlier this year that Cytec has investment-grade debt and a low-risk capital structure. And despite the high cost of energy and raw materials, he notes that the firm’s capital-intensive core basic chemicals operations generate substantial cash.

That “core” purchases “a high level” of ammonia, propylene, and natural gas to produce building block chemicals such as acrylonitrile, melamine, and methyl methacrylate, Lilley says. The firm has been able to pass the increased costs of energy and petrochemical feedstocks to acrylonitrile customers in Asia. However, it has been unable to fully recover the increased energy and feedstock costs in sales of products such as water treatment chemicals and polymer additives.

Asked whether Cytec would be better off without the distraction of a commodity chemicals business, Lilley says: “You could argue it is not strategic for us. We’ve shut down the plants that don’t make sense because we can buy ammonia and methanol cheaper than we can make it ourselves. But it’s a good business for us.

“Its prime aim is to provide us with low-cost, secure supplies of raw materials. Its economic role is to give us a positive cash flow at all points in the economic cycle. It is motivated to be cash positive, and we can use that cash to reinvest in our growth platforms.” However, building block chemical businesses are not Cytec’s reason for being. “We are ‘Cy-technology’ not ‘Cy-commodity,’” Lilley adds.

A component of the basic chemicals operations is the Cyro acrylic sheet joint venture with Degussa. It uses hydrocyanic acid, a coproduct of the acrylonitrile process, as a raw material to produce methyl methacrylate and acrylic polymers. Rumors concerning Cytec’s sale of its Cyro interest to its partner pop up now and again. “There are always talks about the future” between the two, Lilley says.

He points out that “we do not have a strategic position in methyl methacrylate and acrylic polymers globally. We want to be number one or number two on a global basis. This joint venture is a Western Hemisphere joint venture. So if ever Degussa wants to consolidate this business and make us an offer, then we will give it every consideration. But we will view it purely as a financial alternative.”

THE FIRM has other financial concerns: the potential impact of asbestos liabilities. Cytec joins other traditional industrial companies including Dow Chemical, Hercules, W.R. Grace, and Honeywell that must plan for asbestos liabilities. “Like many old companies, we had asbestos in all of our facilities-in our boiler houses for insulation, in the floor tiles, and in the roof tiles,” Lilley says.

The firm took a hard look at asbestos lawsuits, mostly from maintenance contract workers, about 18 months ago, after a flood of suits from Mississippi where tort reform was about to cut off filings. Cytec hired a consultant, who found that accruals and insurance proceeds were more than adequate to cover expected costs, Lilley says. At the end of last year, Cytec had 26,955 claims filed against it, had accrued $54 million of its own funds, and could draw on $29 million in insurance to defend itself and cover claims.

The legal cases are a distraction, Lilley admits, and they warrant continued attention. More important for now is incorporating the soon-to-be acquired UCB businesses into Cytec’s structure. That will include establishing a new surface specialties segment within the company and folding polymer additives, water treatment, and phosphine chemicals into a new performance specialties segment. Engineered materials, which include composites, and building block chemicals, are unchanged.

However, until the new structure is in place and Cytec fully incorporates the former UCB businesses into its structure, Lilley says Cytec is unlikely to make any bold new purchases. “We’ll polish this jewel first,” he says.