Fluid Dynamics

When Lubrizol's 2004 results came out earlier this month, Wall Street cheered. The company's acquisition of specialty chemical maker Noveon last June was looking more and more like a winner.

The acquisition of the $1.3 billion-a-year firm added several high-growth personal care and specialty product lines and provided an alternative path to the traditional low-growth fluid lubricant and fuel additives business. "Together we can do better than either one of us could individually," James L. Hambrick, Lubrizol's chairman, president, and chief executive officer, tells C&EN.

But Lubrizol could just as easily have started on a dynamic downward spiral with its purchase of Noveon.

Last April, when Lubrizol announced that it had agreed to buy Noveon for $1.8 billion, many thought the company had overpaid. A group of financial investors--including AEA Investors, Credit Suisse First Boston, and MidOcean Capital Investors--walked away with a $568 million profit on a three-year-old investment. When the deal was done, Lubrizol's outstanding debt had climbed from $938 million at the end of 2003 to almost $3.4 billion.

"They definitely paid a full price for Noveon," says Richard O'Reilly, an equity analyst at Standard & Poor's who calls the huge purchase "out of character" for the traditionally conservative company. Stephen O'Neil, an equity analyst at brokerage firm Hillard Lyons, agrees that Lubrizol "paid a pretty high price."

But it wasn't just the price that Lubrizol paid for Noveon, the former BFGoodrich Performance Materials business, that raised concern among investors. Just days before Lubrizol closed on the acquisition, the firm announced that Hambrick, then age 49, had early-stage testicular cancer and would immediately begin medical treatment.

While the firm assured investors that Hambrick would retain day-to-day responsibility for operations, it also said that then-chairman William G. Bares, who planned to retire at the end of 2004, would actively assist Hambrick in overseeing operations.

ACCORDING TO company insiders, Hambrick remained in daily contact with the firm's executives as he underwent the sort of aggressive chemotherapy that had been used so successfully to treat Tour de France winner Lance Armstrong. Internally, senior managers had their marching orders.

Donald W. Bogus, 57, president of the Noveon subsidiary, says Lubrizol had the benefit of a mergers-and-acquisitions committee that was set up to manage the firm's push into new markets. Bogus had joined Lubrizol in 2000 from PPG Industries, where he had headed specialty chemicals and industrial coatings units and was in charge of the Lubrizol acquisitions team.

Lubrizol didn't miss a beat, even though Hambrick could not always be physically present. At the end of June, the company cut 95 jobs at its Wickliffe, Ohio, headquarters to eliminate redundancies as a result of the acquisition of Noveon, based in nearby Brecksville, Ohio. Hambrick participated in the firm's second-quarter conference call with analysts at the end of July and said there were no negative surprises with the acquisition.

Late last summer, as Lubrizol got the okay from the Securities & Exchange Commission to sell $2 billion in stock and debt, the firm announced that Hambrick had successfully completed cancer treatment. Bares retired as planned at the end of last year, and total debt has been reduced by $400 million since June, to $3 billion.

In January, Lubrizol said it would close a fuel and lubricant additives facility in Bromborough, England, eliminating 69 jobs and saving $10 million annually. Earlier this month, Lubrizol released the year-end results that had Wall Street crowing. On a pro forma basis, sales in 2004 rose 16% compared with 2003, to $3.7 billion, while net income increased 40% to $156 million. The firm's 2005 earnings guidance of between $2.72 and $2.87 per share exceeded analysts' expectations.

"While the earnings were a mess, with a number of one-time and merger-related charges," the merger "seems to be working out," O'Reilly says. O'Neil acknowledges that the outlook for 2005 is a little better than he expected. "The acquisition of Noveon exposes them to fast-growing markets," he says.

With its newly gained heft and complexity, Lubrizol joins the ranks of similar-sized specialty chemical firms such as Eastman Chemical, Crompton, and Cytec Industries.

Lubrizol intends to continue work on the integration to reduce costs and become among the more profitable specialty firms. But debt reduction is the first order of the day. Hambrick, who is a chemical engineer with a B.S. from Texas A&M University, says that by "working on synergies, we are right on target to generate about $40 million per year in operating savings over the next three years."

The firm also plans to divest what Hambrick calls certain "underperforming and nonstrategic businesses" with total annual revenues of $300 million to $500 million. "We would use all the money we generate from the sale of those businesses to pay down debt." Lubrizol has hired an investment bank to advise the firm in the divestiture process, which it expects to complete by the end of the year.

While Hambrick won't say what businesses are for sale, Bogus acknowledges that Noveon businesses in dyes, flavors and fragrance, and rubber chemicals "are under review." During a conference call with analysts earlier this month, the firm said the coating additives business is not among the businesses targeted for sale.

DEBT REPAYMENT will be aided by what Hambrick calls "a tremendous operating cash flow." The lube additives business generated operating income last year of $244 million on sales of $2.0 billion. Lubrizol's goal is to once again achieve a solidly investment-grade ranking from credit-rating agencies, he says.

Despite the financial burden, Lubrizol executives say they are happy they didn't miss the opportunity to acquire Noveon, which had sizable businesses in personal care ingredients and in coating, ink, and other additives that together had sales of about $750 million. They complemented a $250 million business in additives for personal care, pigments, and other markets that Lubrizol had built up over 10 years through a series of small acquisitions.

The company maintains that such businesses fit very well with its fluid additive business approach. Lube additives, for instance, affect the wear, viscosity, and oxidation properties of a lubricant film on metal surfaces. Similarly, the personal care ingredients Lubrizol acquired from Noveon affect the performance properties of skin creams and hair conditioners. Additives for lubricants, personal care, and coatings all involve surface chemistry, Hambrick notes.

A "greater surprise" to Lubrizol were two Noveon product lines with about $350 million in sales that Hambrick says "we didn't include in our earlier view" of the combined company. Lubrizol executives thought that the Estane thermoplastic urethane (TPU) and TempRite chlorinated polyvinyl chloride (CPVC) compound businesses "really weren't for us."

TPUs can be formulated into hard telephone shells, resilient tennis shoe soles, or flexible medical tubing. CPVCs are heat-resistant thermoset plastics used in residential hot water plumbing systems, fire sprinkler systems, and chemical-resistant industrial fluid-handling systems.

However, Hambrick says, "when you really get in there and start looking at them, you find that those two businesses have a strong analogy to our specialty fluid technology businesses." Both the CPVC and the TPU businesses are "very highly formulated and very 'nichey,' " just as the lubricant additives business is.

And because CPVC and TPUs are formulated to deliver performance properties, "there is a very strong connection to what we already know how to do," Hambrick contends. "Despite the fact that the chemistry is different from what we're familiar with in lubricant additives, they work on the same business model."

Hambrick admits that Noveon might seem like a very large bite to those who follow Lubrizol. But as far as he is concerned, a big acquisition was always a possibility. Lubrizol needed to find new growth opportunities, and homegrown efforts weren't doing the trick.

A few years ago, the firm had high hopes for PuriNox, a stable blend of emulsifying chemicals, water, and diesel fuel that lowers engine emissions of nitrogen oxides and particulates. Though Lubrizol still hopes the fuel system will take off one day, Stephen F. Kirk, 55, president of Lubrizol Additives, says PuriNox is unlikely to get wide use without regulatory pressure.

GROWTH IN the worldwide lubricant additives business is relatively flat, Kirk explains. Lubrizol claims it has one-third of the $6 billion market for lubricant additives. And with just three other major additive package suppliers--Afton Chemical, Infineum, and Chevron's Oronite--there are no real consolidation opportunities.

But tighter engine-manufacture and air-quality standards require constant updating of additive packages. About 40% of the additive packages for internal combustion engines have been developed over the past five years. This is a costly exercise for which Kirk says Lubrizol is not always adequately compensated, but it does keep the business from becoming commoditized. And even though demand is slipping in Europe, growth markets such as China, where lubricant additive sales increased 40% in 2004, offer pockets of opportunity.

Hydrogen-fueled electric vehicles, which would not use the volume of lubricants required for internal combustion engines, are too far into the future to affect demand for lubricant additives. "We don't even factor fuel cells into our long-range strategic planning," Kirk says. And even if the hybrid gasoline-electric vehicles now coming into the market are a success, they still depend on internal combustion engines--and lubricant additives, he says.

Hambrick claims that lube additives will be a Lubrizol mainstay for the foreseeable future. "It is a very stable business. It is one we dominate globally from a marketing and technical position. And when I look at the risks lube additives face, compared to the upside opportunities that still exist, I see nothing to suggest that lube additives is not a place we want to be."

But given the reality of slow growth for lube additives, Lubrizol has long aspired to be more than just a well-oiled machine. As far back as 1993, Lubrizol acquired Georg M. Langer & Co., a German maker of additives for paint, coatings, and inks. And Lubrizol continued to grow outside of traditional lubricant additives. In 2002, it acquired Chemron, a maker of specialty surfactants for personal care, and Dock Resins, a coatings resins maker.

In 2003, the firm added to personal care ingredients with the acquisition of Dow Chemical's methyl glucoside and lanolin derivatives businesses. That year, it also acquired BASF's North American business in silicone products used for foam control. A few months before it bought Noveon, Lubrizol acquired Avecia's pigment dispersion additives business.

All the acquisitions introduced Lubrizol into markets with double-digit growth rates. "In the heyday of the specialty chemical industry 40 or 50 years ago, it was possible to invent your way into new markets," Hambrick says. But today, "there are no whole new classes of compounds and molecules to invent."

THE TRICK for Lubrizol was to gain entry into existing markets. The acquisition program of the past few years was meant to help the firm gain access to markets, product lines, people, and capabilities well beyond its traditional scope, Hambrick says.

With Noveon, Lubrizol now has the heft it needs to sustain a long-term push into new high-growth niche markets. Size for its own sake, though, is not what Lubrizol is about, Hambrick says. It is not about how big you get, he says, but it is about how a business grows by bringing valuable developments to its customers. This sort of qualitative growth sustains a business over the long term, he says.

Hambrick hasn't ruled out further acquisitions, though he acknowledges that paying for Noveon might keep Lubrizol away from the acquisition table for the time being. "Just because you make a large acquisition doesn't mean you've switched off all your external sensors.

"Intellectually, you've got to keep playing the game to stay in top form. Are we still interested in acquisitions? You better believe it," Hambrick says. The Noveon acquisition is, he hopes, the continuation of an upward climb that will double the size of Lubrizol over the next five years.