Germany’s Evonik Is Taking Shape

Last month, the private equity firm CVC Capital Partners paid more than $3.5 billion for a 25.01% ownership stake in Evonik Industries. The sale was a prelude to Evonik’s launch on the stock market and, its managers hope, to the end of a long-running German industrial soap opera.

Company executives look forward to finally shifting the focus away from the political and financial machinations behind the creation of Evonik and toward the growth and profit potential of the disparate businesses they are running. In particular, they see society’s need for greater energy efficiency as a unifying theme that will take all of Evonik forward.

Evonik, as anyone who has seen the company’s purple-tinged advertising campaign should know, is a less-than-one-year-old company composed of the former Degussa specialty chemicals business plus smaller businesses in energy and real estate. Less prominently acknowledged in Evonik’s promotional material is the fact that the company was created mainly to help its owner, the RAG Foundation, shut down Germany’s coal-mining business over the next 10 years.

Coal in Germany is a money-losing enterprise that employs some 34,000 miners and has many vested interests. The way in which coal production draws to a close is of intense interest to labor unions, federal and local governments, and the big German companies that long owned stakes in RAG.

The plan conceived in 2005 by Werner Müller, the former chairman of RAG and now Evonik’s chief executive officer, was to disentangle mining from the rest of RAG by creating two separate companies: an industrial firm that included Degussa, which RAG partly owned at the time, and a coal-mining operation.

Under the plan, RAG would take full control of Degussa. Its owners would then sell their shares in RAG for the symbolic price of one euro and wash their hands of coal. The proceeds from selling stock in the new Evonik would cover the coal industry’s environmental and other liabilities, which will continue well past 2018.

Klaus Engel, the head of Evonik’s largest unit, its chemical business, has been a part of the Degussa/Evonik saga on and off since completing his Ph.D. in chemistry at Germany’s Ruhr University in 1984. He joined Hüls, the Degussa predecessor company, that year and worked there for 15 years in R&D, plant management, and the corporate offices of energy giant E.ON, Hüls’s parent company at the time.

In 1999, Engel took a career detour into chemical trading and distribution, eventually becoming the chairman of the German logistics firm Brenntag. But in June 2006, when RAG completed its takeover of Degussa and chief executive Utz-Hellmuth Felcht was shown the door, Engel came back to chemistry as a member of the RAG board.

He says he brought back from his detour into logistics a better understanding of sales, marketing, and what customers want from a supplier. “At Hüls I had been heavily involved in R&D projects and managing assets,” he says. “What I learned at Brenntag was how to care for customers. That is something that chemical producers are lacking in their genes.”

Engel returned at a time of upheaval for Degussa and its employees. “I would not be completely honest if I said it has been a perfect process,” he says. Yet to some extent the employees were accustomed to it, he points out, having already been through years of reorganizations that accompanied the absorption of large chemical businesses such as Hüls, SKW, Stockhausen, Röhm, and Goldschmidt.

“We are living in an industry that is subject to constant change,” Engel observes. “The rebirth and spin-off of parts of big companies has become almost business as usual.”

He maintains that the recasting of Degussa and its new sister businesses as Evonik was both necessary and, on balance, a positive experience for employees and customers. “People are getting acquainted with Evonik,” Engel says, acknowledging that it took him some time to get used to the company’s bold signature “deep purple” color. Some Chinese customers, he adds, thought Degussa had turned into a fashion company.

Engel also acknowledges that the disparate nature of Evonik’s three businesses has some analysts viewing it unfavorably as a conglomerate. He prefers to see Evonik as a combination of stable, dividend-yielding businesses in energy and real estate and a growth-oriented chemicals business.

Moreover, all three are linked by a common goal to promote efficient use of increasingly expensive energy in their own operations and those of their customers—be they chemical buyers, energy users, or home dwellers.

Last year, for example, the real estate business refurbished a group of rental homes in Düsseldorf, Germany, with new windows, insulation, and heating controls to use 87% less energy than before. The carbon dioxide emissions associated with the housing complex are down by 160 metric tons per year. Likewise, Evonik says the last coal-fired power plant opened by its energy business operates at more than 45% efficiency, a full 5% higher than similar new plants.

Not surprisingly, though, it’s at the chemical business that Engel sees the biggest opportunity in energy efficiency. “The cautious use of energy has been a part of the chemical business for many years,” he says. “The issue is not new, but the situation today has motivated us to do even more.”

Evonik’s biggest thrust is in solar energy, where Engel says he is committed to investing close to $1 billion in the next several years. Evonik’s role in the industry is mainly as a supplier of raw materials to manufacturers of polysilicon, the key ingredient in a solar panel. The one exception is a polysilicon joint venture with SolarWorld that is set to open later this year in Rheinfelden, Germany.

Otherwise, Evonik is building facilities that will supply chlorosilane precursors over-the-fence to polysilicon producers. Two examples are The Silicon Mine, which plans to open a silicon plant in the Netherlands late next year, and Silpro, which is building a similar plant in France that is expected to open by 2010. The schemes allow chlorinated by-products to be recycled back to Evonik.

Engel thinks there’s a bit of a solar bubble right now, particularly in Germany where companies are being lured by generous government incentives. “We get 15 to 20 requests per month for projects,” he says. “There is a risk of a shakeout, so we are very careful in the selection of our partners.” For example, Engel won’t build a chlorosilane plant in China right now out of fear that Evonik’s intellectual property could be compromised.

Beyond solar, Engel sees multiple energy-efficiency opportunities in the auto industry. In tire manufacturing, he says, Evonik is the only chemical company to produce the rubber additives carbon black and precipitated silica as well as the organosilane cross-linkers that help silica bond to rubber.

“They make up a very sensitive triangle of performance levers,” Engel says of the three ingredients. “If you can decrease tire rolling resistance by 10???15%, you can save significant amounts of fuel and help the car industry with its CO₂ goals.” Working with tire manufacturers such as Michelin and Goodyear Tire & Rubber, he adds, Evonik has helped reduce rolling resistance without compromising tire performance.

Lithium-ion batteries for low-energy electric cars are another big automotive opportunity. Indeed, while visiting Evonik’s plant in Kamenz, Germany, in late May, Müller declared his goal to become Europe’s leading producer of lithium-ion battery components.

Evonik plays in the battery market two ways. Its Separion brand polymer/ceramic membranes have pores that allow lithium ions to flow from electrode to electrode yet block electrons from doing the same thing. Unlike the separators that caused a series of now-infamous laptop computer battery fires, these membranes won’t rupture or leak, the company claims.

Evonik also manufactures lithium-ion battery electrodes under the Litarion name. It opened an electrode facility in Kamenz in April, and on his visit Müller signaled that an expansion of the facility would soon be completed.

While silicon precursors and battery separators are directed almost exclusively at energy-efficiency opportunities, Engel notes that many of the engineering polymers and other specialty materials Evonik manufactures are valued at least in part for their light weight and, hence, energy-saving ability. He points to Evonik’s Rohacell brand polymethacrylimide foam, which is used to lighten aircraft such as the Airbus A380 jumbo jet.

Evonik’s capital spending is following the trend. “Roughly one-half of our investment in the coming years will be geared toward projects that support energy efficiency,” Engel says. In internal discussions, he acknowledges, some company executives have cautioned against overselling Evonik’s role in the fight against carbon dioxide emissions and climate change. “But when we made a serious analysis, we were surprised about our positive contribution to the climate challenge,” he says.

China is another big investment target. Although Engel is hesitant to invest in chlorosilanes there, he is generally bullish on the country. Evonik already employs some 4,000 people in China, more than it does in North America. And its second-largest-ever investment, a $400 million complex producing methyl methacrylate monomers and polymers, is under construction now in Shanghai.

Engel asserts that all of Evonik’s facilities in China will be built to the same safety and environmental standards that the company follows in Europe and North America. He claims not to be overly concerned about local competitors that might undercut Evonik by cutting safety corners. Although many Chinese chemical companies have a cheap-and-dirty reputation, Engel says that’s changing.

Evonik started up its biggest investment to date, a plant making the animal feed amino acid DL-methionine, two-and-a-half years ago in Antwerp, Belgium. It opened just as the bird flu epidemic was sweeping Asia and had a rocky first two years. But now the plant’s capacity is sold out and Engel says Evonik is eyeing the construction of another methionine facility, this time at its Mobile, Ala., complex.

Indeed, Engel is pretty happy with almost all of Evonik’s businesses these days. The company recently completed the sale of its initiators business and wants to sell its German business in nitrogen-carbon-nitrogen bond chemistry. “But other than that we are fine with our portfolio. All businesses are earning the cost of capital,” he says.

In 2007, the company posted a 2% increase in sales to $19.7 billion and a 14% increase in pretax earnings to $1.8 billion. Pretax earnings were up another 12% in the first quarter of 2008, Engel says, and so far this year the company has been able to pass on higher energy and raw material costs.

Although Evonik’s business performance may be strong, Tobias Mock, director of corporate ratings at Standard & Poor’s in Frankfurt, Germany, cautions that the company has a fairly high debt-to-earnings ratio—higher than Degussa did—and that it has sizable pension obligations. Moreover, Mock points out that the proceeds from CVC and any future stock offering are going straight to the coal mine fund, and not into Evonik’s coffers.

That may be so, but for now Engel is concentrating on the good earnings news and the fact that competition among private equity firms to buy a stake in Evonik was robust. CVC’s purchase puts an overall value on Evonik of almost $15 billion and, in keeping with Müller’s original plan, paves the way for a stock market launch in the next few years.

“It’s true that Evonik has undergone a period of vivid change,” Engel says. “But it speaks well to our business that with all the distractions involved in these processes our performance has not deteriorated. I think it reflects the strength of our people and the strength of our portfolio.”.