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ONE-ON-ONE - December 2005
by Ed G. Lane
'We Are No Longer Ashland Oil'
The head of Ashland Inc. outlines how and why the company is changing its focus
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James J. O'Brien
James O’Brien is the chairman of the board and CEO of Ashland Inc., a Fortune 500 chemical and transportation construction company headquartered in Covington. Prior to being named to his current position, he served as senior vice president and group operating officer for Ashland Distribution and Ashland Specialty Chemical. He has also served as president of Valvoline, a division of Ashland. The Ohio native is a graduate of Ohio State University, where he earned a bachelor’s degree in accounting and finance and a master’s in business administration. A volunteer “big brother” with Big Brothers/Big Sisters of the Bluegrass, O’Brien is on the organization’s national board of directors and is also a member of the American Chemistry Council, chairman of the board of trustees for Midway College, and a member of the Association of Governing Boards of Universities and Colleges. |
Ed Lane: The Lane Report’s last major Ashland interview was conducted in 1998 with Paul Chellgren, who preceded you as CEO. During that interview, Chellgren discussed the then-recent merger of Ashland’s petroleum division with Marathon Oil and plans to reposition the corporation for the 21st century. Under your leadership, Ashland sold its ownership in Marathon Ashland Petroleum LLC (MAP) in a transaction valued at $3.7 billion. That sale was effective on June 30. Why did Ashland decide to go ahead and sell its 38 percent interest in MAP?
Jim O’Brien: When the original MAP merger transaction was structured in 1997, it contained an exit strategy. Marathon had the option to buy Ashland’s MAP interest on or after Jan. 1, 2005. If Marathon exercised its call, it had to pay a 15 percent premium above market value. If Ashland exercised its put to sell its interest, the sale price would be discounted by 15 percent.
About two years ago, I made it very clear that Ashland would not take a 15 percent discount on the value of this asset. But, obviously, for Marathon to pay a 15 percent premium on a call, it would have to buy MAP at almost “trough” prices to justify a 15 percent premium to their shareholders and board. So it was unlikely that Marathon would call Ashland’s interest at a peak price environment. Not to say Marathon wouldn’t, but it was unlikely.
During the last two years, the petroleum business had its up and down vagaries. To avoid having the timing left strictly up to Marathon, Ashland wanted to negotiate an exit. It was best to negotiate an exit for Ashland’s shareholders versus just waiting for whatever time frame Marathon felt was in its best interest. Those negotiations took well over a year. Subsequently, Marathon and Ashland came to a final mutual agreement in April and closed at the end of June 2005.
In early 2005, the valuation of oil properties just skyrocketed – gasoline and distillate got tight. Ashland was also fortunate that the MAP closing was delayed by the IRS review. These events allowed Ashland additional time to negotiate and to further improve its values. And during that time, other similar sales transactions took place and provided benchmarks to help value the MAP sale transaction.
EL: Could you summarize how the purchase consideration was paid?
JO: The transaction was structured to help satisfy tax requirements. It was important that the $3.7 billion that Ashland received be tax-free. Our management also wanted a sizeable dividend paid to Ashland’s shareholders at closing. Ashland shareholders received about $936 million, or $12.62 in Marathon Oil stock for each share of Ashland stock, as well as shares in the new Ashland.
EL: What was the response from Ashland’s shareholders?
JO: The sale had a high shareholder acceptance rate. Ninety-eight percent of shareholders voting approved – an unheard number for a transaction of this size. The shareholders were thrilled. As a matter of fact, I had three thank you notes from shareholders and one even sent flowers.
EL: How have the stock analysts responded to the spin-off of MAP and Ashland’s repositioning?
JO: Ashland is positioning for the future; it’s going to be a diversified chemical company with interests in road construction. So the analysts now covering Ashland are chemical analysts. Ashland probably needs another three to four analysts to cover it. The analyst community is now looking at Ashland as a chemical company and we’re pleased with that.
EL: What was Ashland’s major benefit in selling MAP?
JO: The sale will help Ashland complete its transformation from a refining marketing company with interests in chemicals to being a primarily focused chemical company. But it’s going to take some time; Ashland can’t reposition in a period of 12 or 24 months. It’s going to take years to do it right.
EL: What would you say is the most negative aspect of the sale?
JO: It will take time for Ashland to be perceived as a diversified chemical company after being thought of so long as a refining marketing company. Ashland has to re-establish its reputation to re-position in the market. Even today, people in Kentucky primarily still refer to Ashland Inc. as Ashland Oil. So that’s going to be a tough transition for people mentally to get over – that we are no longer Ashland Oil.
EL: Ashland Inc. is a Fortune 500 company. Will the MAP spin-off impact its ranking?
JO: No. MAP revenues were never counted in Ashland’s sales. Fortune 500 rankings are determined by sales and Ashland’s ranking did not change with this transaction.
EL: How did the sale of MAP impact Ashland’s debt/equity ratio?
JO: For all practical purposes, Ashland’s debt is zero. Ashland has about $1.4 billion in cash and the ability to take on about $2 billion in debt. About $3.4 billion worth of capacity is available to expand the corporation.
EL: What is the overall strategy for reinvestment and how might Ashland invest that money?
JO: Ashland is going to focus in diversified chemicals – primarily in the water and adhesive businesses. Ashland would like to redeploy assets in these types of industries because their growth is above GDP growth rates, they have nice margins, and the long-term future looks very strong. Ashland also holds strong positions in these businesses.
EL: What is Ashland’s area of interest in the water business?
JO: In industrial usage. So when you think of heat exchangers and big cooling towers, the water in these systems gets pathogens and needs to be treated. Ashland has developed non-chemical treatments to help clean and purify the water. The patented technology is called Sonoxide. These technologies are being developed by Ashland’s laboratories. Sonoxide just came out of the test market into the commercial phase. It’s a worldwide technology.
EL: Ashland is one of the top five publicly held corporations based in Kentucky. What is the possibility that some of Ashland’s new business development may be in Kentucky?
JO: When you look at how Ashland is organized today, its chemical sector is headquartered in Columbus, Ohio, and it’s a very large operation and will remain there. Our water business is in New Jersey and we’re trying to get it more coordinated with the Columbus, Ohio location. The road paving business is in Atlanta and it makes sense because APAC predominantly serves the Southeast and Southwest markets. Ashland’s headquarters are in Covington and there we have financial, executive and legal offices. That office will remain.
Valvoline is in Lexington but it is tied into the chemical sector in Columbus. If you look at Kentucky – besides the headquarters – investment is going to be limited. Ashland’s strategy is to follow its customers and they are moving to Eastern Europe, Asia and South America. Ashland has to be where our customers actually assemble and manufacture because Ashland’s products are building blocks not the end product.
EL: In reviewing financials for the FY ending Sept. 30. 2005, Ashland’s paving company (APAC) had some hard times because of bad weather and the rising price of petroleum-based products.
JO: When you look at the APAC business, it had a good year last year and not so good year this year. That’s been the history of the business. We’re trying to get sales and profitability more predictable and consistent. APAC has been changing some business processes to do that. At the same time, APAC is trying to get more structure work (bridges, culverts, and road improvements built out of concrete) that doesn’t require working the earth and getting the ground prepared to pave. APAC needs more work like that.
EL: APAC has about $2 billion in work under contract. If the cost of petroleum products that go into the asphalt increases, can those costs be passed through?
JO: 80 percent of APAC’s contracts have a provision to either put the market price into the finished product or APAC has a price guarantee from the supplier of the asphalt. The wild card is productivity and that’s where the weather comes in.
EL: Will Ashland develop corporately owned Valvoline Instant Oil Change locations or will the focus be on franchising?
JO: Valvoline Instant Oil Change has a sufficient number of company owned stores and our primary strategy is to franchise. Valvoline will continue to focus on the automotive industry for new products, and try to drive more products through its stores and at retail. Valvoline has been fairly successful at doing that during the past three or four years.
The last huge success was MaxLife motor oil – a product that actually created a whole new category for the industry. Now every oil company has a MaxLife knock-off, but Valvoline still has a substantial share of that product category since it was the first mover on it. The price of lubricants has gone up substantially. It’s been difficult to pass through 100 percent to the consumer and that hurt Valvoline’s sales last quarter.
EL: Looking at sales for the fiscal year ending Sept. 30, Valvoline’s lubricant sales in gallons went from 191 million to 175 million. Was the decline in sales related to the price of oil being higher or longer times between drains?
JO: Primarily, Valvoline chose to protect its profit margins while its competitors offered significant retail price discounts. Valvoline did not want to bring the price down to a level where the consumer would perceive that its motor oil is only worth X, when it’s really worth X+. Consumers may also be extending their drain (time between oil changes) either because they are following manufacturer’s recommendations and/or they may be trying to stretch their dollar on automotive purchases because the price of gasoline and motor oil is higher.
EL: In 2000, Valvoline’s market share of premium oils was around 10 percent and now it’s over 20 percent. That means that Valvoline chipped away at its competitors and doubled share over a five-year period.
JO: Our strategy is to gain share of the market.
EL: Valvoline is big into racing.
JO: Being in racing creates one of the primary personalities that the Valvoline brand exudes. We’ve been in racing for well over 60 years. NASCAR is the primary focus of today’s racing fan. It used to be open wheel was big, around the world – today Formula One is still very large. But in the United States, broadly it’s NASCAR.
Ashland is going to continue to find a way to participate in that success, but the price to race keeps going up. Valvoline obviously had a very successful run with Mark Martin. Ashland left Mark, Jack Roush and his team because the price was just getting astronomical. We’ve gone the route of having a joint venture. Ashland started a new one with Ray Evernham and his team. We’re hopeful that a relationship with Ray will bring our team better technology and make us competitive. We’ll see.
EL: Ashland’s selling, general and administrative expenses increased about $125 million in FY 05. Were these costs related to the MAP sale?
JO: There were several transactional costs that were part of the MAP transaction. Retiring the debt cost almost $100 million. Ashland had a big insurance claim – because of the hurricanes – that was part of a mutual group called OIL. Ashland no longer wanted to be in a mutual and elected to just buy insurance from the merchant market. The company paid an exit premium to get out of that insurance contract. Also, there are additional costs when Ashland buys back or issues stock. There were a lot of options exercised this past year because Ashland’s stock did so well.
EL: About five years ago, Ashland Inc. moved its headquarters to Covington from Ashland. What are the benefits of being in Northern Kentucky?
JO: Ashland’s move is working out really well. The Northern Kentucky market is a very vibrant part of the state’s economy and also benefits from being part of the greater Cincinnati market. Having a major airport and the benefits of a big city like Cincinnati helps attract talent that Ashland might otherwise not be able to recruit. Ashland has access to a large pool of quality business, legal, and accounting services throughout the Midwest.
EL: Under your leadership Ashland has carefully evaluated its processes and streamlined its organization – do you anticipate that additional restructuring will be required?
JO: Yes. It normally takes about five to seven years for a company to incorporate all the process change that needs to be done and to get the organizational structure properly designed. Ashland just now started its fourth year. It is going to be a major impact year because Ashland is restructuring its supply chain and that’s going to require the company to make some significant changes.
EL: What is Ashland’s focus in research and technology?
JO: Ashland’s primary research, product development, and application lab is located in Columbus, Ohio. About 1.5 percent of the specialty chemical group’s revenue is spent on product development. A product development research lab for Valvoline was built about seven to eight years ago in Lexington and we have a lab for our water business in New Jersey.
EL: Where does Ashland recruit researchers?
JO: We try to hire well-regarded scientists in the industry, as well as recruit people out of the universities and train them.
EL: What two companies would you consider to be Ashland’s direct competition?
JO: Ashland competes with an array of companies but probably the one that matches up the best is Rohm & Haas. The firm is a diversified chemical company and it competes directly in every aspect of Ashland’s business.
EL: Because Ashland successfully markets its specialty chemicals, I presume that its clients have manufacturing problems that need to be solved.
JO: It’s called solutions. That’s one of Ashland’s primary value statements. We are solution providers. Our employees go into a marketplace and look for performance problems that manufacturers are having with materials. Ashland’s expertise can formulate products to overcome those issues.
EL: Regarding solutions, do you have any advice for Gov. Ernie Fletcher regarding the operation of state government?
JO: I have highest respect for the governor. Leaders in public service take on a burden and responsibilities that many business executives don’t choose to accept. Gov. Fletcher is a very capable person and I am sure he will deal with these issues and come out okay.
EL: What does the general public need to know about Ashland?
JO: Ashland is a company in transition. It will take time to mature and prepare itself for new opportunities. I’m a little concerned that even our employees at times think Ashland has cash available and it needs to be immediately invested into something else. My point of view is that I want to take the time necessary to carefully invest our cash, and not to be rushed or let the money burn a hole in Ashland’s pocket.
EL: Do you have a closing comment?
JO: Over the last two or three years, there’s been a marked improvement in Ashland’s position in its markets and its ability to earn sufficient returns for shareholders. Ashland is making consistent improvements every year, management understands what it takes to win, and our people are focused on that. Ashland is an intense place to work these days. Anybody who wants to come here to work and coast is in the wrong place.
Ed G. Lane is chief executive of Lane Consultants Inc. and publisher
of The Lane Report.
edlane@lanereport.com
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