Ackman Copycats Risk Air Products Regret: Real M&A

Investors seeking to ride the coattails of Bill Ackman by buying shares of his latest target, Air Products & Chemicals Inc., may have little left to gain.

The activist said in a letter obtained by Bloomberg News July 8 that his firm would take a stake in a company trading at a “substantially lower multiple of earnings” than its closest competitor. Yesterday, he identified the investment as Air Products, which was 19 percent cheaper than rival Praxair Inc. last month, according to data compiled by Bloomberg. That gap has since shrunk to just 8 percent yesterday after Air Products shares reached an all-time high of $108.64, the data show.

The stock looks expensive after the price surpassed the average value analysts assign it, estimates compiled by Bloomberg show. While SunTrust Banks Inc. says Ackman may be able to unlock more value by pushing Allentown, Pennsylvania-based Air Products to divest some businesses, Alembic Global Advisors says the already simplified structure of the $23 billion company leaves few options.

“If Ackman was out there looking for this valuation disconnect, that gap has already been bridged now,” Hassan Ahmed, a New York-based analyst at Alembic, said in a phone interview. “It’s as fully valued as can be.”

Air Products is an industrial gas producer that provides oil refiners with hydrogen used to make low-sulfur fuels and steelmakers with oxygen to make furnaces burn more efficiently.

Lagging Returns

Since John McGlade became chief executive officer of Air Products on Oct. 1, 2007, the company’s shares advanced 11 percent through yesterday, lagging behind rallies ranging from 38 percent to 100 percent at Air Liquide SA, Praxair, Linde AG and Airgas Inc.

Last week, Air Products said it instituted a takeover defense known as a poison pill to prevent any one investor from gaining too much control after the company noticed unusually high volumes of stock trading. Ackman’s Pershing Square Capital Management LP began buying the shares May 22, according to a person familiar with the firm’s trading.

In its filing yesterday disclosing the Air Products stake, Pershing Square said the stock was undervalued, and that it would seek discussions with management, the board and other shareholders about topics including the company’s operations and financial condition. Pershing Square didn’t detail any specific changes it might seek.

A representative for New York-based Pershing Square declined to comment further.

Taking Steps

Air Products has “taken a number of steps in recent years that have allowed us to drive earnings and operating cash flow growth in a difficult economic environment,” David Reno, a representative for the company who works at Sard Verbinnen & Co., said in an e-mailed statement. “We are continuing to actively review additional steps we can take to further improve our operations and increase value to shareholders, and look forward to engaging with Pershing Square to understand their thinking.”

The stock had risen 9.4 percent this year through July 5, the last trading day before Bloomberg News reported Ackman’s plan to raise money for a large, activist investment. At the time, Air Products’ price relative to its trailing 12-month earnings per share was 17, compared with a multiple of 21 at Praxair, data compiled by Bloomberg show.

After rising 2.9 percent yesterday, Air Products’ valuation swelled to 20 times earnings, versus almost 22 at Danbury, Connecticut-based Praxair, the data show.

Today, Air Products shares fell 1.3 percent to $107.25.

Fully Valued?

There is no obvious way for an activist to boost Air Products’ share price further, Chris Shaw, a New York-based analyst at Monness, Crespi, Hardt & Co., said in a phone interview. The stock ended yesterday 5.5 percent above his $103 share-price estimate. The average estimate among analysts was $101.29 as of yesterday, according to data compiled by Bloomberg.

Ackman may see an opportunity to boost profitability at Air Products, which earned less per dollar of sales in the last 12 months than some of its closest rivals, data compiled by Bloomberg show. Its operating margin of 15 percent compares with 17 percent at Paris-based Air Liquide and 22 percent at Praxair. Munich-based Linde’s was 13 percent, the data show.

While there is room to improve Air Products’ margins, any additional gains for shareholders may be limited, according to Sachin Shah, a special situations and merger arbitrage strategist at New York-based Albert Fried & Co.

Limited Upside

Comparing the potential further gain on the investment to a hit in baseball, Shah said in a phone interview that it “seems more like a single or double rather than a home run. The upside is not necessarily behind you, but the materiality of that upside probably is.”

Air Products trades at a discount to Praxair for a reason and its lagging returns may not be easily remedied, according to Ahmed of Alembic. Praxair benefits from a more concentrated geographic focus, he said.

Getting Air Products’ returns in line with those of Praxair “is not a simple fix,” Ahmed said. “This is where, probably, Ackman got it wrong. The fact of the matter is that the portfolio of Praxair is very different than the portfolio at Air Products.”

Ackman could seek to boost the company’s valuation through sales of Air Products’ non-core assets such as its units that make chemicals and provide specialty gases to computer-chip makers, according to James Sheehan, an analyst at SunTrust.

Latent Value

“This company has a lot of value the market doesn’t seem to recognize,” Sheehan said in an interview yesterday on Bloomberg Radio’s “Bloomberg Surveillance.” “It may require a different kind of thinking to look at these non-core businesses in a different way and maybe focus the business more on the industrial gases, the core businesses.”

Air Products has already taken steps to streamline its business, including shedding process chemicals and non-pressure emulsions units in 2008. The simplified structure may limit divestiture possibilities, according to Ahmed.

“Now it is more of a pure-play industrial gases company,” he said. “In terms of further portfolio changes, frankly there aren’t too many opportunities.”

Buyers for the assets may also be scarce because the industry is consolidated to the point that any major transactions would spark antitrust concerns, he added.

Even without pushing for changes, Ackman likely already made money on his investment. Air Product shares have climbed almost 15 percent since the activist began purchasing them.

Any changes Ackman attempts to further boost the value will take time to play out, said Shah of Albert Fried.

“It’s premature to say, ‘Sell the stock,’” he said. “This is good for shareholders. But you have to have patience.”

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