Elliott Turnaround of Arconic Is Longer Journey

(Bloomberg) -- After Elliott Management Corp. claimed victory in its boardroom battle at Arconic Inc. last May, I warned that the hard part was just starting. I didn't know the half of it.

Elliott's agreement to nominate three board directors capped one of the nastiest (and most bizarre) activist spats of the past few years, with former Arconic CEO Klaus Kleinfeld ousted over a threatening letter and soccer ball he sent to the hedge fund's founder, Paul Singer. Investors were looking for a regime change, and they certainly got one. Only two board members standing for election at today’s annual meeting started their tenures before 2016, and the company has made plans to scrap symbolic eyesores like a ritzy Park Avenue headquarters. Financially speaking, though, investors are worse off.

Arconic's market value has shrunk by almost a third since Elliott's settlement. At about $18, the stock is nowhere near the $33 to $54 price range the investor once said was possible if Arconic followed its suggestions. It looks from the outside like a failure on Elliott's part, but I wouldn’t call it that. It's all relative, after all, and there's reason to believe Arconic's challenges would be even more acute under the previous leadership and its ability to fix the situation (and be honest with investors about it) less adroit. If anything, Arconic's recent struggles prove how right Elliott was about the governance, operational and capital allocation shortfalls at the company. There is such a thing as being too right for one's own good.

Many of the pressures on Arconic's stock have been beyond Elliott's control: For one, the company is facing legal challenges over sales of combustible cladding blamed in part for the rapid spread of the fire at London's Grenfell Tower that killed 71 people last year. Meanwhile, aluminum tariffs and sanctions on Russian producer United Co. Rusal are driving up Arconic's input costs and pinching profitability. Other challenges stem from a prior management team that seemed bent on maintaining optics at all costs.

Take Arconic's 2014 purchase of Firth Rixson for $2.85 billion. Elliott had roasted Kleinfeld over the expensive price tag and his repeated assurances the deal was on track even as most analysts priced in significant operating shortfalls. Arconic took a $719 million goodwill writedown in the fourth quarter of 2017 tied to disks assets it acquired as part of the takeover. New CEO Chip Blankenship, who officially started as Kleinfeld's permanent replacement only in January, last month cited an "unacceptable" performance at the Firth Rixson rings and disks businesses as one factor behind Arconic's decision to cut its 2018 guidance.

Fixing the rings and disks business is about making sure each step in the manufacturing process has the proper capacity and ability to make quality parts, Blankenship said. He's also looking to hire people. This is pretty basic stuff. So, to me, this suggests the previous leaders were underinvesting in and mismanaging the business, leaving it shortchanged as demand for aerospace parts grows.

Arconic is now targeting $750 million in capital expenditures for 2018, compared with about $600 million in 2017, which was about half what was spent in each of the previous two years. Activist investors often complain that companies battling a board overhaul will cut back on spending in mercurial, illogical ways in order to make earnings look better. In this case, it looks like skepticism was warranted. During the campaign, Arconic said it would limit capital expenditures to about 5 percent of annual revenue, which seemed arbitrary. Elliott also cited unsolicited communications it received from employees and suppliers regarding delays in vendor payments.

Of course, it's one thing to accurately sound the alarm from the sidelines; it's another when it’s your problem to fix. Elliott is as involved as ever at Arconic, with portfolio manager Dave Miller joining the board in December. The extent of the previous mismanagement of Arconic has earned Elliott an extension, but whatever winds up happening to the company will be a test of its operational chops and appetite for long-term turnarounds. With Arconic conducting a strategic review, it could also be that the business winds up carved up or sold off. No extra points will be given for financial engineering.  

  1. Arconic split from the Alcoa mining and smelting operations in late John Plant, Ulrich Schmidt and Sean Mahoney were added to the board ahead of the separation that year as part of a pact with Elliott.

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