By Nick Carey
CHICAGO (Reuters) - Alcoa Inc (NYSE:AA) said Monday it will break itself in two, separating its faster growing business manufacturing parts for planes and automobiles from its traditional aluminium smelting operations as shareholders seek higher returns amid a commodity slump.
Pressured by a 42 percent drop in its share price this year and a surge in Chinese aluminium exports, Alcoa is splitting into two publicly traded companies focusing on smelting and higher-tech products. It is joining a wave of major corporations which this year have divested business to add shareholder value.
Alcoa shares jumped 2.4 percent to $9.29 as analysts applauded its intensified focus on products for expanding businesses like aerospace and auto.
The stock surge made the 127-year-old company the biggest percentage gainer on the benchmark S&P 500 index.
The global glut of aluminium, which has depressed prices, has battered Alcoa stock, driving the company's market value this year down to about $12 billion.
"Alcoa has faced this problem for decades: No matter what they have done to enhance their product line, their stock has traded based on metal prices," said analyst Charles Bradford of Bradford Research.
The company's traditional business, which also includes better-performing bauxite and alumina, will retain the Alcoa name. The newer company is still unnamed.
The split is expected to be completed in the second half of next year.
"We are interested in creating value for our customers, for our shareholders, for our employees, and at this point this is the option we see that creates the biggest value," Chief Executive Klaus Kleinfeld told Reuters.
Kleinfeld will become CEO of the new company, and remain Alcoa chairman during a transition period.
"We believe both entities have gotten into a shape that they are competitive and sizeable and they can stand on their own," Kleinfeld said.
Josh Sullivan, an analyst with Sterne Agee CRT, said Alcoa had already been in the process of a transition, including acquisitions to beef up its business for such sectors such as aerospace and autos.
"The commodity business was a significant drag, not only on valuation but on the resources of the company," Sullivan said.
Alcoa did not provide details on the cost of carrying out the split, which it said should be tax free for shareholders. It is targeting an investment grade credit rating for its "value-added" business and "strong non-investment grade" rating for its legacy business.
The company also said that as of Dec. 31 2014, its pension was underfunded by about $3.3 billion. Executives said Alcoa will allocate debt and pension liabilities "in a manner that is prudent for the two businesses to have the balance sheet" the company is targeting.
HIGH-STRENGTH ALUMINIUM
A 25 percent drop in aluminium prices since last September has pushed benchmark London Metal Exchange prices to six-year lows. An unprecedented plunge this year in premiums –surcharges paid for physical delivery - to their lowest in 3-1/2 years have posed the biggest threat to producers' margins since the 2008 financial crisis.
As a result, more than 10 percent of smelting capacity outside of China, or 3.5 million tons of production, is running in the red. Alcoa Inc has closed or curtailed 170,000 tons of annual output this year, part of a review of 500,000 tons of smelting capacity announced in March.
At the same time, the company has bet on growth from higher-margin titanium and high-strength aluminium sales to the aerospace industry, as its order book swells for airplane production and amid renewed global spending on automobiles. About 40 percent of revenue for the new value-added business was generated by the aerospace sector.
Recent purchases include aerospace and defence industry-focused titanium supplier, RTI International Metals Inc (NYSE:RTI), for $1.3 billion and privately-held TITAL, which makes titanium and aluminium structural castings for aircraft engines and airframes.
The company has also been working to improve in-house technology. Last December, Alcoa unveiled a process it calls Micromill to produce high-strength aluminium alloy, targeting automakers who are seeking an alternative to heavier steel.
In mid-September Alcoa announced a deal with Ford Motor Co to provide components for the 2016 model F-150 pickup, the best-selling U.S. vehicle since 1982, using Micromill
"They have been acquiring more businesses away from what they founded the company on," said Phil Gibbs, an analyst at KeyBanc Capital Markets.
The company did not provide a timeline for choosing a CEO for Alcoa after the split. The division of the company does not need shareholder approval, sources familiar with the matter said.
The company's financial advisors are Morgan Stanley (NYSE:MS) and Greenhill & Co. The legal advisor for the split is Wachtell, Lipton, Rosen & Katz.