The British company’s new CEO has a reputation as a turnaround artist, and he has boosted its stock price. But investors aren,t sure it can actually make money.
By David Lanchner
July 2002
Institutional Investor Magazine
When Rick Haythornthwaite took over as chief executive of British automation control conglomerate Invensys last October, the company was on the brink. Born of a 1999 merger between two slow-growth engineering companies, Invensys was making everything from washing machine timers to software for nuclear power plants. Its market share in automation controls had shrunk to less than 6 percent from 11.7 percent at the time of the merger, and its stock had plummeted to 27.5 pence from a 1999 high of nearly 400p. With debt of £3.2 billion ($4.8 billion) and negative free cash flow, the company was close to insolvency.
A geologist educated at the University of Oxford, Haythornthwaite was a breath of fresh air. His predecessor, a burly American named Allen Yurko, was best known for possessing a temper so fierce that London reporters had dubbed him the Mr. Nasty of the FTSE 100. He hobbled Invensys with endless rounds of layoffs and asset sales; his most dramatic strategic move was overpaying for Baan, a money-losing, scandal-plagued Dutch software company.
Haythornthwaite, by contrast, exudes a quiet charisma and openness - qualities that have calmed the nerves of rattled employees. His résumé includes a successful 17-year stint at British Petroleum Co., where, among other accomplishments, he turned a struggling oil field into a moneymaker. And in 2000, as CEO of cement maker Blue Circle Industries, he thwarted a takeover bid by French rival Lafarge, becoming the first head of a major U.K. company to fend off a hostile all-cash offer in 15 years.
In his nine months manning the switches at Invensys, the 45-year-old Haythornthwaite has considerably improved its situation. He took a hard look at the company’s 24 business units and designated eight high-cost manufacturing subsidiaries for divestiture, lumping them together in a special division. He has sold off four so far, yielding almost half of the £1.5 billion he promised shareholders he would raise by March 2003. He has reshuffled 14 other, less capital-intensive businesses into three new divisions, each with a clear focus. Between October and May Invensys’ share price quadrupled, climbing above 100p, before retreating to 85p in late June. The shares climbed from a roughly 40 percent discount to the sector average to a 10 percent premium.
“Haythornthwaite has done a good job stabilizing finances by raising funds from asset disposals,” says Andrew Chambers, an engineering analyst at Commerzbank in London. The divestiture plan “is unlikely to provide an immediate fix, but long term the core businesses have significant market and margin potential.”
Haythornthwaite’s goal is to get all of Invensys’ business lines - the ones he means to keep, at least - communicating for the first time. Yurko never bothered investing in a common information technology platform; Haythornthwaite is spending roughly $50 million on IT, creating client databases the entire group can share. With more coherent marketing, he says, he can raise Invensys’ operating margins before interest, taxes and amortization from an average of 3.9 percent over the past four years (compared with a peer group average of 10.2 percent) to 15 percent by 2005,'06, while taking sales growth from negative territory to more than 7 percent.
“These are not sets of numbers or margins plucked out of the air as a figment of wishful thinking,” Haythornthwaite insists. “They are based on very broadly participative and data-driven processes where we built the financials from the bottom up. The numbers have been generated through a lot of detailed, thoughtful work.”
But despite his strong credentials and personal charm, Haythornthwaite’s promises draw considerable skepticism. “There is nothing in the Invensys portfolio that suggests he can achieve anything close to a 15 percent margin, even if he achieves operational efficiencies,” says Sanjay Jha, an engineering industry analyst at London-based brokerage firm Williams de Broë. “He could be working on a new product that is a world-beater, but if not, all he is doing is guessing. It looks like he’s motivating people to work hard, hoping something will click and that he will make a lot of money.”
Even Invensys’ staunchest backers worry that Haythornthwaite has inherited a company too troubled to repair. “This is a technology-based business that was so murdered under Invensys’ old management that it has a structural decline problem,” says Ian Brown, a portfolio manager at London’s Morley Fund Management, Invensys’ second-largest shareholder. Yurko lost market share, Brown explains, by underspending on new technology while competitors like Emerson and Honeywell International developed new and better products. Although Brown thinks Haythornthwaite can boost the stock price further, he cautions that “the company may have to invest more money than it realizes” to engineer a comeback - and it’s not clear where the funds will come from. (Morley accumulated most of its £128.7 million, 4.1 percent stake at prices below current levels; Invensys’ biggest shareholder, San Diego,based fund management firm Brandes Investment Partners, bought its 14.8 percent stake mostly at higher prices during Yurko’s tenure and would not comment for this article.)
Now a partner at London-based private equity firm Compass Group, Yurko, 50, notes that Haythornthwaite doesn’t appear to be doing anything radical. “I am not so sure their strategy has changed much,” Yurko says. Any differences between the way he ran the company and the way Haythornthwaite is running it, he says, reflect economic conditions.
Even Haythornthwaite admits that what he is doing amounts to little more than motivating staff and pruning and integrating operations. “To arrive at a level comparable with our best peers and achieve double-digit margins is just a question of better sales discipline, better project management and plugging some of the technology holes,” he says. “It is basic blocking and tackling.”
Haythornthwaite learned the ABCs of corporate turnarounds at British Petroleum, which he joined as a geologist immediately after graduating from Oxford in 1978. He moved into a senior management position after the company sent him in 1990 to the Sloan School of Management at Massachusetts Institute of Technology in Boston for a nine-month program.
His formative managerial experience came in 1991 when, as a protégé of then-chairman Robert Horton, he was parachuted in to run one of BP’s bigger but lower-margin assets, the Magnus oil field in the North Sea. Horton was trying to combat falling oil prices and weak margins by eliminating what he scornfully called the “brigadier belt,” a small group of central managers who set production and profitability targets with little input from the field. He wanted a more participative system that solicited field managers’ views on how to boost production and cut costs.
“BP was in the early days of its turnaround, and it was all about inventing how to take a company that was in crisis and move forward,” recalls Haythornthwaite. “It involved changing the behavior of people rather than pushing assets around the board.”
Haythornthwaite turned Magnus into one of BP’s most productive assets, essentially by giving every worker a voice in decision making and developing “best practices” for problems like rig breakdowns. “We turned it around in exactly the same way we are doing it here at Invensys,” says Haythornthwaite. “We laid down a strategy that actually enabled the workforce to do what was necessary.”
He left Magnus in 1993 and spent the next two years as president of BP Venezuela, expanding the unit from a small operation that shared office space with an art gallery into one of the country’s biggest oil producers. In 1995 he left BP for Premier Oil, a U.K.-based exploration and production company moving aggressively into Asia, as director of strategy, organization and communications.
But it was at Blue Circle Industries, which he joined in 1997, that Haythornthwaite made his mark as a turnaround artist. BCI was the U.K.'s largest cement producer, with operations in 13 countries and sales of £2.3 billion, but it had a relatively small presence in Asia, which Haythornthwaite oversaw as chief executive of heavy building materials for Europe and Asia. He first pursued an organic growth strategy, then switched into acquisition mode when the Asian currency crisis hit in the summer of 1997, spending $700 million to buy cement operations from mostly distressed companies. The purchases, made at fire-sale prices over a little more than a year, turned BCI into the largest cement producer in Malaysia, where it had 48 percent of the market, and the second-largest in the Philippines, where it had 20 percent.
Haythornthwaite’s Asian successes earned him a promotion to chief executive in July 1999, but investors were not impressed. For one thing, his predecessor, Keith Orrell-Jones, had run the company as a collection of independent regional fiefdoms and was known for his inability to get a grip on costs. In addition, although the foreign acquisitions had been a bargain, they diluted 1998 earnings, and BCI’s profit had fallen by 7 percent, to £317.6 million, on flat sales.
“No one really knew much about Haythornthwaite,” says Ken Rumph, a cement analyst at Merrill Lynch in London. “The Asian purchases made it look like the company had shot itself in the foot, since they weren’t making any money because of the region’s recession.”
As CEO, Haythornthwaite began demanding more detailed financial breakdowns from subsidiaries, and he expanded the company’s information systems, making them a conduit for operational as well as financial information. He also announced a massive cost-cutting initiative. But largely because he had inherited an organization with poor cost controls, he was obliged to issue a profit warning only three months into the job, causing BCI’s shares to plunge by a third.
As a result, when Lafarge launched its E5.7 billion cash bid for BCI in February 2000, the offer seemed generous. For one thing, the Internet craze was reaching its peak, and few investors were interested in Old Economy companies. And Lafarge was valuing BCI at a 26 percent premium to its prebid price - more than 13 times expected 2001 earnings.
But investors weren’t taking BCI’s full earnings potential into account. In April, after the European Union’s competition commission had approved Lafarge’s bid, Haythornthwaite announced that BCI’s Asian investments were beginning to pay off. Cement revenues had risen 25 percent year-to-date in Malaysia and were projected to increase at least 10 percent over the next two years.
More important, Haythornthwaite revealed that his cost-cutting plan would save £116 million - almost £30 million more than Lafarge’s estimated merger efficiencies. And he said he could drive those savings to the bottom line, boosting pretax earnings 46 percent, to £409 million, by the end of 2001. At the same time, he announced an £800 million share buyback. The buyback and the projected savings led analysts to boost their earnings-per-share forecasts 20 percent for both 2001 and 2002. That made Lafarge’s bid, even after a 7 percent hike, to E6.1 billion, look cheap.
In an ironic twist, what finally clinched Haythornthwaite’s victory was the fact that Lafarge and its investment bank, Dresdner Kleinwort Benson, had bought a 29.6 percent stake in BCI to strengthen their position. When it became clear that Lafarge had no intention of giving up its holding even if it lost, investors figured they could safely reject the bid. There was no reason they couldn’t entertain another, sweeter offer later.
Sure enough, Lafarge, taking note of the new reality, came back eight months later with a friendly bid, 18 percent higher than its original offer. “Rick persuaded investors to back a big cost-cutting program and convinced them that they could expect a big recovery in Asian markets and that Lafarge was not offering enough,” says Merrill Lynch’s Rumph. “That has relevance at Invensys, because clearly the story there again is persuading investors that you are going to do what you say you are going to do.”
There’s just one problem - Invensys is no BCI. First of all, it makes not one product but many: gearboxes, timers and software for running assembly lines and refineries, among other things. It also sells advice on how to efficiently manage automated processes to more than a dozen different industries, from consumer goods to building maintenance. Given Invensys’ broad portfolio of goods and services, transferring efficient manufacturing, marketing and sales practices from one division to another, and cross-selling those goods and services, is likely to be a lot tougher than it was at Blue Circle.
Invensys’ two constituent parts Have long histories: Siebe was founded in 1819 as a manufacturer of diving apparatus for the British Navy, and BTR in 1924 as the British Goodrich Tire Co., a manufacturer of tires, golf balls and other rubber products. In the 1970s both were transformed into conglomerates that bought a diverse range of engineering companies and made money by slimming them down.
Yurko, who had previously worked for U.S. engineering company Mueller Holdings, joined Siebe in 1989 as finance director of its Robertshaw Controls unit, a maker of thermostats. Rising to Siebe chief operating officer in 1992 under CEO Sir Barrie Stephens, Yurko headed a much-feared, 1,000-strong cadre of so-called black-belt managers. He and his colleagues would sweep down upon divisions and try to bring them up to snuff by cutting costs and improving production methods. Significant layoffs were almost always part of the process.
By the time Yurko succeeded Stephens as chief executive in 1994, Siebe was a highly profitable stock market darling, largely because of its 1990 acquisition of Foxboro, Massachusetts-based software maker Foxboro Co. - then one of the world’s leading producers of industrial controls software. But Yurko kept buying and selling companies at a frantic pace, investing less and less in Foxboro and other subsidiaries. In late 1998, with Siebe’s stock starting to falter, Yurko announced an £8.4 billion, all-share merger with BTR, creating Invensys and giving Siebe shareholders 55 percent of the new company.
At the time, BTR, an even less focused business than Siebe, was on the ropes. With more than 30 businesses catering to such diverse industries as autos and paper manufacturing, its market capitalization had declined to £3.1 billion from a 1993 high of £14.2 billion, and its operating margin had shrunk from about 7 percent to roughly 1 percent. Yurko promised that the new company would be able to provide “total solutions” for customers’ control needs for everything from conveyor drives to energy management and assembly lines. Yet critics saw the merger as a desperate attempt to achieve growth through acquisition at a time when Siebe was beginning to lose market share.
Over the next three years, as Yurko struggled to weed out underperforming businesses, Invensys was the slowest-growing of the nine major companies in the automated controls field. While Invensys downsized and sold off businesses, more-focused, better-organized competitors like Emerson, Siemens and Honeywell were spending more on technology and winning contracts from big Invensys clients, including Royal Dutch/Shell Group and Dow Chemical Co. And Invensys’ inefficient structure didn’t help. “Our clients would see eight faces rather than one and get very little support or understanding,” says Haythornthwaite. “The merger produced a random complexity, not an ordered complexity, as you have at ABB, Siemens or Emerson.”
Under Yurko, Invensys’ revenues declined by 40.2 percent, from £11.7 billion in 1998 to £7 billion last year. Over the same period retained profit fell from £568 million to a loss of £939 million. Meanwhile, peer group revenues rose 23.7 percent, according to Dresdner Kleinwort Wasserstein.
The company is still suffering from an ill-timed, debt-financed, £930 million share buyback in March 2000 and the £766 million purchase of Voorthuizen, Netherlands,based Baan in August of that year. At the time of its acquisition, Baan, a specialist in enterprise resource planning software, had reported eight straight quarters of losses and was on the verge of bankruptcy; creditors had discovered that it had inflated revenues through bogus sales to subsidiaries. After spending more than £266 million in a cost-cutting and restructuring drive initiated by Yurko, Baan is now barely profitable, according to analysts, and is still struggling to regain market share. “Baan actually has very good technology,” says Haythornthwaite. “It also has good people, and it has some very good customers. We just have to do some work on marketing and a little bit on product development.”
Streamlining Invensys’ sprawling structure, Haythornthwaite believes, will go a long way toward improving its performance. He has set up four divisions: Industrial Components & Systems contains the for-sale subsidiaries; Production Management focuses on automation software and assembly line controls and includes Foxboro, Baan, two specialized food industry units (APV and APV Baker) and Eurotherm, a maker of instrumentation equipment for industrial drives; Energy Management encompasses five businesses ranging from controls for household appliances to electricity regulation for factories; and Development is a three-business division that includes a designer of high-performance geared motors, a railway automation company and a provider of power components for industrial machinery and retail items like mobile phones.
A key part of Haythornthwaite’s strategy is to improve margins by combining hardware sales with consulting services. One early example: Energy Solutions, which collects and analyzes data from the hardware it sells, such as thermostats, and then helps customers decide on the most efficient ways to heat or cool their facilities. “The old Invensys didn’t have that much in the way of consultancy and service skills,” says Rod Powell, head of the group development team that Haythornthwaite created to turn his vision into reality. “But we will be adding people to the company with expertise in energy and production management systems, just as we will be developing cross-selling between the different business units.”
Yet Energy Solutions’ roughly 8 percent margin is well below Haythornthwaite’s 15 percent target, and executives admit that the lion’s share of revenues still comes from hardware sales, not consulting contracts. Observes Williams de Broë analyst Jha, “They are painting a very rosy picture but offering little in the way of substance to back it up.”
Another piece of Haythornthwaite’s strategy that draws skepticism is his insistence that clients would rather have better service than better technology. He is maintaining research spending at about 4 percent of annual sales. That means Invensys is earmarking some $187 million to improve old products and create new ones in 2002. By comparison, German electronics giant Siemens is devoting roughly $485 million to automation controls research alone - 6 percent of the $8.1 billion in revenues analysts expect it to earn from that industry in 2002. And while Invensys is putting a greater emphasis on customer relationships, so are most of its competitors. That fact is likely to limit the competitive advantage Invensys hopes to gain from better account management.
Indeed, investors and analysts wonder if Haythornthwaite can fully transform Invensys. In its three years the company has never made a profit after taxes and dividends. (It will pay out £220 million to shareholders for 2001.) “Trying to turn a company around that makes losses year in and year out is difficult,” says Philippe Kuster, a capital goods analyst at Geneva-based fund manager Lombard Odier & Cie. “It does not just require a marketing campaign, it requires new investment in research and development, and there is nowhere Invensys can go to easily get that money.” Kuster has advised Lombard Odier’s fund managers to stay away from the stock. “This is a classic example of there being too much of a management hope factor in the share price,” he says.
Equally disturbing to shareholders, the company is not saying much about projected profits and sales apart from Haythornthwaite’s 2005,'06 goals. He is providing no targets for Invensys’ current fiscal year, which ends in March 2003, though he tells investors he would like to raise the operating margins in the Production Management division from its current 2 percent to between 8 percent and 10 percent by mid-2004. As for Energy Management, he says, “It will look to improve [profit margins] by up to 2 percentage points, from 10 percent to 12 percent,” also by January or June 2004. But he will provide neither growth targets nor other overall figures for Invensys as a whole before 2005,'06.
Haythornthwaite’s progress on debt reduction has been his clearest triumph so far. The four subsidiaries that he had sold through June - BAE Automated Systems, a manufacturer of luggage-handling equipment; Comp Air, which makes air and gas compression systems for pneumatic tools; Energy Storage Group, an industrial battery maker; and Flow Control Division, which manufactures valves - fetched £663 million, more than either analysts or company executives had expected. Six other, smaller businesses, several of which were already on the block when Haythornthwaite arrived, raised an additional £87 million. That puts Haythornthwaite halfway to meeting his target of £1.5 billion from disposals.
In April he gave himself breathing room to wait for better prices for the four companies remaining in the Industrial Components & Systems group. He refinanced, in effect, £950 million in debt that comes due next month with a £1.39 billion revolving credit facility that matures in March 2003.
Some industry observers believe that Haythornthwaite is dressing Invensys up for a merger. “Frankly, this looks like just the first phase of a shareholder value plan aimed at flushing out the very best price for Invensys once they’ve fully got their debt under control and once the U.S. and European economies bounce back,” says one London-based investment banker. “In truth, this does not look like a serious plan to operate as an independent company, given current margins and future targets.”
According to this banker, Haythornthwaite has set a deliberately conservative price target for the subsidiaries he wants to sell - essentially, managing investors’ expectations. “If he hits his short-term objectives and spruces up the company a bit, that will give his long-term goals credibility and force any potential buyer to pay more for the company,” says the banker. “It’s hard to believe he seriously thinks he can deliver what he’s promising.”
Although Haythornthwaite says he much prefers pursuing an operational strategy rather than a breakup or a sale, he concedes that “all options for how to get value out of this company are always open. Whatever option makes the most sense for the shareholder is going to be the one we will go with.” But some investors believe that there are limits to what this Mr. Fix-it can accomplish; they figure he’s already tinkered too long with an engine that has seen its best days.
