Elliott Management Sends Another Letter To Arconic
Three weeks ago, Elliott announced its nomination of five new independent directors to serve on Arconic’s Board of Directors. We also suggested the Board consider hiring Larry Lawson as the Company’s next Chief Executive Officer.
Since that announcement, Arconic’s equity value has increased by more than 39%.1 Investors clearly want a change in leadership and have told us they hope to see someone of Larry’s caliber at the helm – sooner rather than later. The purpose of this letter is to carry forward that message to the Board: Arconic needs a new CEO. To that end, the Board should form a search committee and conduct a full search without delay. Larry Lawson should be a lead candidate.
Why are investors excited about Larry Lawson?
Larry has a proven track record of delivering outstanding results in the aerospace industry. Most recently, Larry served as Spirit Aerosystems’ Chief Executive Officer. When Larry took over Spirit in 2013, the Company was beset by operating problems. Spirit was losing money on the 787 program, was saddled with unprofitable contracts on Gulfstream business jets, had failed to properly manage its supply chain, and possessed a facility footprint poorly matched to its future needs. For investors, Spirit had produced nothing but frustration and losses. From the date of its IPO on November 20th, 2006, to the day Larry took over on April 6th, 2013, Spirit had produced a cumulative total return of -28% vs. a gain of 13% for its former parent Boeing, and a 27% gain for the S&P 500.2
To right the ship, Larry undertook a comprehensive strategic review. He reorganized Spirit around key programs, installed a firm-wide focus on free cash flow, recruited key additions to the executive team, and made the tough decision to divest unprofitable businesses. Above all else, Larry began to change the culture. From the executive suite to the shop floor, Larry insisted that Spirit achieve world-class performance. He demanded “rigor and discipline” and he delved into the details. Larry summed it up on Spirit’s Q4 2013 earnings call: “And so today, we have a very by-program, by-product, week-to-week, did you earn your hours, did you hit your productivity?”3
Larry’s efforts bore fruit almost immediately. In less than a year, Spirit’s adjusted free cash flow improved from negative $84 million to positive $57 million.4 The firm hit its build rate targets and the quality of the product delivered to customers improved.
Over the next few years, Larry continued to drive the organization forward relentlessly. In May of 2014, about a year into the job, Larry was complimented by an analyst on Spirit’s rapidly improved performance and asked if he was pleased. His response: “[T]o be honest with you, for me to say I’m pleased, that’s a hard thing … as opposed to saying I’m pleased, let me just say that, well, this is a transformation and we’re moving along smartly in that transformation. We’re not where we need to be. We’ve got a lot of room to improve.”5
So Spirit improved further:
- Adjusted free cash flow improved from negative $84 million in the year prior to his arrival to $420 million in 2016, and $738 million in his final full year, 20156
- In Larry’s first year, EBIT was negative $364 million. In 2016, EBIT was positive $725 million7
- The year Larry took over, 2013; Spirit produced the worst earnings in its history. The next year, Larry’s first full year, Spirit generated its highest earnings ever and then repeated the feat in 2015
- The Company repurchased nearly 10 million shares of Common Stock in 2014 and 2015
- Over the course of his tenure, Returns on Invested Capital improved dramatically from -5% to 22%8
- Under Larry, Spirit shares increased from under $19 to more than $47 – producing a total shareholder return (TSR) of 153%9
(Follow this link for a graphic illustration of Spirit’s TSR with Mr. Lawson as CEO: http://newarconic.com/content/uploads/2017/01/Spirit-TSR-under-CEO-Lawson-1024x695.jpg)
Don’t Take Our Word for It
Here’s how analysts have described Larry’s performance at Spirit:
“The company greatly improved its operations under the leadership of CEO Larry Lawson, and customer perception of SPR recovered where it is now more of a valued partner in the aero supply chain”. – Wolfe Research, 6/22/1610
“Simply put, shareholders love Larry Lawson. Why? Probably because he delivers results and that’s almost all that shareholders care about.” – Barclays, 6/9/16
“Having significantly improved SPR's internal structure, management, processes and financial performance, we think Mr. Lawson sees his mission as largely accomplished and the timing appropriate to pass the baton.” – Credit Suisse, 6/8/2016
“Over the past three years SPR, under the leadership of CEO Larry Lawson, has dramatically turned around the business.” – Wolfe Research, 4/29/16
“In what has become a regular pattern for the company under CEO Larry Lawson, SPR posted another good quarter led by better-than-expected margins.” – Barclays, 10/27/15
“SPR has returned nearly 200% since naming Larry Lawson CEO in March 2013 vs. nearly 40% for the S&P 500…” – JP Morgan, 7/14/15
“Considering the changes Larry Lawson and his management team have implemented at SPR, we expect continued strength in execution to be attainable.” – BAML, 4/30/15
“SPR stock is up over 160% since Larry Lawson was named president and CEO of the company on March 19, 2013 effective April 6, 2013. Sentiment for SPR has improved as the company focused on controlling costs, generating positive free cash flow, and divesting the problematic G650 and G280 wing programs in Tulsa. In our view, market expectation for performance is now significantly higher for SPR than with the previous management team.” – BAML, 4/30/2015
“[H]e is a tough change agent with unrelenting demands on performance improvements. As such, we’re beginning to conclude that he might be just what SPR always needed.” – Barclays, 12/18/13
“SPR shares are up strongly since new CEO Larry Lawson’s arrival, a pattern we’ve seen elsewhere in the industry whenever investors seem to believe that a management change is the best possible catalyst for a turnaround in performance.” – Barclays, 8/13/2013
“Mr. Lawson is well regarded for his experience with high rate aerostructures manufacturing. He has fostered good relations with large sophisticated customers, understands the needs of a unionized workforce, and has run highly profitable programs.” – Jefferies, 3/19/13
Why is a leader like Larry the right fit for Arconic?
Our assessment of Arconic is straightforward: Arconic has world-class assets and a world-class workforce, but it is run by a subpar management team which has failed to make the most of its capabilities. In contrast to Arconic’s management team, Larry understands the task at hand. Discussing Spirit, Larry said: “[I]t’s not easy to find 15,000 skilled people. And certainly, it isn’t easy to find 15 million square feet that’s capitalized with property – PPE and capital. So our job is to get the most out of that.”11For three years, Larry did just that. He got more out of Spirit than anyone ever had.
Arconic is bedeviled by operational issues similar to (although perhaps worse) than those faced by Spirit when Larry took over. By management’s own estimates, the process of rationalizing the Firth Rixson operation is three to four years (!) behind schedule.12 Arconic is having trouble delivering key parts to customers. Asset turns and labor productivity lag industry peers. Targets have been regularly missed and missed again. Free cash flow has been almost non-existent historically and is projected to be anemic in the future. Culturally, Arconic is a bureaucratic organization, run by management consultants, prioritizing image over substance, marketing over engineering. Its management team has lost the confidence of its shareholders and, worse, has surrendered its credibility with employees. Critical talent is leaving for competitors. Valued executives are retiring, exhausted not by the rigor of the job but by the frustration of dealing with a senior leadership with no aerospace experience that would rather appear at conferences or on TV than on the factory floor.
Larry is an operator’s operator. He is an engineer, not a salesman. Before Larry took over Spirit, he ran Aeronautics at Lockheed Martin. He was the General Manager of the F-35 program and before that the F-22. Larry was Lockheed’s Mr. Fix-It. When a program was at-risk of going adrift, Larry was brought in to steer the ship. To the most demanding customers (the armed forces of various nations) and with aircraft designed for the most critical roles (national defense), Larry produced. We do not expect Larry to make fancy films (see Arconic’s remake of the Jetsons), but we have confidence that Larry will deliver fan blades and more.
What is Arconic’s Board doing?
This isn’t a close call.
Imagine Arconic did not have a CEO today. To pick a new leader, the Board would consider certain key facts. More than 40% of revenue is from aerospace and aerospace is an even higher percentage of EBITDA. The rest of the sales are from automotive and other industrial applications. Operational issues abound. A recent acquisition is three to four years behind schedule. Key aerospace platforms have been spec’d out, and what matters most looking forward is disciplined execution.
To fill the CEO role, the Board is presented with two choices.
The first choice is a former marketing executive. He is charismatic and intellectually impressive. But he has no aerospace experience. He has never run a plant or worked on a factory floor. Most recently, in his current role, he has failed to hit any of his three-year targets. At his current company, under his leadership, his shareholders have the seen the value of their holdings plummet by nearly 70%.13 His TSR vs. Proxy Peers is dead last. Of the current S&P 500 companies that have been public since his tenure started, his TSR is the worst of any continuously-tenured CEO.14 Capital expenditures have soared, acquisitions have been made at rich prices, and returns at his organization have plummeted.
The second choice is a proven operator and exceptional capital allocator. He has 37 years of aerospace experience. He has built the most advanced airplanes in the world – the 787 at Spirit, the F-35 and the F-22 at Lockheed. In his last stint running a public company, his shareholders saw the value of their equity increase by 153%. His TSR vs. Proxy Peers is top quartile. During his tenure, record earnings were produced consistently and free cash flow improved from negative $84 million to $420 million.
Presented with these two options, the choice is obvious. Isn’t this in fact the decision before this Board today? CEOs do not hold the job by right. The Board must continually evaluate who should be running the company. Each day, the CEO is effectively hired by the Board. Unfortunately, a majority of Arconic’s Board seems to have forgotten this. We recognize there are extensive ties between some members of the Board and Dr. Kleinfeld. Not counting the directors added in the past two years, this Board has served a collective 40-plus years together. To each of you, Dr. Kleinfeld is not merely an agent or employee, but also a friend. However your obligations require objectivity unclouded by personal relationships.
Before this Board is an extraordinary opportunity – the chance to bring in someone of Larry Lawson’s caliber and turn Arconic around. He turned around Spirit and, if entrusted with this organization, he can be expected to produce world-class results.
We have now written you four letters. Many other large shareholders have weighed in echoing our assessment. By the rapid ascent of Arconic’s share price, even those shareholders who have said nothing have sent a similar message. If it wasn’t clear enough, let us reiterate: Do the right thing. Change is needed.