Adapting to Pricey Oil
Energy costs pushed Air Products to transform its business
ALLENTOWN, PA.—Air Products is a company that literally found a way to make money out of thin air, by selling oxygen, hydrogen, and other gases to industry. It was a good business for 60 years. But by 2000, the $5.5 billion company—now a diversified conglomerate—was adrift. Much of its chemicals business was in slow-growth mode, and federal antitrust regulators had blocked its plan to expand revenues and reach by merging with foreign rivals. The outlook was weak, as most of the company's new investment was going to prop up its worst-performing segments. A full plate of trouble for incoming CEO John Jones, who might have thought twice about the job if he had known what loomed: a relentless surge in energy prices that would threaten the economic model of the entire industry.
But in retrospect, Jones—and Air Products shareholders—are glad he took the gig. Under his direction, businesses were bought and sold as Jones focused the company on maximizing growth. Chemicals were mostly out, and energy and electronics were in. Profits are up 82 percent since 2003, while sales have grown 40 percent, on track toward $10 billion this year. The workforce has grown 20 percent to 20,000, and operations reach from its eastern Pennsylvania headquarters to 40 countries. What's more, Air Products stock has jumped 30 percent in the past year. It's a turnaround that also serves as an example of how companies can survive and thrive, even when up against the uncontrollable, like a new era of pricey energy.
"We said we're going to focus on portfolio management," says Jones, "and we've reshaped the company to get to the point where we have this trajectory that's going in our favor."
Steel years. It's not the first time Air Products has had to retool. The company was founded just before World War II by entrepreneur Leonard Pool, who saw the steel industry's soaring demand for oxygen used in welding. The raw material—air—was everywhere, but separation and transport were costly. Pool's innovation: Build oxygen plants right at steel mills, instead of delivering gas by cylinder, and lock in long-term contracts. Decades passed, and the U.S. steel industry had its rise and precipitous fall, but Air Products continued to grow, mainly because it took care to diversify into a variety of chemical businesses.
But Air Products' broad portfolio proved unwieldy at the turn of the millennium. It churned out an array of compounds—for agriculture, glues, security glass, printer's ink. Yet scores of global competitors kept prices and profit growth low. So Jones began a process of divesting $1.5 billion worth of these businesses. At the same time, he embarked upon $1.3 billion worth of higher-growth acquisitions, such as Ashland Electronic Chemicals, maker of ultrapure substances for the semiconductor industry, and several Asian specialty products firms.
Jones's strategy became even more urgent when energy prices took off. Traditional chemical manufacturers suffered a double blow, both as big fuel consumers and as users of natural gas—traditionally cheap but now more volatile than oil—as a major feedstock. By 2003, Air Products' profits had dropped 24 percent, largely because of raw material costs. "Our chemical business—over a long, long period of time it did very well, had consistent growth, and contributed to the overall well-being of the company," Jones says. "I think the difficult part for companies is dealing with reality. And our reality changed." Yet the company had some businesses that flourished in the harsh energy climate—especially its service to the energy business itself.
New direction. Air Products is the world's leading producer of hydrogen—a potential future energy source. But the future is now for the oil industry, which needs the gas to make cleaner fuels. Refiners used to make their own hydrogen, but then came the 1990 Clean Air Act. "We had some folks that read all these regulations and figured out that this is going to change the dynamics of the hydrogen needs of a refinery," says John McGlade, Air Products' chief operating officer. In the early 1990s, the company began selling a new idea: Air Products would build hydrogen plants near refineries, just as it had marketed oxygen for steel decades ago.
The best part of the deal for Air Products: long-term contracts that pass natural-gas costs through to the customers. Who better to take on that risk than oil companies, which see revenues soar when energy prices rise? "We deal with volatility every day," says J. Douglas Sparkman, senior vice president at Marathon Petroleum. In cases where it makes economic sense, Sparkman says Marathon could still make its own hydrogen, but for recent refinery expansions, it hired Air Products. "This is absolutely their core business, and they bring a reliability component that has a value," he says.
High oil prices further boosted hydrogen use, to improve the heavy, sour crude that is ever more abundant and cheaper than light, sweet standard. Air Products now has more than 30 refinery plants, six built in 2006—each at a cost of more than $200 million. In this business, Air Products has twice the capacity of its competitors—Praxair and Paris-based Air Liquide. It's one reason Air Products is growing faster, despite its rivals' bigger shares of the overall gas market.
Another Air Products energy foothold: It dominates the global market for the enormous equipment used to liquefy natural gas. Only when natural gas prices are high do companies invest billions to transport the fuel from remote locations by cooling it to liquid at minus 260 degrees Fahrenheit. The United States has recently looked to LNG, as Japan and other energy-short nations have done for decades. Air Products won its first LNG contract in Libya in 1964. Air Liquide had proposed to build from the ground up in the desert, where labor was scarce and construction problems inevitable. But Air Products proposed to construct the huge heat exchanger in Wilkes-Barre, Pa., and ship it overseas, ready to go. Since then, Air Products has provided 76 heat exchangers to about a dozen countries, more than 80 percent of the units in operation. The $25 million to $100 million units take 18 to 24 months to build. They look like rockets, weigh 500 tons, and stand 180 feet tall. Inside is a spaghetti of up to 1,000 miles of aluminum tubing for the refrigerant. Gas-rich Qatar has purchased a half dozen of Air Products's new high-capacity units.
The company kept one chemical business—a venture started in the 1970s with a nitrogen pipeline to serve fledgling companies in Santa Clara, Calif. But Air Products now reaches beyond the Silicon Valley as a supplier of cleaning and etching mixes that transform silicon wafers into logic and memory chips. More than half its business is now in Asia, although it still does research at its Pennsylvania headquarters. One recent breakthrough: a new insulation that will allow the semiconductor industry to continue on the path to smaller, faster, more powerful chips. Jones admits electronics is notoriously cyclical but says Air Products isn't hurt by falling prices for laptops, MP3 players, and game systems. "Our business is much more driven by the square inches of silicon produced," he says. And that has been growing rapidly enough that Air Products showed 23 percent profit growth in electronics this past quarter.
But consider NF3, a crucial chemical for producing flat-panel TVs and monitors. Air Products is the No. 1 producer, shipping the gas from Pennsylvania to Asia in 18,000-pound containers, compared with the 40-pound cylinders a decade ago. The company will expand capacity 25 percent later this year with a new plant in South Korea. The price of NF3 has been falling, but Air Products so far has compensated by simply selling more.
"That works as long as volumes are growing substantially," notes Matthew Warren, a Morningstar analyst. "But it's a fine and delicate balance." Warren thinks risky down cycles for Air Products are still possible, especially in economic downturns. But he is quick to praise the company's overall strategy. "The moves they've been making make a lot of sense," he says. "It should help on returns on capital and reduce cyclicality. And the market's clearly rewarding it."
Now, Air Products faces more transition. Jones is retiring at age 56 while passing the baton to McGlade (three years his junior). McGlade, who like Jones has spent his whole career at the company, certainly faces challenges—including the sale of the last chemical division Air Products is trying to jettison, which hasn't yet found a buyer. But McGlade intends to follow through on tough choices. The key to future success, as he sees it: "Our ability to honestly look at the portfolio and to make decisions on their potential and the value we can bring, versus a love affair with any particular business."
How to Deal With Change
People resist change only when it involves the possibility of loss, says Ronald Heifetz, cofounder of the Center on Public Leadership at Harvard's Kennedy School of Government. In other words, people resist change often—and corporations avoid potentially painful transitions. A better leadership approach involves some simple principles.
Face reality. Air Products executives John Jones and John McGlade, addressing the issue by E-mail, say external events like 9/11 or Hurricane Katrina can drive change in uncontrolled ways, and executives must react quickly. "Don't fall in love with any one business or strategy," the executives advise, "because you just might have to change it tomorrow."
Prepare your people. Gordon Quick, coauthor of The Enlightened CEO, says companies sometimes spend so much time charting a new course that they forget to let employees, customers, or shareholders in on what's happening.
Watch out for traps. Heifetz says companies often blame outside forces, or delay by hiring a consultant, or tinker. A new accounting system won't help a business that at its core no longer makes sense.
This story appears in the July 16, 2007 print edition of U.S. News & World Report.