Relatively few market leaders are critical to creating value in the global lubricants arena. We shouldnt take them – or the industrys current profitability – for granted when the chatter turns to mergers and acquisitions.
With rumors of takeovers in the air, one particularly huge potential divestment could have far-reaching implications for the lubricants industry: There has been recent talk in the international press and financial community that BP could be a takeover target, given that the price of crude is some 40 percent below its 2014 high and BPs U.S. problems from the Gulf of Mexico offshore drilling disaster are far from resolved.
Plenty of companies might be sufficiently interested to have already run the numbers for such a deal. Shell, which might have taken the opportunity to pounce, recently announced its proposed acquisition of natural gas company BG for $70 billion. ExxonMobil, on the other hand, has plenty of cash, and theres no limitation on what we might be interested in or considering, its CEO Rex Tillerson told analysts earlier this year.
While the chances of a deal may be very low it has turned our thoughts towards merger and acquisition deals and their impacts on the lubricants business, BP Castrol included.
History Repeating?
Were ExxonMobil to acquire BP there would be many ironic aspects to the deal. Not least, it would entail a second honeymoon for those BP and Mobil managers who were involved in the two companies European downstream joint venture through much of the 1990s. However, honeymoon would hardly be the right way to describe that marriage of convenience that created two separate joint ventures. One, for fuels, was managed by BP; the other, for lubricants and bitumen was managed by Mobil. Together they combined all the companies assets from the U.K. to the Urals.
The j.v.s came together through the mutual realization that neither had the critical mass to win in the European downstream sector. But some people close to the action could sense that the arrangement would not be permanent. Either BP and Mobil would merge their entire businesses, or they would separate. To be sure, a full merger seemed highly likely at one point but was blocked perhaps only because of personality clashes at the top.
When in the late 1990s Exxon moved to merge with Mobil, BP was handed a golden opportunity to sue for divorce in Europe, to comply with European Union competition law. In the ensuing settlement its fair to say BP was, as it were, granted custody of the children, most of the house and the record collection. Mobil, as the errant spouse, was lucky to get the dog.
But from a lubes perspective the j.v. experience was important for BP. As they observed how Mobil successfully exploited lubricants, senior BP management came to realize the strategic importance of a top-flight lubricants brand.
Soon after the j.v. broke up, when the opportunity arose to acquire Burmah-Castrol, BP moved decisively and paid nearly $5 billion to clinch the deal in 2000. Now, unlikely as it seems, a link-up between ExxonMobil and BP would bring all the brands into the same company. But for how long?
Acquisition Success
BPs acquisition of Castrol has proved an outstanding success. As an energetic, specialist independent lubes player Castrol became part of an operation driven by performance management. After a slow start during a period of integration in the early 2000s, its profitability steadily rose reach an impressive $1.4 billion last year. In recent years this has meant that, in turn, Castrol has regularly contributed pre-tax profits that approach 40 percent of its parents total Downstream operating results.
Holding an estimated 7 percent share of worldwide lubricants demand, the Castrol business has been a pace-setter for the global industry. In fact, it has generally chosen to play in higher-tier market segments rather than chase volume.
Its punching above its weight, too. According to its own analysis it has market-leading sales in premium products, in the main driven by relationships with original equipment manufacturers and its marketing strategies in emerging markets.
Alongside rival brands such as Mobil and Shell, it has pioneered several innovative marketing and customer-management programs. Whats more, RPS Energy believes the current high rates of return enjoyed across much of the lubricants industry have benefitted from these brands marketing and sales management. (Thank you Castrol!)
The most successful brands would appear to have all drawn a critical conclusion: While on the one hand there have been impressive technological improvements in lubricant product development, on the other, customers increasingly see product quality as a given – a license to operate. And why wouldnt they? Given the bewildering complexity of global and regional lubricant specifications, consumers look to the brand for reassurance rather than wade through all the small print of myriad approvals.
In the business-to-consumer and business-to-business spaces, extracting the value from hard-won quality improvements relies on world-class sales and marketing.
Branded Sales Impact
RPS Energy believes that the current state of the worlds lubricants markets is based on these brands providing price and reputation leadership. What would be the impact if such brands took a different approach to the market, say in the hands of a new owner?
The Castrol brand would in all probability be put up for sale if a deep-pocketed competitor like ExxonMobil bid for BP. (Face it, there would be no sense in folding the Mobil and Castrol brands together only to have to sell off large chunks of the business for antitrust reasons.) It would then go to the highest bidder.
Perhaps more likely, Castrol could be directly offered for sale if the litigation which is still in train in the United States following the 2010 Gulf of Mexico disaster puts sufficient strain on BPs cash flows. Its unlikely to be a sale of BPs choosing – it would not readily give up that 40 percent of downstream profits, only to be left with a commoditizing fuels and petrochemicals business.
In case of a direct sale, there could be several candidates keen to pick up the assets. These could include growing, aspirational players wanting to have a global calling card within their stable. Alternatively, various financially driven groups could sense an opportunity to exploit the brand in ways that have so far eluded BP.
We can imagine the announcement of such an acquisition in the financial press would be full of grand strategic statements about the challenge to build on the legacy and to create long-term value. But the temptation to realize value in the short term could prove overwhelming.
In the wrong hands, the potential for value destruction is eye-watering. For example, if new owners were tempted to push for over-rapid volume growth at the expense of margin, simply by matching the prices of mid-tier competitors, the brands profitability would crater.
Similarly, immediate cash flows could be boosted by cutting back on crucial long-term revenue investment. Then again, new owners might venture into high-volume areas like general industrial lubricants – but with low margins and without in-house base oil manufacturing in support, they could lose margin, focus and reputation all in one go!
Raising or Razing?
More concerning still for the lubricants industry as a whole, a strategic change of direction for one key brand could simultaneously undermine value for competitors who benefit from strong players who not only set high prices but also create a climate of excitement and encourage customers to pay for quality through sophisticated marketing programs.
Leading brands are highly visible. If they were to go for growth by stealing share through cut-throat pricing, in markets where volume growth will be minimal for the foreseeable future, the whole industry would risk a general margin decline.
There are several morals to the story:
Lubes businesses are potentially highly valuable assets which can become acquisition targets more because of the state of their parent companys operations than their own underlying business.
Their value to an acquirer – and the basis for further value creation – often lies more in their marketing strategy than any access to technology.
An acquisition based simply on short-term cash generation will most likely end in tears. Market margins can evaporate rapidly if customer expectations are allowed to gain momentum.
But perhaps the most important lesson in the Castrol context would be the need for any new owner to hold on to key staff and to retain strategies which underpin the brands current long run of success.