DuPont management may still have the faith that the science based strategy is right, but everyone else seems to disagree. Trian criticized the company for bloated costs and lack of returns on its R&D spend and we have echoed that in research both before and after the Trian involvement.
The bear case is winning today and it goes as follows: DuPont management takes the proxy win as an endorsement of the strategy and the path the company has followed for the last decade. The company continues to waste money on ineffective R&D, continues to ignore its high cost base and possibly makes further bolt on acquisitions which disappoint and destroy value. On this basis you would expect low earnings growth and a continuation of the recent history of negative guidance following too bullish expectations based on optimism around the R&D return and the value of novel products. On this basis the stock at best moves sideways.
This is perhaps one of the least sophisticated analyses you will see from our group, but it illustrates a point. In the exhibit below we show the cumulative spend on R&D for the last 20 years, divided by 2014 revenues. The R&D spend at DuPont over the last 20 years is equivalent to almost 90% of the 2014 revenue level – overshadowing everyone else on the list with 20 year history. Obviously we are not taking into account portfolio changes, but if you then compare this data with average 20 year TSR, you can see the disconnect.
DuPont will argue that the past is not a good predictor of the future, but we, and clearly many investors, believe that it is.
The bull case is that all this could be fixed and that billions of dollars of value could be unlocked. We would contend the following:
- There is at least $3.0 billion of costs that could be cut out of DD without breaking up the company – the number would most likely be higher with a break-up
- $3bn of costs – if all taken to the bottom line – would be worth $2.40 per share
- At least $0.75bn of R&D could be abandoned with no impact on earnings
- 35% of R&D – $0.60 per share
- The balance of the R&D spend could be managed more effectively to generate a better return
- Free cash can be deployed in share buyback and the company could buy back as much as 12% of the stock over the next two years including the one-time cash dividend from Chemours
- Adding this all up gives a conservative $7.00-7.50 per share earnings number in 2018 versus current consensus of $4.50
Perhaps it would take more than 3 years to pull out all of the costs, but the opportunity is clear and this is what Trian was looking for and where the target price north of $100 per share came from.
Those selling the stock today are either convinced that the activists are not willing to have another go and/or that the DuPont board is willing to sit back and hope that a flawed strategy to date can suddenly come right. We think neither conclusion is right. The bull case is much more believable