Material world Bayer's Patrick Thomas: Plastic is Fantastic

Bayer is spinning off its plastics business this autumn to focus on Life Sciences. In his first interview, Patrick Thomas, head of Bayer MaterialScience told Handelsblatt why the newly spun off company will thrive.
Patrick Thomas is still convinced that the Chinese market will continue to grow.

Patrick Thomas is chief executive of Bayer's plastics division Bayer MaterialScience, which is about to be spun off into a separate company to be called Covestro. He talked to Handelsblatt about future acquisitions, an IPO and plastic cars.

 

Mr. Thomas, how does it feel to be tackling what is probably the most difficult job in the Bayer Group at the present time?

Everyone here has a challenging job to master. But leading Bayer MaterialScience, the future Covestro, toward independence is a great job at an exciting time of transformation. I'm enjoying the opportunity to shape the future of this company.

You do after all have to sell investors on a company that Bayer is no longer interested in because it has apparently become a burden to the Life Science strategy.

We see this from a different angle. Covestro is transitioning into a pure chemical company and will no longer be competing with Bayer's Life Science businesses – health care and agriculture – in the future.

When Lanxess was spun off ten years ago, the first order of business was a three-year restructuring phase.

There is no comparison. Lanxess was in a different position because very different businesses had been brought together for which a common bond had to be developed.

And it's a different situation at Covestro?

All our products are underpinned by the same basic chemistry. That's the very reason why Bayer created and sustained MaterialScience in its present form. We have a network-like structure that offers considerable advantages – such as in process development or the construction of major production facilities. We also have a focused product portfolio in large and growing market segments. That's the second difference. Here we're talking about growth from the outset.

It hasn't even been decided yet whether it will be an IPO or a spin-off. But if it is a conventional stock market flotation, it will be one of the biggest to take place in Germany in recent years.

What makes you so confident?

We've already received very positive feedback in our initial non-binding discussions with investors. There aren't that many opportunities to invest in a polymers company which has sales of around €12 billion and operates in substantially growing markets. Investors value the quality that has come from Bayer. Bayer was a very good owner of this business and did everything it could to maintain and grow the value of MaterialScience.

Yet this business is also subject to considerable fluctuations.

Obviously, most of our businesses are cyclical. Yet one of our activities – the business with raw materials for coatings, adhesives and specialties (CAS) – is very immune to economic cycles and posts stable EBITDA margins in the region of more than 20 percent. In this business, we generate sales of around €2 billion and are the clear market leader.

Is that sufficient to generate reliable earnings?

Over the past ten years – in other words during a weak economic cycle – MaterialScience has always earned money and generated a respectable €3.4 billion in free operating cash flow for the Bayer Group. In future we will be able to utilize this cash flow ourselves.

What will be the dimensions of the IPO?

It hasn't even been decided yet whether it will be an IPO or a spin-off. But if it is a conventional stock market flotation, it will be one of the biggest to take place in Germany in recent years. And certainly also one of the biggest to ever take place in the global chemical industry.

Will Covestro receive new capital or will Bayer sell shares exclusively?

No final decision has yet been taken regarding the structure of the transaction but there is clear agreement between ourselves and Bayer that Covestro should be provided with a healthy capital structure that allows further growth.

Wouldn't it be better for you to have more money in your coffers?

Bayer will decide the financial aspects of the project. However, it is clear that we will have adequate financial resources.

You are already positioning Covestro as a growing company. Yet looking at the last ten years, your sales have grown by one to two percent at most, while earnings have shrunk.

It only appears that way on the surface. You have to look at the volume growth in our core business. We also had to cope with the financial crisis and an extraordinary dip in the polycarbonates business...

... which clearly held back the performance of MaterialScience.

In the 1990s, the polycarbonate business received an unusual boost from the dramatic development of optical data carriers such as CDs and DVDs, which in turn tempted many market players to substantially expand capacities. Due to the decline in the use of CDs and DVDs, this segment has shrunk considerably since the mid-2000s, with market share declining from 30 percent to about 10 percent. This has greatly dampened the polycarbonate market overall. In the meantime, however, this effect has been largely digested. We are now returning to normal market growth of four to five percent. This was already reflected in our strong first-half figures, and the second quarter was the best quarter since 2006.

In the long term, we continue to see growing demand for our products not just in China, but also in regions like India or Africa. People there want to sit and sleep comfortably. In Nigeria, for example, polyurethane foam mattresses are a popular wedding gift.

Haven't you polished the figures a bit for the stock market flotation?

No, there is no window dressing here. None whatsoever. Today's accounting rules do not allow any scope for that. Our polycarbonate business really did post a very gratifying performance.

How sustainable is this trend?

Market researchers expect all our customer industries to grow faster than the economy as a whole. They are predicting average annual growth in demand for the polyurethane raw materials MDI and TDI of 5.8 percent and 4.8 percent, respectively, through to 2020. The figure is 4.6 percent for polycarbonate.

The Chinese economy seems to be slowing dramatically. Doesn't this call such forecasts into question?

Growth in China has certainly slowed, but it remains robust. In the long term, we continue to see growing demand for our products not just in China, but also in regions like India or Africa. People there want to sit and sleep comfortably. In Nigeria, for example, polyurethane foam mattresses are a popular wedding gift.

Is growth of four to five percent a yardstick for Covestro as well?

We definitely have plenty of room for growth in this market. Bayer has already positioned us for the next growth phase with the necessary capital expenditures already made and largely paid for.

How high is your capacity utilization?

Capacity utilization for the industry currently stands at around 80 percent for polycarbonate and TDI, and as much as 85 percent for MDI. That means there's enough room to keep growing in the coming years without having to build new facilities. This will be the main driver of our earnings growth.

On the other hand though, you will have to establish the new administrative functions you will need in the future as an independent company.

Of course, we will need additional administrative positions. However, we will no longer have to pay the Group allocation to Bayer. At the same time, we will also be optimizing production and implementing other efficiency improvements.

Can you give an example?

In 26 countries where we currently operate through Bayer subsidiaries, we will in future be steering our business from our own sales center. As a Life Science enterprise, Bayer needs a separate company with its own address in each of these countries. As a chemical company, we don't. We will be reducing the number of our legal entities worldwide from 120 to 70.

Over the past ten years, the EBITDA margin of MaterialScience has fallen from over 18 percent to below ten percent. Do you feel you have a chance of returning to the previous level?

We cannot make any statement about this until our stock market prospectus has been published.

Many analysts are concerned that the margins will remain depressed by overcapacities. For example, Bayer and BASF have built massive TDI plants at nearly the same time.

Analysts usually only focus on newly built facilities and overlook the shutdowns of older plants. At the same time we are closing facilities in Brunsbüttel and Brazil, while BASF is taking capacities in Schwarzheide and Poland out of the market. The net effect of the new facilities is therefore much smaller. Market researchers are assuming that capacity growth in the coming years will remain below anticipated market growth. By 2020, capacities for MDI and TDI are likely to have grown by only about four percent annually while those for polycarbonate will have expanded by just two percent. This will make the market situation tighter. We are already seeing this in the case of polycarbonate.

How can you be so sure?

Major new projects are often publicized. Since they involve complex planning and permitting procedures and construction itself takes years, we can gauge the situation pretty well.

What is the risk that entirely new competitors will enter the market?

We think it's relatively small.

MaterialScience registered about the same number of patents as Bayer HealthCare last year.

The Saudi Arabian company Sadara is currently building large polyurethane plants.

That's certainly a major production complex. However, the products will be marketed by U.S. company Dow Chemical, which has been active in the market for a long time and has just shut down its polyurethane facilities in the United States.

Sabic is also investing heavily.

Sabic isn't a new competitor either. It acquired GE Plastics years ago.

How significant are the Arabian producers' cost advantages?

They certainly have cost advantages, but they are also at a disadvantage in terms of transport because the sales markets are not located in the Middle East. And transporting polyurethane materials over long distances is not that easy. We also considered building there, but we came to the conclusion that it makes no sense economically. Instead, we built our new TDI plant – one of the world's largest – in Germany, which might seem surprising.

So why did you do it?

Because Europe is a very important market for us and our new production process makes do with 60 percent less energy. This partially offsets the disadvantage of high energy costs in Germany.

With that statement you are basically contradicting all the complaints about excessively high energy costs.

I can see the critical aspects faced by many in the chemical industry. Indeed, exemptions are essential to the survival of energy-intensive companies. Yet despite this relief on the levy and electricity tax, MaterialScience pays almost 20 percent less for electricity in France than it does in Germany. In the United States, it pays only half as much. On the other hand, the cost of energy is one of the factors driving our growth on the product side. Wherever there is a need to save energy – be it in the construction industry or in lightweight automotive engineering – our products play a role. And thanks to our new TDI process, the energy balance of our products is now even more favorable.

As far as product innovation is concerned, chemical products seem boring compared to pharmaceuticals.

I don't think so. It takes around ten years to develop a new pharmaceutical product. The polymer industry has innovation cycles of six or 12 months. It is constantly coming up with new things. And it might surprise you to learn that MaterialScience registered about the same number of patents as Bayer HealthCare last year.

But polyurethane was invented 80 years ago and polycarbonate in the 1950s. What has happened since then?

We have since invented 3,000 new variants of polyurethane and countless applications for polycarbonate.

In other words, the base substances have been modified.

With dramatic effects on the product properties. 40 years ago, an insulation panel like this (Mr. Thomas takes a piece of five-centimeter insulation from his rucksack) would have had to have been a half-meter thick to produce the same insulating properties. And this kind of product (he takes out a chrome-colored car door handle) can now be made from polycarbonate. Anyone would think it's made from metal. We can even ensure that it feels just as cold as metal.

Carmakers had better not tell their customers that.

Indeed they should. It's a great improvement if it cuts down on weight. A ten-percent weight reduction in a car saves five percent on fuel costs.

You're still working on substituting materials.

Yes. That is the focus for all our products. We are replacing older materials and are therefore seeing above-average growth. (Mr. Thomas takes a gray plastic panel from his rucksack.) Take this carbon-fiber-reinforced polycarbonate sheet. It's lighter than aluminum but has greater structural strength.

But composite materials like that have been around for 30 years.

Not a material like this. It's unique. Using technology acquired when we recently purchased TCG, we can produce these sheets for downstream thermal processing – pretty much like sheet metal. Carmakers can now keep liquid resins out of their factories when they want to use plastic car body components. This is the automotive industry's dream.

What is the advantage?

It's far more efficient than today's process. A panel like this is placed in a press and comes out a tailgate three seconds later.

Have you already spoken with customers in the automotive industry?

Of course. And they're really keen.

When will we see the first cars with components made like this?

They could be on the roads within the next five years.

So polymer innovations aren't that fast after all.

Lead times in the automotive industry are longer than in other industry segments. Take a product like this one for the textile industry. (Mr. Thomas takes a strip of synthetic leather from his rucksack.) It looks black but if you stretch it, it's a different color. This effect is based on our polyurethane technology and will be a fashion trend in the coming season.

Has research produced any entirely new substances?

We're still inventing new substances as well. Take this foam. It's made using a precursor we manufacture from carbon dioxide. It represents a real breakthrough in C1 chemistry, which is based on molecules with just one carbon atom.

This probably also has something to do with giving plastic a green image.

That is certainly one beneficial aspect. However, this isn't about greenwashing. It's also financially attractive. CO2, the raw material used, is available for free. In the future, we might even be paid to use it.

Don't you need a lot of energy to separate CO2?

You need a good catalyst. And that is precisely where the breakthrough has been made. We came up with the product in collaboration with Aachen University, one of the world's leading institutes in this field.

Has polymers research received too little recognition and attention from Bayer in the past?

No, but Bayer's main story is certainly to be found in the Life Sciences – in the health care and agriculture businesses. I can live with that. As long as companies like Henkel, Ikea and BMW know who we are, then that's OK.

Bayer CEO Dekkers justified the planned stock market flotation of MaterialScience with the fact that there are too many investment opportunities in HealthCare and the polymers business. But if you don't need any new facilities at the present time, what have you got in mind?

As far as capital expenditures are concerned, we are certainly well positioned for the coming years. This statement reflected more the need to look at what will happen in the next investment cycle.

What are you considering there?

It's too early to talk about that. It all depends on future market development. Basically, Bayer's long-term portfolio policy is exemplary. The company looked forward ten years and, from a position of strength, concluded that it would be strategically better to separate these two businesses (Life Sciences and polymers). It has advantages for both. Covestro will no longer have to compete with the very strong Life Science businesses for financial resources – it will be able to refinance itself on the capital market.

What will Covestro look like in ten years?

It should certainly be a much larger company but, viewed from the current perspective, will still be based on the same three pillars as it is now.

Are you interested in acquisitions?

Given our already large shares of the polyurethane and polycarbonate markets, antitrust regulations will make it difficult for us to make any acquisitions there. We are more interested in clever complementary technologies. Slightly larger acquisitions in the area of polyurethane coating raw materials or dispersions are conceivable – provided the right assets actually come up for sale.

Your market shares here are already even larger.

But it's a fairly heterogeneous field with scope for consolidation.

What about expansion into entirely different areas of the polymer or chemical industries?

We see absolutely no need for that. We are continually analyzing the situation and believe that we still have great growth potential with today's technologies.

In other words, we can continue growing for a very long time without having to make any changes to our portfolio. Our production structure is basically the perfect puzzle. If you were to add a different piece, it wouldn't fit.

North-Rhine Westphalia's politicians dream of creating a new champion out of the chemical companies located in the region. Could Covestro play a leading role here?

I don't believe this would create any value at all. The only thing these companies have in common is the fact that they are based in North Rhine-Westphalia. And it certainly wouldn't be good for jobs.

What about individual activities like Evonik's acrylic glass business – would that not be of interest to Covestro?

Those plastics are based on an entirely different chemistry. With their properties, our polycarbonates have the potential to replace acrylic glass and a number of other polymers. Why should we consider taking a step backward? We're moving forward.

On your way forward, have you already been looking out for a fancy new corporate headquarters?

No, it's quite chic enough here. Leverkusen is a really good location. We have everything we need here and don't want to lose qualified employees by relocating. Why should we spend money on a change like that?

Perhaps to put a little more distance between you and Bayer and locate the company to a more attractive site?

No way. This is my office and my view. Covestro was born here and it's going to stay in Leverkusen. Period.

 

Siegfried Hofmann conducted the interview. Mr. Hofmann is the chemical and pharmaceutical industries correspondent and is based in Frankfurt. To contact the author: [email protected]