LEGACY OF SUCCESS
When Jack A. Hockema was promoted to chief executive officer of Kaiser Aluminum in October 2001, he had no idea just how tortured his first five years as leader of the fabled company would be.
Hockema knew, of course, that Kaiser had problems. Aluminum prices were low, and sales were terrible in the business world after the attacks of Sept. 11, 2001. But after a thorough review of the company during his first several months on the job, Hockema concluded there was only one possible way to save Kaiser: Chapter 11.
“Things were not going well for the industry at the time,” he recalls. “We had two large tranches of debt coming due. We had asbestos liabilities; we had spiraling pension costs and spiraling retiree medical costs. It became very obvious that there really wasn’t any other option.”
So it fell to Hockema, who didn’t really want to be CEO, to put Kaiser and 25 of its subsidiaries into bankruptcy. At the time, he thought the company might emerge from Chapter 11 protection in two years. Instead, it took 4½ years to negotiate satisfactory settlements in a tangle of liabilities, worth $4.7 billion, that included some of the most intractable issues that any business can face. Several times, the aluminum company founded back in 1946 by Henry J. Kaiser seemed close to death.
“The bankruptcy judge thought there was no way we would ever emerge from bankruptcy because of the kinds and depth of the issues we were dealing with,” Hockema says. “So it was a tremendous accomplishment just that we got out.
But the company did much better than simply “get out.” “We have our fabricated products business well positioned competitively. We cleaned up our balance sheet. We took out more than $4 billion of liabilities and have the balance sheet of a newborn baby. We have no net debt and a very good business going forward,” Hockema says.
The newly renamed Kaiser Aluminum Corp., now based in Foothill Ranch, California, emerged from Chapter 11 in July 2006. It was no longer a multinational, vertically integrated aluminum company. All of its bauxite and alumina production assets were sold, and its only remaining primary aluminum production capacity was a 49% interest in an aluminum smelter in Wales. Kaiser’s surviving operations focus on valueadded sheet, plate, extrusions and forged products for the aerospace, defense, automotive and general industrial markets. Annual sales at the time were about $1.1 billion, while output was more than 637.5 million pounds of mostly fabricated aluminum products.
The impact of the company’s orientation toward value-added products shows in this year’s first-half results. First-half 2007 net income totaled $51.8 million, up 44.2% from 2006 first-half net income of $35.9 million. Sales rose 12.6% to $777.3 million. Nearly 78% of Kaiser’s first-half shipments of 356.4 million pounds were fabricated products, for which the company realized an average price of $2.41 a pound, compared with $1.38 a pound for the small amount of primary aluminum sold by Kaiser from its share of the Anglesey smelter in Wales. (The power contract for Anglesey is scheduled to expire in 2009.) First-half operating margins for fabricated products equaled 31 cents per pound, compared with 24 cents in 2006 and 19 cents in 2005.
In June, Kaiser declared a quarterly dividend of 18 cents a share. The company has announced investments of $230 million to increase its high-value heat treat plate production at its Trentwood, Washington, rolling mill, near Spokane, and to improve the efficiency of its rod, bar and seamless tube operations.
“The outlook for Kaiser is favorable,” says Tim Hayes, an analyst for Davenport & Co. “They will more than double their plate capacity by 2009, and we like their strength in the aerospace market.”
Of course, the road hasn’t been easy. “[Kaiser] went through a very difficult time, a very hard process,” says William K. Sales, Jr., senior vice president for non-ferrous operations at Reliance Steel & Aluminum Co., an important Kaiser customer. “I give Jack and his team a lot of credit. He said early on that they would treat the bankruptcy almost as a separate business unit, so that it had no impact on operations, and they were very successful. From the point of view of quality, service, delivery and those things, they performed very well.”
Hockema originally worked for Kaiser from 1977 to 1982 in production and operations management positions at several plants, then left and held senior executive positions with such metals companies as Bohn Extruded Products, a Gulf+Western division, and American Brass Specialty Products. He also was a principal in a metals industry management consulting and investment advisory firm.
He returned to Kaiser in 1995 as acting president of its forgings business unit. He had been an executive vice president of the company and president of its fabricated products operations for several years when the call to the top job came in 2001. Hockema holds an M.S. degree in industrial management and a B.S. degree in civil engineering, both from Purdue University.
Forward spoke with Hockema about what it took to survive the bankruptcy and emerge with a company that’s strong, confident and growing.
FORWARD: You became CEO of the company at a particularly difficult time. Had you planned for that?
JACK A. HOCKEMA: No. I didn’t want the job, but I was very good friends with [Raymond J. Milchovich, Hockema’s predecessor as CEO]. When he became CEO, and I was president of the extrusion business, he asked me if I would back him up. I said, ‘Only on an emergency basis.’
But then I got the call that he was leaving [to become CEO of engineering and construction firm Foster Wheeler]. I told him that we couldn’t afford to have an acting CEO. And he said, ‘No, we can’t. You’re it, pal.’ I’d seen the depth and loyalty of these employees and customers, and so I took it on from a leadership standpoint. Somebody had to do this, and I was the guy. It was my turn.
Today I’m thrilled that I did it and with what we accomplished here. It’s a great feeling to go out into the plants now and hear the people talk about how wonderful it is that we’re out of bankruptcy.
FORWARD: What does it take to navigate a complex bankruptcy like you faced with Kaiser?
HOCKEMA: At the core was an abiding interest throughout the bankruptcy for this company to succeed. We had support from our customers. We’ve been doing business with service centers and many OEMs for decades, from back when they were founded in some cases.
What I learned is that if you don’t get the creditors on your side, it doesn’t matter what management wants to do. The creditors call the tune. And if you look at any one stakeholder that was probably more dedicated throughout the bankruptcy than even the creditors, it was the [United] Steelworkers. From the beginning, they were intent that this company was going to emerge strong and successful.
The Steelworkers … recognized most of the value they could get for their members and retirees was from a thriving company. The union, as an entity, called most of the final shots in terms of what the emerging entity would look like.
FORWARD: Were there times when you thought the process would fall apart?
HOCKEMA: I never did believe that we wouldn’t get out. I thought it would take two years. It took 4½.
I have to tell you that if we had known at the beginning of 2003 what it would take to make it through that year, we probably would have just thrown in the towel. We were really getting hurt. Gas prices just killed us in the alumina business, and we needed to dredge up another $100 million to $125 million to make it.
We identified sources for that cash. People just did what they had to do. It’s amazing when you’ve got your back against the wall what you can accomplish, and this team did that.
FORWARD: How much has it helped that aluminum is in a positive cycle now?
HOCKEMA: Timing is everything. We’ve exited a lot of product lines, and we’ve positioned ourselves where we have competitive strength. In fact, we believe that 80% of our sales go into market segments where we have either a No. 1 or No. 2 market position.
We exited the can business at Trentwood, which was probably the toughest one, and it was a big one. It was painful, but boy, are we glad we did it. We freed up a lot of cash and didn’t sacrifice any income. In fact, you can probably make a case that we improved our income while we were throwing off a bunch of cash exiting those businesses.
The other thing is that it facilitated all our expansion at Trentwood. You use basically the same equipment to hot roll plate as you do can stock, so it has given us nearly infinite upstream capacity in very capital-intensive assets. With a relatively modest investment, we had upstream assets that we needed for aerospace and heat treat plate.
FORWARD: And in terms of timing, the heat treat plate business is very good right now.
HOCKEMA: It’s as good as it gets right now. We’re more than doubling our capacity in heat treat plate, and that capacity is fully committed through 2011.
There are three things driving the growth. One is builds of aircraft. The growth of the global economy is driving build rates.
The second is larger aircraft, and again, that goes back to the international economy. There’s demand for more large aircraft because of the long hauls and payloads.
But the third one is how the plate is used, and that’s what caught all of us by surprise and caused a step-change in demand. Boeing and Airbus changed their concept to ‘monolithic design.’ Historically, they would buy heat plate extrusions and forgings and assemble them, welding and riveting them into a component. But machining technologies evolved to the point that it was better for them to buy a big chunk of plate and machine that plate into the [final] shape. It’s a monolithic structure, with no assembly.
The manufacturers typically machine away 90% of what we sell to them. So we sell prime aluminum, plus the value-add we put in it for melting scrap, casting it into ingot, hot rolling to gauge, heat treat, stretch, gauge it and then ultrasonic inspection. Then we do the finish sawing, pack it and ship it.
(Editor’s note: The recent spread between the price of prime aluminum and scrap was more than 40 cents a pound.)
A little less than half of our business is aerospace and defense and other highstrength type products, with a little more than half in general engineering and custom products.
FORWARD: Does today’s Kaiser Aluminum do anything it considers unique in the marketplace?
HOCKEMA: We think so. It’s our Kaiser Select product. We offer it today in precision rod. There’s no one part of what we do that’s unique. It’s the combination of all of our technologies that makes what we think is a unique product.
Our application engineers started working with screw machine operators to find out why they preferred one type of rod to another. We took samples back to the lab to look at the metallurgy, the alloying elements and metallurgical structure. We designed a metallurgy that optimizes the performance of that part, and then we took it further, into our production system, to design a process that could replicate those metallurgical characteristics consistently.
The traditional extrusion process for the kind of physical properties that we’re seeking generally is right around 3 Sigma. We’ve demonstrated with our Kaiser Select process getting up to 9 Sigma. When our bar goes on the screw machine, the operator knows that it’s going to perform well. That’s why we expect to get a premium price for our products and services, and generally do.
In 2010, when all of our planned investments are on line, all of the rod we produce nationally will be Kaiser Select. We’re working on similar programs for our plate and bar products.
Back to the fundamental point: We believe we have an ability to combine all of these technologies to produce superior products. It’s very, very difficult for anyone to match it.
FORWARD: How does a small company, with sales of about $1.4 billion, survive in an era of consolidation?
HOCKEMA: We see ourselves as one of the consolidators as we go forward. We’ve got tremendous financial strength, and we have an excellent platform. That’s my vision and the board’s vision, for us to grow and build upon what we have.
Right now, we have a significant obstacle for any acquirer, and that is we have close to a billion dollars in tax attributes, which are a significant portion of the value of the company that would be lost in an acquisition within two years of our emergence from Chapter 11.
After funding the growth initiatives that we have on the table, we have dry powder. We can still have a very conservative balance sheet and debt load to invest $3 billion. We’re roughly $1.5 billion in enterprise value today, so we could triple the size of the company tomorrow and still have a very conservative capital structure.
FORWARD: Are you contemplating something overseas?
HOCKEMA: We’re basically a domestic company today, but in our executive team I have international experience. However, go back to the $1 billion tax attribute that shelters U.S. income. We have a significant incentive and get a lot more pop from acquisitions that involve U.S. income rather than international income.
FORWARD: What are your expectations about continuing consolidation in the industry?
HOCKEMA: The big consolidation that we’re seeing right now is really on the mining side, where the big mining companies are all consolidating. I think there’s also another sea change happening in aluminum. We’ve done it, and Alcan did it to some degree. We’re beginning to separate the upstream part of the business from the downstream.
Look at the red metals as an example. They separated the upstream from the downstream decades ago. Aluminum is really the only one left that’s been fully integrated, and there’s no reason to be fully integrated. There’s no value in having the upstream assets with the downstream assets. They are two very different businesses, and there’s no rationale to have those together.
I think it can be a distraction to have them together. You’re running a conglomerate, not an aluminum company.
FORWARD: What about the possible integration of metals companies with service centers?
HOCKEMA: I don’t see any benefit in it. They are two separate businesses. I don’t understand what the synergy is.