Strategy Case Study:

Corporate Strategy and Portfolio Development

Tuebingen, 2011/01/24 University of Tuebingen A case study in the context of the masters seminar Competitive Strategies Winter semester 2010/2011 Prof. Dr. Wilhelm Rall Torsten Arnold

Torsten Arnold BASF Corporate Strategy and Portfolio Development

Purpose and Organization of the Research

Torsten Arnold BASF Corporate Strategy and Portfolio Development

Questions to be answered
1. BASF will have a new CEO at the end of the year. This is a perfect time to think through the portfolio restructuring of the last 10 years. What was the strategic rationale behind it? Do you think this rational is still valid and should be further pursued? 2. The corporation is thinking about further major enhancements of efforts in the agrobusiness. This means that they would have to up-scale their respective R&D even further, but potentially make some aquisitions as well. There is an option to acquire a major EU seed company for about 1.5 2.0 bn USD. Is this option worth to be pursued further?

Torsten Arnold BASF Corporate Strategy and Portfolio Development

Outline
1. Understanding the context
1.1 BASF The Chemical Company 1.2 Portfolio Analysis Basic Methods

2. BASF - Acquisitions and Divestures

2.1 Empirical Analysis 2.2 Strategic Rationales 2.3 A New Acquisition Target

Torsten Arnold BASF Corporate Strategy and Portfolio Development

1. Understanding the context

1.1 BASF The Chemical Company

Torsten Arnold BASF Corporate Strategy and Portfolio Development

BASF The Chemical company

Remain the world`s leading chemical company Committed to operational excellence, innovation and investment in growth markets Actions are guided by sustainability Distinguish from competitors through innovation (R&D investments consistently high) Increase competitiveness through active portfolio management

Torsten Arnold BASF Corporate Strategy and Portfolio Development

Four strategic guidelines form the basis of BASF`s activities

Earn a premium on the cost of capital

Help the customers to be even more successful

Activities

Form the best team in the industry

Ensure sustainable development

Torsten Arnold BASF Corporate Strategy and Portfolio Development

Growth in almost all segments (2001-2006)

Chemicals Plastics Performance Products Agricultural Products & Nutritions Oil & Gas

14.000 12.000
Sales per segemnt (in million )

10.000 8.000 6.000 4.000 2.000 0 2001 2002 2003 2004 2005 2006
Figure 1: Sales per segment from 2001-2006, Source: BASF Annual Reports Torsten Arnold BASF Corporate Strategy and Portfolio Development 8

Increasing fluctuation in the industry

Chemicals Functional Solutions Plastics Agricultural Solutions Performance Products Oil & Gas

16.000 14.000 12.000

Sales per segemnt (in million )

10.000 8.000 6.000 4.000 2.000 0 2007 2008 2009

9 Figure 2: Sales per segment from 2007-2009, Source: BASF Annual Reports Torsten Arnold BASF Corporate Strategy and Portfolio Development

Integrated production The Verbund concept

BASF`s greatest asset when it comes to efficient use of resources Production plants at large sites, closely interlinked, creating efficient value chains Production plants, energy, waste flows, logistics and site infrastructure are all integrated Cost-efficient production through six world-scale Verbund sites in all major regions Savings of around 500 Mio each year only at its Ludwigshafen site.
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Vertical integration and resource efficiency

Oil & Gas
Basic Chemicals

Intermediates

Plastics & Performance Products

Agricultural Solutions & Functional Solutions

Creating value-adding chains from basic chemicals to higher value products Implement all business segments into the production process using interdependence Provides new opportunities for more flexible response to economic fluctuations

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1. Understanding the context

1.2 Portfolio Analysis Basic Methods

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Why do we need portfolio analysis?

Portfolio-optimization is one of the corner stones of value creation Gives a direct overview of the existing portfolio Portfolio planning methods help selecting strategic options (future acquisitions or divestures) How to set up a flow of capital and other resources among the business units of a diversified company

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The Nine-box matrix The basic framework of portfolio planning methods

Figure 3: Nine-box matrix. Source; McKinsey and Company. 2000. Thinking strategically. Torsten Arnold BASF Corporate Strategy and Portfolio Development

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A new advanced analytical framework is needed

Nine-box matrix only applies to product markets (selling goods and services to customers) However a strategy also needs to help the company to analize business units on a higher level (acquisitions, mergers, joint-ventures, sale) Market activated corporate strategy (MACS) framework

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MACS Key Insights

Adds a measure of a business`s units suitability for sale to other companies. Analize a corporation`s ability to extract value from a business unit relative to other potential owners Less to do with the unattractiveness of a business unit but more whether a corporation is suited to run it The tool can be used to plan acquisitions or dispositions and to identify the efforts a parents corporation should be engaged in

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MACS - Overview

Figure 4: Market activated corporate strategy framework. Source; McKinsey and Company. 2000. Thinking strategically. Torsten Arnold BASF Corporate Strategy and Portfolio Development 17

MACS Possible strategic results

Sale of structurally attractive businesses if they are worth more to somebody else Keep structurally moderate or even poor business units if you can extract more value out of them then somebody else Top priority to business units at the far left of the matrix Finding the best combination of corporate capabilities and business units that provide the best overall scope for creating value.

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What about risk?

Almost all theories of portfolio management were established on the foundation of the financial portfolio theory (risk vs. return) However until now risk is not considered Similar risk profiles of the business units can lead to an unforeseeable overall risk Including risk in the analysis can radically change the expected value of a companies portfolio

Combining the basic MACS framework with a risk perspective

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Contemporary portfolio theory Risk/Return Matrix

Combination of a business units attractiveness and its risk component Both factors are assessed on a stand alone base and under the consideration of overall portfolio interdependences

Figure 5: Risk/Return Matrix. Source; Rall, W. and Knig, B., 2003. Aktuelle Herausforderungen an das strategische Management. Handbuch strategisches Management Torsten Arnold BASF Corporate Strategy and Portfolio Development 20

2. BASF - Acquisitions and Divestures

2.1 Empirical Analysis

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Empirical Analysis: Basic Methods (1/3)

1st step: Based on second generation portfolio theory
stand-alone attractiveness
Market position, competitive situation, product differentiation, growth potential

parenting advantage
Synergistic effects through integration (Verbund), scale effects, effects on exisiting market position

At best:

D
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Empirical Analysis: Basic Methods (2/3)

2nd step: risk integration
stand-alone business risk correlation with portfolio risk
Effects of acquisition/divesture on overall portfolio risk (increase/decrease) Assumption: acquisitions are negatively correlated with portfolio since they are supposed to reduce risk in overall portfolio in the long term

At best:

D A

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Empirical Analysis: Basic Methods (3/3)

3rd step: Third generation portfolio theory
expected rentability risk delta of portfolio (combining stand-alone risk with risk impact on portfolio, ex-ante)
Investors dislike high volatilities of portfolio return

At best:

A
D

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BASF Acquistions - 1st Step: Strengthen portfolio plus high ROI chances

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BASF Acquistions - 2nd Step: Decrease overall portfolio risk

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BASF Acquisitions - 3rd Step: Risk/Return integration

1Cyanamide/AHP: agricultural products 2Treffert Group: Foil Coatings business (outside of Germany) 3Foam Enterprises: American rigid polyurethane foam producer 4Merck KGaA electronic chemicals business 5BASF Coatings Japan Ltd. 6Orgamol: Swiss fine chemicals 7BASF Akzo Nobel --> BASF Coatings Australia Agricultural Solutions Functional Solutions Plastics Chemicals Functional Solutions Chemicals Functional Solutions Plastics Plastics Functional Solutions Functional Solutions Functional Solutions Performance Chemicals Plastics Agricultural Solutions

30 11 07 24 01 10 06 20 19 22 03 23 28 09 13 25 26 02 05 21 08 31 04

12 34 33 1517 27 16 18 14

8Huntsman: global TDI business 9Leuna-Miramid GmbH: engineering plastics Europe 10Rhenania Coatings GmbH: coil coatings business 11Degussa: construction chemicals business 12Engelhard: catalysis and surface finishing 13Johnson Polymer: resins 14Lanxess: SAN business 15CropDesign: biotechnology company 16PEMEAS: fuel cell components 17Chinese motorcycle catalyst business 18Chinese Hi Con: concrete admixtures 19Billakksenteret AS: Coatings, R-M sales activities 20Autolacke Handel GmbH: Coatings,R-M sales activities 21Dutch Polymer Chemical Company: Polyurethane System House 22DERIS and Chteau-Arnoux Peinture: Coatings, R-M sales activities 23Michel DE-RIS S.A.S. France 24SABIC Innovative Plastics joint venture 25BCD Rohstoffe fr Bauchemie HandelsGmbH (Austria) 26Multi Chemical Est.:: polyurethane business 27Yasar BASF Automotive Coatings Ltds 28Revus Energy ASA (Wintershall) 29Recticel: car windows, polyurethane specialities business 30Ciba Holding AG. 31Sorex pest control business, Whitmire Micro-gen 32NOF Thailand: motorcycle coatings business 33Kejie: concrete admixture business 34 Cognis Holding Luxembourg S. r.l.

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Functional Solutions Chemicals Functional Solutions Functional Solutions Plastics Functional Solutions Functional Solutions Plastics Chemicals Plastics Functional Solutions Oil & Gas Plastics Chemicals Agricultural Solutions Functional Solutions Chemicals Functional Solutions

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BASF Divestitures 1st Step: Sell units with low level of attractiveness and low parenting advantage

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BASF Divestitures 2nd Step: Reduce overall portfolio risk

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BASF Risk/Return Matrix: Divestitures

1pharmaceutical and nutrition market 2Phenoxy Business 3Fiber Board Coating business in Spain and Italy (Treffert) 4Polystyrene Specialty Compounds business 5Dystar BASF 6triforine business 7polystyrene business: U.S., Canadian 8sell stakes in Basell 9decoration color business Pharmaceuti cal Agriculture Functional Solutions Plastics Chemicals Agriculture Chemicals Functional Solutions Performanc e Products

08 21 05 15 17 19 20 01 16 06 14 09 02 11 04 12 10

22 23

18 03 07 13

1014 percent shareholding in DENC 11major assets of Micro Flo Comp. Agricultural Solutions Agricultural 12global terbufos insecticide business Solutions Chemicals 13animal feed premix sites, Netherlands 14Chemische Fabrik Wibarco GmbH Chemicals Chemicals 15exit human nutrition premix marketplace 16rail cargo company RAIL4CHEM Chemicals 17Seal Sands site, UK Pharmaceuti 18Shreveport site cal Functional 19China process catalysts site Solutions Functional 20Ako site to Kansai Paint Solutions 21styrene monomer site in Korea 22polystyrene business in Brazil Chemicals 23 European starch business

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2. BASF - Acquisitions and Divestures

2.2 Strategic Rationales

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BASF`s strategic rationales - Overview

Acquisitions
High attractiveness (e.g. eROI), low portfolio risk Strengthen less cyclical businesses (specialty chemicals) Penetrate emerging markets Hedge against environmental risks

BASF Core Business

Divestures
Low attractiveness and high portfolio risk Low synergies Non-strategic Improve leadership in other segments

Figure 6: BASF strategic rationales, Reasons for Acquisitions and Divestures; Source: Own illustration Torsten Arnold BASF Corporate Strategy and Portfolio Development 32

Hedge against cyclicality and widen R&D intensive businesses

Divest unattractive and cyclical segments

Oil & Gas plus Agricultural solutions build a stable earnings base -> Strengthen

Figure X: EBIT by segments. Source: BASF Homepage, Strategy, Portfolio Optimization

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Strategic rationale Acquisitions of BASF

Strengthen less cyclical businesses

The strategic logic of the transaction is convincing, since the combined businesses will be strengthened sustainably and positioned for long-term profitable growth. (Dr. Jrgen Hambrecht, Chairman of the Board on the acquisition of Ciba Holding AG) The aim is to strengthen our involvement in less cyclical areas that are driven by innovation and offer growth above the average of the chemicals market. (Dr. HansUlrich Engel, Member of the Board on the largest acquisition within the last years) Construction chemicals is an innovative business area with cyclically resilient margins that we will develop into a profitable growth sector in BASFs portfolio. (Dr. Andreas Kreimeyer, Member of the Board on the acquisition of Degussa's construction chemicals)

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Strategic rationale Acquisitions of BASF

Penetrate emerging markets:

Our investment programs are geared to growth markets and to Asia and China in particular. Examples include the $1.4 billion expansion of our Verbund site in Nanjing, China (Dr. Hans-Ulrich Engel, Member of the Board)

Hedge against environmental risks

Through this, we open up further opportunities for a long-term and reliable supply of Russian natural gas in Europe to competitive conditions." (Dr. Jrgen Hambrecht, Chairman of the Board on the joint venture between Gazprom and Wingas)

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Strategic rationale Divestures of BASF

Low synergies and non-strategic for BASF
We have identified some products such as triforine that offer limited synergy for us, however are clearly a better strategic fit for a specialized company (Hans W. Reiners, President, BASF Agricultural Products division on the sale of its triforine business to Sumitomo Corporation) BASF considers the LAB business as non-strategic mainly due to its lack of integration into the Verbund (Patrick Prvost, head of BASFs Performance Chemicals division on the divesture of the Wibarco GmbH to Hansa Chemie International AG)

As the starch business is a regional, stand-alone business offering few synergies with BASFs paper chemical operations, we have taken the decision to divest this business (Christian Schulz, Vice President Business Management Paper Coating and Starch Europe on the sales the European starch business)

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2. BASF - Acquisitions and Divestures

2.3 A New Acquisition Target

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Acquisition Target Overview

Top-10 seed companies with strong position in corn, sugar beet and wheat
Strengthens BASF`s leading position Fits into historical acquisition scheme of BASF (e.g. Agricultural: Cyanamide/AHP 2000, 3.8 bn; Biotechnology: CropDesign, 2006; Sorex pest control, 2008)

High one-digit growth rates in the last five years, ROE 12 14 % range
High attractiveness Lowers overall portfolio risk

R&D intensive business

High entry barriers Distinguish from competition
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Acquisition Target BASF statement

BASF Annual Report 2009 on agricultural solutions: Innovation is decisive for success. That is why we continuously invest in our active ingredients pipeline and develop improved formulations. Successful growth also means using the potential of new business models and developing new market segments, through acquisitions when appropriate

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Acquisition Target Portfolio analysis (1/3)

1st step: Based on second generation portfolio theory
High stand-alone attractiveness (high growth rates & high ROE) High parenting advantage (strenghten leading position)

AT

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Acquisition Target Portfolio analysis (2/3)

2nd step: Risk Integration
Low stand-alone business risk (high growth rates, global scale for already 30 years) Relatively high negative correlation with portfolio risk (two existing R&D cooperations with BASF)

AT

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Acquisition Target Portfolio analysis (3/3)

3rd step: Thrid generation portfolio theory
High attractiveness for the overall business of BASF Low risk delta of portfolio -> relatively low volatility of portfolio returns

AT

Strong buying option for BASF

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Thank you for your attention!

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List of figures
Figure 1: Figure 2: Figure 3: Figure 4: Figure 5: Sales per segment from 2001-2006, Source: BASF Annual Reports Sales per segment from 2007-2009, Source: BASF Annual Reports Nine-box matrix. Source; McKinsey and Company. 2000. Thinking strategically Market activated corporate strategy framework. Source; McKinsey and Company. 2000. Thinking strategically. Risk/Return Matrix. Source; Rall, W. and Knig, B., 2003. Aktuelle Herausforderungen an das strategische Management. Handbuch strategisches Management Figure 6: BASF strategic rationales, Reasons for Acquisitions and Divestures; Source: Own illustration

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