By Nick Carey
CHICAGO (Reuters) - Alcoa Inc (AA.N) said Monday it will break itself in two, separating a faster growing plane and car parts business from traditional aluminum smelting operations as shareholders seek higher returns amid a commodity slump.
Pressured by a 42 percent drop in its share price this year and a surge in Chinese aluminum exports, Alcoa is joining a wave of major corporations which recently have sought to break up to add shareholder value, such as General Electric Co (GE.N) and Hewlett-Packard Co (HPQ.N).
Alcoa shares rose 2.4 percent to $9.29 as analysts applauded its intensified focus on products for expanding businesses like aerospace and auto.
The 127-year-old company was the biggest percentage gainer on the benchmark S&P 500 index, as U.S. stocks slumped broadly on Monday.
A global glut of aluminum, which has depressed prices, has battered Alcoa stock, driving the company's market value this year down to about $12 billion.
"Alcoa has faced this problem for decades: No matter what they have done to enhance their product line, their stock has traded based on metal prices," said analyst Charles Bradford of Bradford Research.
In another stark example of such a link, Glencore (GLEN.L) shares tumbled almost 30 percent to close at an all-time low on Monday, on fears that the mining and trading company was not doing enough to rein in its debt to withstand a prolonged fall in global metals prices.
Alcoa's traditional business, which also includes better-performing bauxite and alumina, will retain the Alcoa name. The newer company is still unnamed.
The split is expected to be completed in the second half of next year.
"We are interested in creating value for our customers, for our shareholders, for our employees, and at this point this is the option we see that creates the biggest value," Chief Executive Klaus Kleinfeld told Reuters.
Kleinfeld will become CEO of the new company, and remain Alcoa chairman during a transition period.
"We believe both entities have gotten into a shape that they are competitive and sizeable and they can stand on their own," Kleinfeld said.
Alcoa had already been in the process of a transition, including acquisitions to beef up its business for such sectors such as aerospace and autos, said Josh Sullivan, an analyst with Sterne Agee CRT.
"The commodity business was a significant drag, not only on valuation but on the resources of the company," Sullivan said.
Alcoa did not provide details on the cost of carrying out the split, which it said should be tax free for shareholders. It is targeting an investment grade credit rating for its "value-added" business and "strong non-investment grade" rating for its legacy business.
The company also said that as of Dec. 31 2014, its pension was underfunded by about $3.3 billion. Executives said Alcoa will allocate debt and pension liabilities "in a manner that is prudent for the two businesses to have the balance sheet" the company is targeting.
A 25 percent drop since last September has pushed aluminum prices to six-year lows. An unprecedented plunge this year in premiums – surcharges paid for physical delivery - to their lowest in 3-1/2 years have posed the biggest threat to producers' margins since the 2008 financial crisis.
As a result, more than 10 percent of smelting capacity outside of China, or 3.5 million tons of production, is running in the red. Alcoa Inc has closed or curtailed 170,000 tons of annual output this year, part of a review of 500,000 tons of smelting capacity announced in March.
Aluminum output in China, the world's biggest producer, climbed 12 percent during the first seven months of the year.
At the same time, the company has bet on growth from higher-margin titanium and high-strength aluminum sales to the aerospace industry, as its order book swells for airplane production and amid renewed global spending on automobiles. About 40 percent of revenue for the new value-added business was generated by the aerospace sector.
Recent purchases include aerospace and defense industry-focused titanium supplier, RTI International Metals Inc, for $1.3 billion and privately-held TITAL, which makes titanium and aluminum structural castings for aircraft engines and airframes.
The company has also been working to improve in-house technology. Last December, Alcoa unveiled a process it calls Micromill to produce high-strength aluminum alloy, targeting automakers who are seeking an alternative to heavier steel.
In mid-September Alcoa announced a deal with Ford Motor Co (F.N) to provide components for the 2016 model F-150 pickup, the best-selling U.S. vehicle since 1982, using Micromill.
"They have been acquiring more businesses away from what they founded the company on," said Phil Gibbs, an analyst at KeyBanc Capital Markets.
The company did not provide a timeline for choosing a CEO for Alcoa after the split. The division of the company does not need shareholder approval, sources familiar with the matter said.
The company's financial advisors are Morgan Stanley and Greenhill & Co. The legal advisor for the split is Wachtell, Lipton, Rosen & Katz.
(Additional reporting by Lewis Krauskopf; Editing by Michele Gershberg and Christian Plumb)