March/April 1994
After weighing out a number of factors, Chatham elected to sell its scrap recycling division and concentrate on its steel service business.
By Arnold Tenenbaum
Arnold Tenenbaum is president of Chatham Steel Corp. (Savannah, Ga.).
You have brains in your head, you have feet in your shoes, you can steer yourself in any direction you choose.
With those words of wisdom from Dr. Seuss guiding us, Chatham Steel Corp. began to seriously consider selling our scrap recycling division in 1991. In essence, what we were really setting out to do was to choose our own destiny--to decide what we really should be, not just taking the cards we had been dealt.
Choosing your destiny, however, is easier said than done, especially when you’re dealing with the financial, logistical, and emotional issues involved in possibly selling a closely held business in its third generation of family leadership. In fact, while Chatham ultimately decided to exit the scrap business in 1993, the decision only came after a lot of planning and soul-searching.
In the Old Days
Prior to changing course, Chatham was active in both the scrap recycling and. steel service center businesses. Chatham Iron & Metal Co. had processing facilities in Savannah, Ga., and Jacksonville, Fla.; a scrap trading arm operating as Chatham Brokerage Services; a small rail division; and Chatham Key Co., a stainless steel scrap recycling joint venture with Keywell Corp. (Baltimore). On the other side was our steel service center business--Chatham Steel--with facilities in Birmingham, Ala.; Orlando, Fla.; Savannah; Durham, N.C.; and Columbia, S.C. Together, annual sales for these businesses were around $150 million--not a small company, but not a giant either.
The firm was founded in 1915, with much of our growth occurring in the 1980s--a decade that saw us undertake a long-range strategic plan focusing on growth of both the scrap and service center businesses. In that period, we made several acquisitions--which seemed the way to grow--but by the end of the decade, while Chatham had expanded to encompass many new parts, we weren't really happy with the whole.
Around 1991, in fact, we weren't feeling very good about either of our businesses, which were performing at historic lows. We were struggling for profitability in the then-severe recession, which meant we weren't generating the profits to develop both divisions the way they needed to be. We felt constricted but weren't quite sure what moves to make to increase the long-term value of the businesses for our stockholders (all of whom are family members, including some not involved directly in running our operations). Adding to this situation, our bank was giving us signals that it wasn't happy with the wild swings in the scrap market. It tended to be more comfortable with the service center business, which has historically been much steadier.
It was clearly time to step back and reevaluate where we were. So we decided to do a "decade review"--it had been about 10 years since we had drafted our previous strategic plan--that we could use to reevaluate Chatham's two core businesses, their strengths and weaknesses, and the direction we should take in the long term. Our goal was to develop not just a plan but an action plan and establish milestones and a timetable to ensure successful implementation.
Heeding the adage that experts who are more than 50 miles from home can, in most cases, produce a better product, we hired a consultant to' help us with this process. In retrospect, we probably could have done it ourselves because the consulting firm spent most of its time interviewing our people, trying to understand the markets through our eyes. Then again, our consultant brought to the process extra credibility and a discipline we wouldn't have applied ourselves. In other words, while you can pick up books and find a model to do this kind of analysis, it's not easy to ask yourself the hard questions and pressure yourself to not only put a plan together, but also execute it. When you have somebody holding your feet to the fire, it makes a difference.
Creating a Plan
To be honest, we figured from the beginning that getting out of the service center business was really not a viable option, so the real question was whether we needed to strengthen the scrap recycling division or sell all or part of it.
To deal with that dilemma properly, however, we had to look closely at both divisions and the company as a whole. We started by studying the historical and current financial data on each business, summarizing their performance in the past decade, then making observations and drawing conclusions. Next we did a company overview: What had we created in the past decade? How was Chatham positioned to proceed? What did the firm's markets, competition, suppliers, and consumers look like? We also evaluated our facilities and equipment, our management, and, most important, our strengths and weaknesses. In addition, we tried to determine company goals by interviewing all active stockholders, asking ourselves what was our mission and vision, what were our values, and where did we want to 90 financially and otherwise'?
This information alone was not enough to guide the decision of whether to remain in the scrap business. It was critical that we also examine the industry itself--the external forces that were affecting Chatham's ability to operate successfully and over which we had no control. While most of what we found was not particularly revolutionary, compiling these details on the scrap recycling business gave us the opportunity to truly evaluate that end of Chatham's business. Here are some key characteristics we identified:
It's a highly cyclical business with dramatic downswings, sometimes low profit margins, and erratic profitability. Brokerage activities as part of a processing operation, however, tend to generate more-consistent profits.
Tougher environmental standards and rising public interest in air, water, and solid waste issues will require greater compliance and costly preventive measures and/or cleanups. Potential environmental risks can be substantial and ultimately the financial responsibility of owners.
The composition of products changes over time-as with automobiles-which will force some processors to invest in larger and more sophisticated equipment, especially shredders. Likewise, the capture of nonferrous residue from shredders, which is an important part of what makes a shredding operation profitable, will require investments in sophisticated downstream cleaning systems and eddy current magnets.
Recycling generally is highly competitive in both the buying and selling of material, and competition is intensifying as many mills and waste haulers integrate backward into the scrap business. Additionally, local municipalities are reinventing the recycling wheel in order to deal with legislative landfill reduction laws. Also, the ease of entry into the business, particularly in nonferrous markets, enables small operators to proliferate. The result of all this? Increased competition is forcing the scrap industry, which has traditionally been slow to adapt to technology, to invest in new state-of-the-art processing equipment.
Consumer and supplier relationships take a long time to build, and many recyclers are heavily dependent on a few large suppliers and/or consumers. The loss of a major supplier or consumer can be devastating, especially in a weak market.
Most recycling companies are little more than mom-and-pop operations, with a recent study showing that 64 percent of all recyclers have 40 employees or fewer. Nevertheless, the industry is becoming more professionally managed, and large national companies are expanding.
In general, few companies have the financial resources or cash flow to make needed capital investments. Consolidation is increasing in the industry because many operators have limited access to capital, steep environmental compliance obligations, inadequate purchasing power, and antiquated equipment, which is expensive to maintain or replace.
With these factors in mind, we also specifically evaluated how lenders view the industry:
Low margins and erratic profitability and cash flow are a serious concern to lenders. They are wary of industries that are cyclical and have dramatic up-and-down cycles, and they dislike ungraded commodity businesses with high price volatility.
Due to the specialized nature of scrap recycling equipment and its often-antiquated condition, many processors' fixed assets are perceived to have low resale or salvage value in the event of a sale or liquidation. These specialized assets are considered, therefore, to have poor collateral value.
Receivables are generally regarded favorably due to the strength of most scrap consumers.
Scrap inventory that is of good quality and properly prepared is viewed as an acceptable industrial inventory, but for borrowing purposes it's subjected to the lower end of the range of standard advance formulas.
Environmental concerns and the potential for expensive remediation make banks nervous about lending to recyclers.
The high cost of maintaining and replacing equipment is seen as a serious drain on capital resources, often without acceptable returns.
Banks are wary of any industry in which the borrower is dependent on a few key suppliers and/or consumers to maintain an acceptable volume.
That's a pretty heavy load, but we felt it was a realistic assessment. Fortunately, our relations with our lenders were good, and although they were nudging us and were helpful in this process, we weren't worried about our future with them.
Still, in general, this isn't an industry that banks understand or even want to understand. Lenders in the 1990s will favor companies with predictable profits and cash flow, and where leverage dictates a fully collateralized position. Loans won't be made to companies that can't quantify their environmental problems and reserve resources for potential remediation.
The last list we assembled was based on our consultant's perception of what the key success factors were for fin-ns in the scrap industry, an inventory that included the following:
Reliable supply and consuming sources based on good long-term relationships.
Regular contact with customers and suppliers and participation in industry conferences.
Emphasis on service and quality of product, as well as a reputation for fair dealing.
Geographic proximity to major consumers, significant market share in an operating region, and a stable or growing industrial base.
A diversified product mix and customer base, thus avoiding overdependence on one or two suppliers and/or consumers. This is important to both lenders and people who might buy your business, as nobody wants to take risks on a company that's so exposed that it could fold if it lost one supplier or consumer.
The ability to buy “right.”
No significant environmental problems, and safeguards in place to prevent any future contamination.
Well-maintained, safe, and efficient equipment.
Plans to finance necessary capital improvements in the future.
A strong balance sheet, coupled with a focus on cost control and a commitment to high inventory turnover.
Training programs for managers.
Good relations with competitors.
We then matched all of these points to our strengths and weaknesses, and that's where the rubber hit the road. Our consultant presented its recommendations, but by that time--in June 1992--the conclusion had become obvious. The fact was that most of our management was more comfortable with the service center end of the industry, plus, if we sold the scrap division we knew that there were alternative outlets for that capital, as well as alternative opportunities for our people who led in that part of the business.
The result was that we decided to try to sell our recycling business.
Putting the Decision to Work
Terrific, we'd made the decision, but the real question was how to translate the decision into action. After all, successful execution is the measure of successful strategy. You can plan forever, but unless you can realize the plan, it's not worth a heck of a lot.
Our first strategy in implementation was to get the blessing of our officers and board, which includes our active stockholders and two non-family non-stockholders. We also decided to sell the business through an investment banker rather than doing it ourselves, which brought two benefits. For one, it helped us manage our expectations. We wanted to be fair to ourselves and realistic about the perspective of a potential buyer, and that balance was something the broker took to the table for us. In addition, working through an investment banker allowed us to concentrate on running our businesses while this effort was going forward, which was fortunate because it took a fairly long time-more than a year-to sell the division.
Most important, we stayed focused on our goal to sell the recycling business. This wasn't easy because, during this period, business began to get better, people started feeling more optimistic, and there were doubters who began to wonder if we were asking for enough money and if we should rethink the whole decision. But we knew in our hearts we were doing the right thing.
Because we didn't have a strategic buyer, we tried to be a strategic seller. Thus, we began the selling process by sending letters of invitation to a limited number of firms and individuals we thought might be interested in the company. Those that responded favorably and agreed to sign a confidentiality agreement were then sent a book we compiled from our strategic analysis work that outlined the details of our recycling division. After interviews with the investment banker and visits by several interested parties, we narrowed the negotiation to one potential buyer.
Before any sale could be finalized, however, we had to do several things, such as deciding how to value the division. We started from book value rather than earnings because the business wouldn't have had much value based on its earnings during the recession of the previous few years. From this, we set a minimum purchase price and left it up to the investment banker to negotiate premiums over that. (The banker's fee included incentives for obtaining a higher price.)
We also had to undertake the best possible environmental impact study to determine the "baseline" environmental status of our recycling plants. This study was designed not only to protect the buyer from potential preexisting problems, but also to protect us from contamination that could be caused by the buyer, who would be renting plant property from us in one location. As part of the sale agreement, the buyer is required to give us quarterly environmental reports, which enable us to monitor the situation and know if the baseline is being maintained.
We also had to consider our employees and how the decision to sell would affect them and, in turn, the scrap division until the sale was finalized. In other words, how could we prevent our employees, especially our key managers, from abandoning ship at that crucial time? One way was to include the key managers in the selling process. We also put an incentive package together for our key people whereby they would receive a financial award if they continued with the company through the day we closed the sale.
Though the closing was four months later than we expected, we ended up holding all the key people, which definitely helped us manage the business during this somewhat awkward time. And even now, more than 90 percent of our other employees are believed to still have their jobs.
As it turned out, we finally wrapped up the deal in June 1993, selling the division to Addlestone International Corp. (Charleston, S.C.), a company we'd known and done business with for more than 60 years.
With the sale behind us, it's natural to wonder where we stand and what we've gained. Today, Chatham has a significant steel distribution business that's probably among the top 10 percent in the United States in terms of volume. We've successfully absorbed the family members who worked in the recycling division into the service center division, and we're planning to expand the business, which is consistent with our initial goal to make one of our divisions consistently a high-performance operation.
What did we leave behind? A 78-yearold business that had been good to three generations, as well as a lot of tradition and feelings. Our departure certainly affected some friendships that had been an important part of our daily lives. While it's true that most friendships will sustain themselves, it's different when you're not doing business together. We also left, to some degree, a customer base that felt betrayed or at least disappointed with our exit.
Despite these "losses," we haven't looked back. Sure, we felt a twinge of regret when we saw scrap steel prices going through the roof, but then again we felt rather smug when we saw the sad fate of nonferrous prices. We think we made the right decision to implement a strategic plan designed to maximize the future value of our company for our stockholders. We were trying to read the future, and only a look back will tell us if we moved wisely.
On reflection, what enabled us to achieve our goal was that we first had clear, simple goals; we had extremely good people helping us, who kept the process on track when it would have been easy to let it slip; and, of course, we had some luck, which is an important ingredient in many a success. In the end, we certainly haven't solved all of our challenges--those will be ongoing--but we do feel we're well-positioned to move forward.
If Chatham's example proves nothing else, it's that every business needs a long-range strategy--be it formal or informal--and that you can take charge of your future. Otherwise, you end up being controlled by events rather than having control over them. Any business can exercise this kind of leadership, and that's what I think it's all about-not just managing your business but leading it. •
Editor's note: This article was adapted from a presentation the author gave at a top management seminar held in December by the Institute of Scrap Recycling Industries (Washington, D.C.).
After weighing out a number of factors, Chatham elected to sell its scrap recycling division and concentrate on its steel service business.