Alcoa and the Sum of its Parts

Here we go again. We’d all feel cheated if a year were to pass without chatter about the possibility of a takeover of Alcoa Inc. (NYSE: AA).

In 2007, BHP Billiton plc (NYSE: BHP) was said to be considering a $40 billion offer for the U.S. company. Alcoa’s shares were trading north of $42 at the time. Three years ago, BHP was again suggested as a possible acquirer, when Alcoa’s stock was trading at about $7.50. And last year’s reported suitor was Rio Tinto plc (NYSE: RIO), at a time that Alcoa shares traded at around $17.50.

Since by now it’s pretty clear that no huge mining outfit is going to acquire Alcoa, today we get the suggestion that the company should split up its non-performing bits and keep it’s good bits. Bloomberg says the company is worth 63% more than yesterday’s closing price of $9.12, or about $14.82 per share.

The pieces that Alcoa needs to get rid of are its mining and smelting operations, which is where the company is most exposed to volatile commodity prices. That these commodity-exposed pieces are dragging Alcoa down is not in question. The questions are, who would buy these bits and what would a buyer pay?

The parts of the company most exposed to commodity pricing do not have a very bright near-term outlook. Aluminum pricing is expected to remain flat at mid-2011 levels for at least another year or more. Potential buyers like BHP or Rio are either slowing down their aluminum production or considering shutting it down altogether.

And as usual, demand from China will be the deciding factor for aluminum pricing, and probably ultimately, for what happens with Alcoa. Auto manufacturing has slowed, and the Chinese economy is not growing at the elevated rates we’ve all become used to. Demand from Europe is stagnant, with physical demand for aluminum lagging speculative trades. Europe’s warehouses are full and traders are just reshuffling the deck.

Alcoa is far more likely to find a buyer for the good bits, like the rolled products division that makes sheets for aluminum cans, car parts, and airplane manufacturing and the engineered products division that makes turbine blades, truck wheels, and other value-added products. The company could also spin off a minority stake in either or both of these divisions and give shareholders a one-time payday.

Alcoa has not shown any interest in splitting itself up or spinning off any of its pieces, and as recently as a year ago the company’s CEO said it made more sense to keep the company together. That doesn’t mean that pressure to break Alcoa up won’t continue.

The company reports earnings after markets close today, and is expected to break even on earnings and record revenues of $5.54 billion. The projected earnings are down from $0.07 a share just 90 days ago.

Shares of Alcoa are trading up about 0.4% at $9.15 in the late morning, in a 52-week range of $7.97 to $11.66. The impact of a possible breakup of the company has certainly not sent investors on a buying spree.

Paul Ausick