Alcoa Splitting in 2, Shares Take Flight

In a historic move, aluminum giant AlcoaAA is splitting into two independent, publicly-traded companies in a bid to shore up growth amid a difficult operating backdrop. The transaction, which is subject to specific conditions including final approval by Alcoa's board, is expected to consummate in second-half 2016.

The separation will result in the creation of two standalone, Fortune 500 entities: "The Upstream Company" and "The Value-Add Company." The Upstream Company will consist of bauxite, alumina, aluminum, casting and energy business units. The Value-Add Company will include global rolled products, engineered products and solutions, and transportation and construction solutions businesses.

The move will also provide shareholders with value-creating investment opportunities. Upon transaction closure, shareholders of Alcoa will own all of the outstanding shares of both the companies. The separation has been planned as a tax-free transaction to Alcoa shareholders for U.S. federal income tax purposes. After the separation, the Upstream Company will operate under the Alcoa moniker while the name of the Value-Add Company will be determined before the transaction closing.

Alcoa CEO Klaus Kleinfeld will lead the Value-Add Company as Chairman and CEO after the separation. Kleinfeld will also serve as Chairman of the Upstream Company during the initial phase to ensure a smooth transition. Both entities will have their own independent boards. The separation will allow both companies to pursue their own independent strategies.

Morgan Stanley MS and Greenhill & Co. GHL are acting as financial advisors to Alcoa while Wachtell, Lipton, Rosen & Katz is serving as legal advisor on the transaction.

Post separation, the Upstream Company will be a highly competitive leader in bauxite, alumina and aluminum production with a world-class asset base including the world's biggest bauxite mining portfolio. The company will be well placed to meet the rising global demand for aluminum which is anticipated to increase 6.5% this year and double between 2010 and 2020. The Upstream Company will be the fourth-biggest aluminum producer in the world and will also have world's largest alumina refining system.

On the other hand, the Value-Add Company will be a leading provider of high performance multi-material products and solutions in attractive markets including the fast-growing aerospace market. The aerospace market represents roughly 40% of its pro-forma revenues. The Value-Add Company will also be well placed to address demand for aluminum intensive vehicles through Alcoa's rolling mill capacity expansions and the commercialization of breakthrough Micromill technology.

Micromill alloy produced by the Micromill technology is 40% more formable and 30% stronger than the conventional automotive aluminum. Alcoa and Ford F recently entered into an agreement wherein the latter selected Micromill material for its 2016 Ford F-150 truck. Alcoa also landed a joint development agreement with Ford to make next-generation aluminum alloys for automotive parts using the Micromill technology. The expected use of Micromill material on Ford vehicles is anticipated to more than double from 2016 to 2017.

The announcement was greeted positively by investors. Alcoa, which was ousted from the Dow Jones Industrial Average in 2013 partly due to its tepid stock performance, saw its shares shoot up 5.7% to close at $9.59 yesterday on the separation news, making it the biggest percentage gainer in the S&P 500. The stock is still down roughly 39% so far this year as lower aluminum prices continue to hit the company's legacy aluminum smelting business.

Alcoa continues to grapple with weak aluminum pricing. Lower realized aluminum prices hurt earnings in its primary metals business in second-quarter 2015 and is expected to remain a headwind.

Aluminum prices at London Metal Exchange (LME) sank to a six-year low in August. Aluminum prices remain under pressure given the oversupply of the metal in the market, exacerbated by ballooning exports of the metal by China (the world's biggest producer) amid weakening demand at home. Alcoa, in its second-quarter call, said that it now sees 2.2 million metric tons of aluminum surplus in China versus 1.8 million metric tons expected earlier.

The separation marks the completion of Alcoa's multi-year transformation. As part of its portfolio transformation strategy, Alcoa is increasingly looking for expansion opportunities beyond its legacy primary aluminum business and diversify into other materials such as those (nickel and titanium-based) used to make aircraft parts.

Alcoa is actively pursuing its aerospace expansion strategy. The purchase of U.K.-based leading jet engine components maker Firth Rixson has reinforced the company's aerospace business and strongly placed it to capture additional growth in this growing market through a broad spectrum of high-growth, value-add jet engine components. The buyout of RTI International has also broadened Alcoa's titanium offerings and added advanced technologies and materials to its portfolio.

Moreover, Alcoa remains on track to move down the cost curve and is actively repositioning its portfolio, including closure of high-cost smelters. The company has cut 33% of its smelting capacity since 2007.

Alcoa, a Zacks Rank #5 (Strong Sell) stock, will report its third-quarter 2015 results on Oct 8. Analysts polled by Zacks currently expect earnings of 16 cents per share for the quarter on an average.

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ALCOA INC (AA): Free Stock Analysis Report

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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