Dig It! A maker of monster machines, Terex has been scraping by for years–until now.
Published in: Fortune
Date: 5/3/2004
By: Siekman, Philip
Since the middle of 2000, construction equipment companies haven’t had much choice but to hunker down, get tough on costs, cut payroll, and wait for a badly sagging market to recover. Not only were their customers in highway construction, mining, and commercial building in the doldrums, but the general malaise was also making everybody else nervous. The continuing boom in residential construction kept ready-mix concrete producers and equipment-rental yards busy, but they still didn’t replace trucks, cranes, or other equipment.
When even Caterpillar, the industry’s grizzled leader, saw sales flatten and profits drop by a fourth in 2001 and 2002, it was time for competitors without its concrete-solid finances to slash and burn. One of them, Terex Corp. in Westport, Conn., had plenty of experience doing just that. Since the mid-1990s, when it was bankrupt in principle if not in law, Terex had survived by acquiring orphans and stragglers, stripping them to their profitable essentials, and outsourcing everything else. Such tactics enabled Terex to underprice competitors while it elbowed its way into new markets like cement mixers and loader-backhoes. It was the ultimate junkyard dog.
Terex’s scrappy methods have paid off. Deutsche Bank says the company has become the “most attractively valued name in the construction equipment industry.” Last year Terex’s revenues hit $3.9 billion, six times their level in 1996. Although it lost $25.5 million with the construction business still stalled, that was a big improvement over 2002, when it lost $132.5 million. Now that the industry is starting to recover, Deutsche Bank and other analysts figure that Terex will hit its 2004 net earnings target of $100 million and pare $200 million from the $1.4 billion mountain of debt it piled up making all those acquisitions.
In construction equipment sales, Terex now ranks third in the world, behind Cat and Japan’s Komatsu. No longer potential roadkill, it has gained the confidence of lenders and Wall Street; its stock has nearly tripled in price over the past year to $38 per share. With stronger finances, Terex is moving upscale. It has stopped trolling for cheap acquisitions and moved beyond its slash-and-burn restructuring tactics. Instead it aims to mold what has been a motley collection of loosely aligned businesses into a grown-up, mature, common-purposed corporation. CEO Ron Defeo says he thinks the new, improved Terex can nearly double in size again to reach “six in six”: $6 billion in profitable revenues by 2006.
Getting all of Terex’s operating units moving toward that ambitious target will take more than a crack of the whip. Until now, Terex has epitomized decentralized management. While it employs more than 15,000 people and is active in 65 countries, Defeo, 52, runs the company with a staff of just 66 people. The suburban-Connecticut headquarters could be mistaken for a local real estate firm fallen on hard times. Yet it is from there that Defeo oversees two dozen operating units, nearly half of them outside the U.S., divided into five scattered baronies. The largest is Terex Construction, which accounts for more than a third of company revenues. Run from Scotland, it has all its plants in Europe and a couple of joint ventures in China. Next in size is Terex Cranes, with $1 billion in annual sales. It has factories on both sides of the Atlantic and is based in Zeibrucken, Germany. The remaining 40% of revenues are contributed by three U.S. groups: Aerial Work Platforms, the newest product line; Mining, an original Terex business but now the smallest; and a potpourri–Roadbuilding, Utility Products, and Other.
Most of the operations are new to Terex. Defeo assembled them in about 5 1/2 years, beginning in 1997. He spent nearly $2 billion making 28 acquisitions, all of them in the tough, low-margin construction equipment business. As soon as he had them, Defeo stripped off unneeded assets, outsourced all the production he could, and strictly limited investment in plant and equipment. Fixed costs are the “enemy of a capital goods company,” Defeo preaches, and “depreciation shows up for work 365 days a year.”
When Defeo joined Terex in 1992, it was a small, struggling player in a mature industry dominated by bigger, better-capitalized companies like Caterpillar, Deere, Hitachi, Ingersoll-Rand, Komatsu, and Volvo. Terex at the time consisted solely of a couple of U.S. plants and one Scottish factory making construction equipment, plus a majority of the stock in Fruehauf Trailer, shares that were sold over the next two years to pay bills. If Terex wasn’t going to become lunch for a larger competitor, it had to bulk up. But technological leaps weren’t likely, and the construction equipment industry grows only as fast as the economy, so the one way to grow was through acquisitions. Short on cash, limited in credit, and with a weak stock, Terex found its choices were confined to shaky companies.
Defeo was brought to Terex by chairman and founder Randolph Lenz as president of the construction equipment business. His first day on the job, Defeo recalls, Lenz took him to a bar and told him, “The good news is, you’re here. The bad news is, we need to make a bank payment of $19 million or $20 million in six weeks, and we don’t have any cash. If we don’t get it, we’re gonna go bankrupt.” To raise the money, Defeo held a fire sale to get rid of finished inventory. For his part, Lenz issued $160 million in high-interest bonds and bought Clark, a money-losing forklift truck builder.
Once the cash crunch temporarily abated, Defeo went to work on Terex’s factories. He dropped product lines to concentrate on construction cranes and heavy trucks, cut production workers along with sales and administrative staff, and stripped out fixed costs by outsourcing machined and welded parts and subassemblies. That became his practice in subsequent acquisitions. Today purchased parts account for upward of 70% of Terex’s cost of goods sold, and parts formerly made in-house are now outsourced. Some Terex machines, like its giant off-road mining trucks that sell for up to $4 million each, are built by outside contractors.
Defeo’s scorched-earth treatment enabled him to slash selling prices and entice business from better-known rivals. Frills are few. For instance, Terex’s Scottish-built articulated trucks–on rough ground, the cab tilts one way while the load tilts the other–have manual, not power-assisted, hoods. Such savings allow Terex to undercut Volvo by about $45,000 on a $300,000 truck that hauls the same amount of dirt.
By 1996, Lenz had left Terex, and Defeo had risen first to president and then to CEO. He had gotten Clark profitable by closing three of its five factories, reducing the payroll from 1,742 to 940, and lowering sales and administrative expenses from 18% to 8% of revenues, but decided it wasn’t a long-term winner. He sold it, paid off some debt, and had $20 million left over. Clark subsequently collapsed.
Using $20 million of Clark proceeds as a down payment, Defeo made his first acquisition as CEO in 1997, paying $90 million for the U.S. assets of Simon Corp., a British equipment company. He got some weak performers with the deal that he later sold but also got winners in the form of truck-mounted cranes, bucket trucks, and digger derricks. Bucket trucks lift a worker and his tools up to a power line, transformer, or traffic light. Digger derricks drill a hole in the ground and plant a phone or power pole. Every electric power and telephone company needs both kinds of gear.
Lifted by a buoyant market, the operating profit of the acquired Simon businesses more than tripled, to $27 million, during their first year under Terex ownership. Defeo calls the deal a “breakout.” Its profits helped stabilize Terex and attracted the attention of Wall Street. Terex stock, which was below $4 a share in mid-1995, rose to $20 in two years. Using debt that was now a bit easier to obtain, as well as the more valuable stock, Defeo went on a buying binge. In 1998 and 1999 he acquired companies at a rate of one every other month. The pace eventually slowed, but by the end of 2002, Terex had more than tripled sales in five years, to $2.8 billion. It also more than quintupled corporate debt, to $1.6 billion.
Nearly every business Defeo bought was a cripple–or looked like one. He had become the “first buyer of last resort” for troubled companies. A typical orphan was O&K Mining, a German firm that makes large hydraulic excavators used to shovel up dirt and ore in surface mines. Owned by Germany’s Krupp, O&K was out of place in a steel company but a fit for Terex, which makes off-road trucks to haul away the shoveled material. Terex paid $168 million for it in 1998, and Defeo went to work cutting costs. Even though job-protection rules can make reducing payrolls in Europe tough and expensive, he cut the number of O&K employees from 360 to 260 in the first year and changed all of the top management by promoting from within. At the same time, O&K began outsourcing parts to Eastern Europe, particularly the Czech Republic. Suppliers also took over some operations within the factory itself. One company bought the paint system in place and now operates it.
Defeo admits that he’s been lucky as well as smart. In early 2001, Terex had just taken a small position in Tatra, a venerable Czech manufacturer of heavy trucks, when an Israeli partnership called Special Task Vehicles approached Defeo with a proposition. The partnership was convinced that a Tatra-designed truck could win a major Israeli military contract if the trucks were mostly built in the U.S., thus qualifying under the generous terms of the U.S. Foreign Military Financing Program. So Terex, Tatra, and the Israelis formed a joint venture, American Truck Co., that won an initial $54 million contract to build 315 trucks. Tatra supplies the design and key parts; Terex, which now owns 70% of Tatra, assembles the vehicles in Fort Wayne; and Special Task Vehicles handles maintenance and crew training in Israel.
American Truck recently shipped its first five vehicles to Israel and is already looking for more business. The U.S. Bureau of Land Management is trying out a Tatra truck for use as a forest-fire engine. This March the U.S. Marine Corps chose the joint venture to build three prototypes that will face off in a 2005 competition against Oshkosh Truck. At stake: a contract for 675 vehicles, with an option for 327 more, at up to $400,000 per truck.
Defeo has been successfully exploiting opportunities like that ever since he went to work after graduating from college in 1974. His two older brothers, who worked at Procter & Gamble, wangled him an interview with the company. (One brother is now CEO of the Pacific Exchange. The other was CEO of Remington Products until Rayovac bought it last September.) On Defeo’s first P&G assignment, hawking soap to commercial laundries, he spent a week working in a South Carolina prison laundry to demonstrate that his products were cheaper to use.
Defeo left P&G in 1984 after nine years and moved to Tenneco, where he eventually rose to become head of the European operations in 1990 for the JI Case construction equipment business. He arrived just after the market began to turn downward in what became a 30% decline. Case was vertically integrated with factories that started with raw steel, made most of their own parts, and assembled the finished machines. That meant a heavy investment in fixed assets and high fixed costs. As long as the factories hummed along, the costs could be absorbed. If sales dropped and production slowed, they ate up profits. Defeo concluded that a solution would be to sell off the factories, write down the assets, and outsource a lot of production, but Tenneco wouldn’t approve the one-time charges.
Frustrated, Defeo was ready for a change, and in 1992 he went to Terex, where he could apply his ideas about structuring a capital goods company. Terex wasn’t an easy case. Often short of cash and pressed by lenders, it struggled to make acquisitions and then labored to make them pay. A big man with a shape that suggests a fondness for pasta, Defeo set an example by stuffing himself into an economy-class airline seat on transatlantic hops.
In time Defeo’s bottom-fishing strategy began to pay off in improved revenues and a higher stock price. By the middle of 2002 he was able to raise his sights and target a higher-quality company that he had long wanted to buy. It was the Demag mobile-crane business in Zeibrucken, which had an international reputation for quality and technology. Originally owned by Mannesmann, the company got jostled when Vodafone made a hostile takeover, and ended up at Siemens, where it was overlooked. By the time Terex paid nearly $160 million for Demag in August 2002, it had dropped from first to fourth in the German crane market and was losing 1.5 million to 2 million euros a month.
Instead of a broadsword, Defeo wielded a scalpel at Demag. He made a few management changes and instilled a renewed sense of purpose. By 2003 the company had returned to profitability and gotten back to the second position in its industry. Just as important, Terex has been able to retain most of its several hundred experienced engineers.
One month after closing on Demag, Defeo paid $250 million for Genie, a Redmond, Wash., builder of aerial platforms, those wheeled, long-armed machines that lift men and materials to construction-site height. Genie had grown rapidly in the 1990s, and its revenues had reached $786 million by 2000. But the three partners who owned the company had financed the growth with debt that became hard to service when sales to rental-equipment yards, their largest market, turned down.
Defeo not only has left Genie alone but also has told his managers to study the company for lessons in customer service and lean manufacturing. Genie has run 750 kaizen events in three years to reduce space on the plant floor, accelerate inventory turns, and otherwise cut costs. These days groups from other parts of Terex are making pilgrimages to Redmond. With good reason: Last year Genie’s operating earnings were 11.8% of sales, about six times the margin in the rest of Terex.
Genie and Demag have become important contributors to Defeo’s new effort to integrate the sprawling Terex empire. For example, a Terex crane plant in North Carolina is now building some large Demag parts, so the German subsidiary can ship partially built machines to the U.S., finish them here, and thus have a cost edge over European rivals in North America. Genie, meanwhile, is marketing other Terex products to rental yards. Last year it started selling long-armed forklifts, called telehandlers, that are made by Terex in Italy and the U.S. This year it’s adding compact equipment such as the mini-excavators used by landscaping companies.
Defeo admits he woke slowly to the need “to turn a patchwork quilt into a blanket” by integrating his businesses. Even though he sits on the board of United Rentals, a big customer, he didn’t notice that five Terex companies called on United separately. Defeo also realized that some of his managers were being too frugal. Another customer complained that Terex was hard to do business with because it wouldn’t buy a particular piece of software. Last August he splurged and took his top managers to the posh Greenbrier resort in West Virginia, where he delivered his new message: “We can no longer live our lives in silos. We have to put the company together from a customer’s perspective.” Out of that meeting came a corporate effort with a number of improvement goals, including two very important ones: Get the operating income margin up from last year’s 1.9%, and raise the corporate profile of a company that sells equipment with some 50 brand names.
In other words, Terex is trying to grow up. Now No. 437 in the FORTUNE 500 and attracting more investor interest, it is backing away from its aggressive bottom-fishing acquisition strategy. Defeo doesn’t rule out more deals but says they will be smaller ones–bolt-ons to fill gaps in the product line or distribution system. He argues that internal growth alone will drive Terex to his “six in six” revenue goal, and that integration and lean manufacturing will boost profits. This year he ought to get a lift from the recovery underway in several of the company’s markets. Higher commodity prices should spur mining-equipment orders, for instance, and billions of federal dollars for U.S. highway construction should produce a boom in Terex cement plants, cement mixers, and pavers.
Defeo tells his executives, “You gotta run the company you’re given.” Of course, in his case that’s only partly true. Given a business in construction equipment, he’s completely rebuilt and expanded it and now is making it over into an integrated manufacturer. It won’t be easy, but as Defeo observes, “The failure to destroy today what they created yesterday is why CEOs get fired.”