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How Caterpillars Big Bet Backfired

CEO Doug Oberhelman invested heavily in production of machinery

and equipment. Then commodities began their slide

A Caterpillar wheel loader runs among other CAT machines at a company facility in Suzhou,
Updated Oct. 17, 2016 9:39 a.m. ET

Doug Oberhelman spent his first years as Caterpillar Inc.s chief executive plowing billions of
dollars into factories to build more of its familiar yellow machines and move the company
deeper into mining equipment.
It was a bold bet, spectacularly mistimed. On Monday, Mr. Oberhelman announced plans to step
down as chief executive by years end.
In 2010, when he took charge, the world was gripped by a global commodities boom, along with
strong postrecession demand from developing markets and the energy industry. The world was
ordering excavators and bulldozers and giant dump trucks at a rapid clip.
Mr. Oberhelman bet he could grab an outsize share if he could just make more equipment. He
spent almost $10 billion world-wide on plants and equipment from 2010 through 2013.

Much of that went toward building more of its flagship CAT construction machinery. It also paid
$8.8 billion in 2011 for Bucyrus International Inc., a Milwaukee mining-equipment maker, to
gain a position in giant open-pit-mining shovels and underground-mining machines Caterpillar
didnt make.
In China, Caterpillar was going to play offense and were going to win, Mr. Oberhelman
proclaimed in 2010. It had missed opportunities in China before. From 2011 to 2014, Caterpillar
roughly doubled its number of plants and facilities there to 26.
Everybody was convinced that this time would be different, said Ken Banks, who retired in
2013 as manager for Caterpillars electric mining shovels. They thought the Chinese market
was so hot, that commodity prices would continue to be very strong and Caterpillar would
increase sales substantially.

Caterpillar said Monday that Mr. Oberhelman would be succeeded as chief executive by Jim
Umpleby, a company group president and 35-year veteran. Caterpillar chiefs by tradition havent
stayed beyond age 65, which suggests Mr. Oberhelman is leaving ahead of schedule. Mr.
Oberhelman will remain as executive chairman of Caterpillar until March 31, when he will retire
from the company.

The year 2012 would prove to be a peak for Caterpillar. Soon after, miners began shelving
equipment-buying plans as commodity prices fell. Chinas growth slowed. Then oil prices fell,
along with demand for related equipment.
Caterpillar now faces its fourth straight year of falling sales, the longest decline in its history. Its
stock is up 29% this yearthe best-performing in the Dow Jones Industrial Averagebut trades
25% below its 2012 peak.
Caterpillar CEO Doug Oberhelman, taking over in 2010 during a global commodities boom, invested
heavily in production of machinery and equipment. Then commodities began their long

Everybody was surprised by the size of the downturn and the length of it, Mr. Oberhelman, 63
years old, said at a September mining trade show in Las Vegas. I firmly believe we couldnt
have forecast that at the time of the Bucyrus deal. The company declined to make Mr.
Oberhelman available for comment for this article.

Slumps are common in Caterpillars world, and rivals are suffering, too. Caterpillar, though, has
long been a flagship American firm, a reliable blue chip in the Dow industrials and a major job
creator with plants around the world. Now, it has fallen behind in the slow-growing economy.

Caterpillar has reduced its workforce 20% in the past four years, about 30,000 jobs, and has said
it expected to close or consolidate as many as 20 plants. In China, Caterpillar said, it has closed
one plant and is operating many others at low production rates. Caterpillar in August said it
would sell off some of the mining-equipment lines it gained with the Bucyrus acquisition.

Its stock, up 46%from the beginning of Mr. Oberhelmans tenure, trails the S&P 500 indexs
107% rise.

They overlooked the possibility that the whole market would collapse, said Charles Yengst, a
Connecticut equipment consultant. They opened factories all over the place to operate at a
market peak that doesnt happen every year or even every 10 or 15 years.

Caterpillar is still the worlds largest seller of construction and mining equipment and continues
to gain market share, especially in China. The Peoria, Ill., company has posted annual profits
throughout Mr. Oberhelmans CEO tenure. In what is likely to be our fourth down year for sales
and revenues, were proud of what were accomplishing, Mr. Oberhelman said in a July release,
adding that our machine market position has increased, including in China, product quality
continues to be at high levels, and the safety in our facilities is world class.
Caterpillar invested in increased production of its flagship construction machinery, such as this CAT
excavator at work near Boke, Guinea. PHOTO: WALDO SWIEGERS/BLOOMBERG NEWS

Caterpillar spokeswoman Amy Campbell said Caterpillar expects to handle the next upturn with
a more-nimble manufacturing operation. Were lowering our cost structure, she said. The
company has learned a lot of lessons on how you drive more capacity without spending on

The possibility of a market collapse was almost unthinkable when Mr. Oberhelman, who joined
Caterpillar in 1975, became CEO in July 2010. The northeast-Illinois native, whose father was
a Deere & Co. salesman, had been chief financial officer in the 1990s and developed a cost-
reduction contingency plan credited with helping Caterpillar navigate the last recession.
Doug had been in the succession pipeline for a number of years, said Gail Fosler, a Caterpillar
director who left the board in 2010. The board felt he would bring a performance discipline to
the company that it really needed.

Expansion strategy
His strategy was to expand Caterpillars dominance into the developing world. In particular, he
set sights on markets such as Brazil and China where mining and infrastructure construction
were running full tilt. Meanwhile, strong crude prices were driving sales of oil-field-related
equipment, especially in North America.
Mr. Oberhelman voiced determination to avoid production-capacity constraints that had clipped
Caterpillars sales growth before the recession. He increased production of the equipment that
contractors use to construct buildings and roads and pipelinesCaterpillars fortein existing
plants. Caterpillar built new factories such as one in Victoria, Texas, to produce some excavator
models and another near Athens, Ga., for small dozersmachines it previously made overseas
and imported.


Mining companies were telling Caterpillar they wanted to buy more of their equipment from one
source. Caterpillar already made some mining machinery, such as the giant dump trucks strip
mines and quarries use.
To produce more trucks at its Decatur, Ill., plant, Caterpillar used a tack it repeated during the
boom: It narrowed the plants assembly lineup by relocating some other work to new, smaller

The approach would come to hurt the Decatur plants workforce, but during the mining boom it
allowed Caterpillar to pledge a 30% increase in mining-truck production capacity. The company
also planned to double production capacity in East Peoria, Ill., for large bulldozers it mainly
exported to mining customers.

What Caterpillar still needed in its catalog were the gargantuan shovels used in open-pit mines
and rock-shearing machines for underground mining, among other pieces of mining machinery.
Rather than building capacity in-house, as it traditionally did, Caterpillar agreed to buy Bucyrus,
the largest deal in the companys history. Caterpillar thus secured a line of shovels, underground-
mining equipment and large assembly plants in Wisconsin, Pennsylvania and Texas.

In less than six months on the job, Mr. Oberhelman had turned Caterpillar into a full-line mining-
equipment player.
Caterpillar aimed to grab a bigger market share in mining equipment with its acquisition in 2011 of
Bucyrus, maker of the giant mining shovel pictured here at a Russian mine. PHOTO: ANDREY

In China, Mr. Oberhelman went on an investing spree. In 2008, Caterpillar had bought Chinese
construction-equipment concern SEM, gaining a local brand to sell in lower price ranges; it now
invested to expand the brand. It expanded existing factories and built new plants to produce more
machines and engines, and Bucyrus made Caterpillar a stronger competitor there.

It acquired ERA Mining Machinery Ltd. in Zhengzhou for nearly $700 million, which sold
hydraulic roof supports for mechanized underground coal-mining systems. Months after the 2012
deal closed, Caterpillar said, it discovered ERA had inaccuracies in reported profit, revenue and
inventory. Caterpillar eventually wrote down ERAs value by $580 million.

Mr. Oberhelmans strategy still looked like a winner. Caterpillar reported profit of $5.68 billion
in 2012, nearly 60% above 2008 results.

After the peak

The year 2012 would prove to be the high point. Afterward, prices for mined and other
commodities began to fall. Chinas GDP growth waned, and equipment sales slowed around the

The market weakened in 2013 as developing countries cut construction and consumed fewer
commodities. Caterpillars machinery and engine sales fell 16% in 2013 from 2012.
Caterpillar added its newly acquired Bucyrus line to a catalog that already included mining machinery
such as this heavy dump truck moving coal in Maryland. PHOTO:LUKE SHARRETT/BLOOMBERG NEWS

In 2014, oil prices began falling. Caterpillar sales fell 15% in 2015 as fracking drillers deployed
less equipment. U.S. coal mining fell as pollution regulations and cheap natural gas reduced the
generation of coal-produced electricity. Caterpillar continued layoffs and in September 2015 said
it would make permanent job cuts that could exceed 10,000 positions through 2018.

Rivals were hurt, too. Mining-equipment maker Joy Global Inc. of Milwaukee expects revenue
of about $2.4 billion for its current fiscal year, down from $5.6 billion in 2012.
Japans Komatsu Ltd., which in July agreed to acquire Joy, said it expects a 5% to 10% drop in
demand for its construction equipment in its current fiscal year and a 15% to 20% decrease in its
mining business.
A significant sign of strategic retreat was Caterpillars August announcement that it would sell
some underground-mining equipment lines that serve markets Mr. Oberhelman had aimed to
expand in by acquiring Bucyrus.

The amount of investment it would take to make that business successful we thought was better
placed elsewhere in our product portfolio, said Denise Johnson, president of the mining-
equipment group, at the Las Vegas trade show. We have to make choices in this environment.
In its Decatur, Ill., plant, Caterpillars mining emphasis has cost jobs. To focus on the giant
trucks, Caterpillar moved away assembly of some other products including graders, used in road
building, which it shifted to a new plant in North Little Rock, Ark.

Now Decatur didnt have those lines to fall back on, as it had in many past downturns, when big-
truck orders waned. Graders kept the lights on for a lot of years, said Craig Karnes, president
of the United Auto Workers Union Local 751. When we lost them, it hurt us.

Fewer than 600 mining and other off-highway dump trucks left the Decatur plant last year, down
78% from the plants 2011 peak, according to market-research firm Power Systems Research,
which forecasts 543 trucks this year. Decaturs production workforce has fallen to about 800
workers, the lowest in more than 50 years and a third of 2012 levels, Mr. Karnes said.

Models of Caterpillar machinery at a CAT dealership in East Peoria, Ill. PHOTO: DANIEL

Caterpillar confirmed the plants volume and production workforce have declined, but had no
comment on the research firms or the unions calculations. The company plans to send some
powertrain-assembly work back to Decatur that it moved to a new plant in Winston-Salem, N.C.
Charlotte Opalka was laid off April 2015. I like building those big mining trucks, said Ms.
Opalka, 45, who assembled hoods and cowls. Each month without work puts more strain on her
family. It took our pay and cut it in half, said Ms. Opalka, whose three small grandchildren
live with her.

Caterpillar has enough production capacity to benefit from the next upturn, industry analysts say.
And investors have shown renewed confidence in Caterpillar, which has remained profitable by
slashing expenses, driving its stock price up in 2016.

U.S. construction-machinery sales, though, are being held down by a slow-growing economy and
persistent inventories of used fracking-related equipment. In the mining-equipment market, sales
droughts typically last seven or eight years.

Caterpillar said it expects overall revenueincluding sales and revenue from its finance
businessof about $40 billion this year, down 39% from 2012, and profit of $2.75 a share after
restructuring expenses, down 68%. Through the first six months of 2016, Caterpillars overall
revenue was $19.8 billion, down 21% from the same period in 2015; profit dropped 60% to $821

Mr. Oberhelman now wont likely be at the helm when fortunes turn. He recently warned that
any recovery probably wouldnt start this year. Still, he said at the Las Vegas show, When the
industry emerges, well be a very key player and a very solid performer for our customers.