Updated Analysis on Dow and DuPont Merger Integration

Activist investors drive companies to seek outside counsel on proposed spin-offs.

An updated analysis on the Dow Chemical and DuPont merger integration has been released by Houston-based IHS Markit. Researched and prepared by Dave Witte, sr. v.p., oil markets, midstream and downstream, and Director Rob Westervelt, this is an update on their initial analysis offered in December 2015, right after the merger announcement.

At that time, the two U.S. industrial and chemical icons described their combination as a $130-billion “merger of equals”, which IHS noted at the time created the industry’s largest deal to date. (It dwarfed AkzoNobel’s 2008 acquisition of ICI for $17 billion). Today, these two companies are worth approximately $155 billion. Here’s the known and the relatively ‘up in the air’:

● The combined company will be named DowDuPont and be dual-headquartered in Midland, Mich. And Wilmington, Del. Dow chairman and CEO Andrew Liveris will become executive chairman of the DowDuPont board, and Edward Breen, chairman and CEO of DuPont, will become CEO of DowDuPoint. (IHS Markit covered the Dow Chemical Company in a recently released Competitive Company Analysis, which reveals an in-depth view of the company’s product integration, financials and strategic direction.)

● At the time of the merger announcement, the companies said in a joint statement on December 11, 2015, they intended to subsequently pursue a separation of DowDuPont into three independent, publicly-traded companies through tax-free spin-offs. This would occur as soon as possible, which was expected within a 18- to 24-month timeframe, following closing and subject to regulatory and board approval.

The devil is in the details: Dow and DuPont engage outside council on spin-offs; as activist agitation increases.

Fast forward to July 2017, and this proposed spin-off is where the details of the deal start to get interesting, at least from an investment perspective. Dow and DuPont announced in late June that they would engage McKinsey & Co. to assist in reviewing the composition of the three companies they intend to spinoff. Both had previously indicated they would review the portfolios, but the McKinsey assignment and statements from each company’s lead director are meant to indicate significant movement to the next phase of the merger.

The announcement came less than a month after activist hedge fund Third Point (New York), led by investor Dan Loeb, called for the companies to shift several “high-multiple” businesses from their planned materials science spinoff into the planned specialty products company. Hedge fund Glenview Capital Management also made similar arguments.

While changes are not impossible, the deal does appear to have a fairly strong Teflon coating.

The activists are promised a fair hearing by the boards, but it appears unlikely significant changes to the existing deal structure will be made. From Dow’s perspective, this was less a “merger of equals” rather than a tax-efficient way to divest its agriculture business. A complex and extended DowDuPont merger transaction timeline introduces risk by raising the potential for disruptive events, including activist agitation. Third Point and activist hedge funds were, in fact, a known risk given Third Point’s previous engagement with Dow. Its proposals and arguments match its earlier call for Dow to consider a separation of non-commodity businesses.

Dow took a calculated risk and nothing in its strong performance since the deal was announced provides an argument for significant changes. While changes are not impossible, the deal does appear to have a fairly strong Teflon coating. Some relatively minor portfolio shifts are possible but an abandonment of Dow’s strategy of combining a market-driven portfolio with strong back integration is not in the cards. Dow management, led by CEO Andrew Liveris, has fought very hard to keep the core of Dow’s integrated portfolio intact through the years, so major changes to the deal are extremely unlikely.

Dow maintains strong controls and much authority to approve any deal or structural changes. Terms of the deal strongly favor Dow should the company leadership not want changes. The materials science advisory committee (this business has already indicated it will retain the Dow name) has sole authority to approve any changes to the scope of that business. The committee is made up of legacy Dow board members in addition to Liveris and DuPont CEO Edward Breen. Legacy DuPont board members have the same authority over the agricultural business.

IHS: Only true peer on this scale that remains is BASF.

Implications: The deal will stand. The full DowDuPont board has some leverage. A majority can abandon any of the spin-offs, but that is an unlikely outcome in IHS Markit’s opinion, barring a dramatic disagreement or deterioration in relations between Dow and DuPont board members, which has not been evident. Upon further review, the IHS Markit experts maintain that the deal will stand, but as mergers and acquisitions continue to heat up in the specialty chemicals sector, the leadership of these other companies is likely to keep a keen eye on activist investors as they structure any deals. 

●   Industry impact—an IHS Markit perspective. As had been reported in their December 2015 analysis on the deal, a DowDupont merger would be followed by a three-way split, broken down to agriculture, material science, and specialty products. As structured now, the deal keeps the core of Dow Chemical’s integrated franchise in place—excluding its agriculture chemical business and electronics materials business (inherited from Rohm and Haas). The materials science company—the largest business, with sales of $51 billion (based on 2014 sales), would also take on DuPont’s performance materials businessincluding engineering plastics and elastomers, as well as Dow Corning. According to the IHS pros, the “only true peer on this scale that remains is BASF”.

The deal continues the shift, accelerated in the past few years by the agitation of activist investors, toward simpler and more focused portfolios. The reshuffle of Dow’s and DuPont’s non-agricultural operations would continue the split between specialty chemical and advanced material niches. Upstream integration would be retained for basic chemicals and polymers (materials) while bringing scale to the specialty business.

Further, the acquisition of Dow Corning—major producer of silicones, will significantly strengthen the combines entities’ electronic materials and consumer-care portfolios. Likewise, DuPont’s portfolio complements Dow’s with regard to food and nutrition and personal-care product ingredients: DuPont (Danisco) is a major player in nutrition and health and a small player in the personal-care products industry. While IHS Markit views this segment as more specialty in nature, this part of the portfolio is slated to remain with the Materials’ focused company, along with the majority of the legacy Dow franchise.

A New IHS Markit Specialty Chemical Update Program Overview of the Specialty Chemicals Industry report identifies 30 or so such niches ranging from more than $40 billion/yr in global revenue (specialty polymers, cleaning ingredients, and electronic chemicals) all the way down to thermal printing chemicals, valued at $450 million. Paints and coatings, roughly a $135 billion/yr segment globally, and industrial gases, are broader specialty-like niches that have become dominated by focused producers.

While Dow retains the upstream integration with expanded capabilities to bring a full portfolio of advanced materials, increasingly Basics (along with integration to commodity plastics) will likely be commanded by integrated oil companies, state-owned enterprises, emerging players in Asia and the Middle East, and a few remaining regional players in the U.S. and Europe.

This would include a DowDuPont combination with an extended advanced material portfolio, LyondellBasell Industries (LBI), Ineos, and Westlake Chemical, notwithstanding the presence of other MNC producers such as ExxonMobil, Shell or ChevronPhillips Chemical.

Recent changes in the global sector are largely driven by the significant shale resource availability in North America and its impact on the global petrochemical sector.

The rest of the industry is focusing on targeted more specialized niches spread across more than 30 segments. The emphasis here is on innovation, market knowledge and close customer relationships. Horizontal diversification is now seen as a distraction for some operators, as their business focus intensifies and broad-based ambitions are reduced.

While not true for agriculture, R&D emphasis for chemicals narrows on developing applications with new materials penetration and extending product lines rather than core invention and developing new chemistry. These strategies will likely be tested in time as emerging players in Asia, including state-owned enterprises continue to expand research capabilities and surely won’t limit themselves to basic chemical production over the long haul.

Witt and Westervelt conclude that this may well be the natural evolution of an industry that has seen giants such as Hoechst, Union Carbide, ICI, and others disappear during the past 20 years, but we are truly witnessing a tectonic change and a continued evolution of the global chemical industry.

One thing is certain, they note: the pace of change in the global industry is accelerated at a speed many of us have not witnessed in the past 30 years. Some would say warp speed. With recent changes in the global sector largely driven by the significant shale resource availability in North America and its impact on the global petrochemical sector, combined with global economic and demographic shifts, the IHS Markit pros expect the face of the industry will be much different in the next five years as compared to the previous 20.