Chemical behemoths DuPont DD and Dow Chemical DOW made it official last Friday that they plan on combining their businesses to create a chemical powerhouse dubbed “DowDuPont” with a combined market value of around $130 billion, before eventually breaking up into three independent companies.
The two iconic American firms – both reeling under the effects of the commodity price slump, weak demand for agricultural chemicals and headwinds from a stronger greenback – have agreed to merge in an all-stock deal that has been unanimously cleared by the boards of both companies.
A Monster Merger
The proposed merger, which has been the talk of Wall Street since its announcement, will see the marriage of two of the America’s oldest companies with more than three centuries of combined history. Apart from being the largest deal ever in the chemical space, it also ranks among the biggest mergers and acquisitions (M&A) deals announced this year.
Under the deal terms, shareholders of Dow and DuPont will each own about a half of DowDuPont, excluding preferred shares. Dow shareholders will get one share of DowDuPont for each Dow share, while shareholders of DuPont will receive 1.282 shares in the new company for each DuPont share they hold.
DuPont’s Chair and CEO Edward Breen will retain his title at the new company. Dow’s CEO Andrew N. Liveris will be the Executive Chairman of the combined company. Board of DowDuPont is expected to have 16 directors, consisting of 8 incumbent DuPont directors and 8 current Dow directors.
The planned merger, however, would be followed by a breakup of the integrated company into three independent, publicly traded companies through tax-free spin-offs. The combined company would split into pure-play agricultural, material science and specialty products businesses that will be leading players in their respective fields:
- The “Agriculture Company” (combined adjusted sales of around $19 billion in 2014) will unite Dow's and DuPont’s seed and crop protection businesses.
- The “Material Science Company” (combined adjusted sales of around $51 billion in 2014) will consist of DuPont's Performance Materials segment and Dow's Performance Plastics, Performance Materials and Chemicals, Infrastructure Solutions, and Consumer Solutions (excluding the Electronic Materials business) divisions.
- The “Specialty Products Company” (combined adjusted sales of around $13 billion in 2014) will include DuPont's Nutrition & Health, Industrial Biosciences, Safety & Protection and Electronics & Communications units and Dow’s Electronic Materials business.
Advisory Committees will be set up for each of these three businesses. Breen will lead the Agriculture and Specialty Products committees while Liveris will head the Material Science committee.
The breakup is expected to take place 18-24 months after the completion of the deal, which is expected in second-half 2016, subject to regulatory and shareholder clearance. Following the transaction closure, DowDuPont will be dual headquartered in Midland, MI and Wilmington, DE. Klein and Company, Lazard, and Morgan Stanley & Co. LLC are serving as Dow's financial advisors for the transaction while Evercore and Goldman, Sachs & Co. are DuPont's financial advisors.
DuPont’s shares slipped 5.5% to close at $70.44 last Friday while Dow ended 2.8% lower at $53.37. DuPont’s shares fell after the company, in a separate announcement, said that it expects sales growth to be challenging in 2016 due to difficult conditions in agriculture & emerging markets and currency headwinds. It also plans to cut 10% of its global workforce as part of a cost savings and restructuring program. Shares of both companies ended nearly 12% higher last Wednesday on reports of late-stage merger talks.
Industry Stalwarts Unite in Bad Times
The deal came as a survival strategy as both DuPont and Dow are feeling the bite of falling farm commodity prices and weak agricultural market conditions. The companies are also faced with weakening demand in emerging markets and significant currency headwinds, stemming from strengthening of the U.S. dollar against a basket of currencies. These headwinds have weighed heavily on their sales and profits this year.
Moreover, both DuPont and Dow have faced significant pressure from activist investors. Under the leadership of its former CEO Ellen Kullman, who retired in Oct 2015, DuPont faced intense pressure from legendary activist investor Nelson Peltz’s Trian Fund Management.
Trian pushed the company to break itself up into two distinct entities through the separation of its high-growth businesses such as agriculture and nutrition & health from its cyclical businesses. However, DuPont prevailed in a prolonged proxy battle with Trian in May 2015 after its shareholders elected all of its 12 director nominees at its 2015 annual meeting while rejecting the Trian nominees.
Dow also came under pressure in early 2014 after activist investor Dan Loeb's Third Point hedge fund (a major shareholder) urged the company to spin off its sluggish petrochemicals business and focus instead on high-margin, fast growing businesses with a view that the move will create more value for the shareholders.
However, Dow and Third Point entered into a crucial peace accord in Nov 2014, under which, the former agreed to add four new, independent directors to its board (including two suggested by Third Point), thus averting the possibility of a board seat battle between them.
Lower crop prices are weighing on DuPont's profits. The company remains exposed to a challenging operating environment in the agricultural market. Its profits tumbled year over year in third-quarter 2015, hurt by bigger operating loss in its agriculture business. On the other hand, Dow saw a double-digit year over year decline in sales in its agriculture business in the third quarter, dragged down by lower agricultural commodity prices.
Both DuPont and Dow have been actively optimizing their portfolios amid the prevailing difficult operating backdrop. DuPont, as part these actions, completed the separation of its struggling performance chemicals unit in Jul 2015 through the spin-off of The Chemours Company, marking its transformation to a company which is more growth-driven, more science intensive and less cyclical.
Dow is also selectively spinning off or selling its underperforming assets as part of its aggressive portfolio management actions. As a big part of these moves, the company closed the separation of a major portion of its chlorine value chain and merger of those businesses with chemical maker Olin Corp. in Oct 2015.
Compelling Prospect, But Tough Regulatory Path
Both companies expect the proposed ‘merger of equals’ to enhance their growth profiles through expanded scale and complementary offerings (especially in agriculture), drive shareholder value and create significant cost synergy opportunities. The merger is expected to deliver cost synergies of around $3 billion, expected to be achieved with the first two years after the deal closure. Around $1 billion of additional growth synergies are also expected to be achieved from the merger.
The deal, however, would need regulatory clearances in several countries and is expected to face a tough antitrust scrutiny due to competitive concerns given its massive size and scale. Analysts expect that the merger could ignite more deals among other agricultural chemical companies including Monsanto MON and Syngenta SYT.
Certain farm groups have also reportedly expressed concerns that the merger could harm competition in seeds and crop chemicals markets. The deal has been closely watched by these groups who are assessing its impact on the prices of seed and chemical products and input costs as they strive to protect the interests of farmers. As such, the regulatory path might not be smooth for the planned mega-merger.
DuPont currently carries a Zacks Rank #3 (Hold), while Dow Chemical is a Zacks Rank #2 (Buy) stock.
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