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Wednesday, 22 October 2014

Third way

Dan Loeb puts the right accelerant in Dow Chemical

Dan Loeb is putting the right accelerant into Dow Chemical. The $52 billion U.S. chemistry giant’s shares jumped more than 7 percent at one point on Jan. 21 after the activist investor called for a split of its petrochemicals and specialty chemicals businesses. Loeb may be overly optimistic about the financial benefits, but a rough sum-of-the-parts suggests merely breaking Dow up could boost its value by a fifth.

Dow Chief Executive Andrew Liveris is by no means averse to hiving off some commodity businesses. The company is already planning about $3 billion to $4 billion of divestments by the end of 2015. That’s on top of cost-cutting that Credit Suisse expects to produce $750 million of savings this year, up from about $500 million in 2013. So far, though, Dow has resisted going the route of U.S. peer DuPont, which is pursuing a full commodity chemical spinoff.

Loeb’s proposal to split off commodity petrochemicals would leave a rump focused on more attractive growth businesses like agriculture, electronics and pharmaceuticals. That might warrant a richer trading multiple than the combined company. The separated businesses would also be free to focus on their own profitability, potentially generating higher earnings over time.

Dow may fret that dividing commodity and specialty chemicals will add costs, due to integration between their supply chains. Loeb thinks that concern is overblown; he estimates the separated companies could generate combined earnings before interest, tax, depreciation and amortization of up to $14 billion in a few years’ time, versus this year’s forecast $8.7 billion and a consensus analysts’ forecast for $10.2 billion in 2016.

That may be aggressive. But the effect of doing no more than spinning off these businesses could have an immediate benefit. Assume commodity chemicals account for about two-thirds of Dow’s forecast $8.7 billion of EBITDA in fiscal 2014. Then apply chemical peers’ average 7.5 times forward enterprise multiple to forecast commodity EBITDA, and ag-focused Monsanto’s11.5 times to the rest.

Adding the two together implies an enterprise value of about $77 billion for the company – a 20 percent premium to its current enterprise value, based on Credit Suisse’s assumption for this year’s net debt. Of course, Liveris still needs to act. But it’s no wonder investors reacted favorably.

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Shares of Dow Chemical rose more than 7 percent on Jan. 21 after activist investor Dan Loeb’s Third Point disclosed it had taken a significant stake in the company. In a letter to investors, Loeb called on Dow to consider spinning off its lower-margin petrochemicals businesses to increase value for shareholders. Third Point said Dow was its “largest current investment,” suggesting the value of the stake was in excess of $1 billion.

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