Dow Chemical is tempting fate with its $5 billion chlorine sale. The $54 billion company is offloading the bulk of its low-margin bleach and vinyl-related operations to smaller rival Olin using an esoteric structure known as a reverse Morris Trust. The valuation looks solid, especially considering the tax savings. Yet investors should remain wary given the history of such complex deals.
The businesses being turned over to Olin’s and Dow’s own shareholders, if they so choose, generate $650 million of earnings before interest, tax, depreciation and amortization. In return, Olin is paying $2 billion in cash, proffering $2.2 billion of its shares and assuming $800 million of pension liabilities and debt. That translates into a little under eight times EBITDA, a respectable multiple for a mature commodity business.
Factor in the tax advantages and the numbers look even better. The reverse Morris Trust, in which a company forms a new subsidiary that merges with a smaller company, in this case Olin, as a prelude to a spinoff, means Dow will avoid paying capital gains on the $5 billion windfall. In a straightforward sale, Dow would have had to sell the business for $8 billion, or more than 12 times EBITDA, to achieve the same result for shareholders.
There are also the synergies to consider. Taxed and brought to present value, $200 million of expected cost savings by year three should be worth close to $1 billion. That equates to another $500 million for Dow shareholders, who ultimately will own just over half of the enlarged Olin.
However attractive on paper, the checkered history of Morris Trusts – only ever utilized about 30 times – suggests the deal warrants a cautious reception. Deals involving Orbital Sciences, Procter & Gamble, C&J Energy, NetScout Systems and Entergy all have found themselves bedeviled in one way or another. The contortions involved make such transactions more precarious and time-consuming to close than a more traditional sale.
Dow shareholders added only $2 billion to the company’s market value on Friday, or a discount to the deal’s headline benefits. That suggests warranted caution of a chemical compound cooked up in a financial lab.