Events: Initial Form S-4 Review
May 20, 2016
(DOW shareholders receive 1.0 shares in the merger, so its stock price is the simplest proxy for the combined entity’s stock price.)
- Recent DOW PPS: $50.81 (5/18/16 closing price)
- FD Shares Out: 2368.48
- Market Cap: $120,342 million
- Net Debt: $13,500
- Enterprise: $133,842
- 2015 EV/EBITDA: 9.1 times
- 2015 PE: 13.8 times
Pretty quick write-up outlining what can be found in the DowDupont Initial Form S-4 summary presentation. I am new to the Materials sector (for lack of a better term), so simply regurgitating a presentation is a good way to begin getting in touch with the situation, financials, industry dynamics, etc.
Without getting too deep into the valuation weeds, my preliminary investment conclusion is that DOW/DD is a borderline terrible investment proposition at this stage of the ‘cycle’ (however you want to define such an overused term). (1) The three companies that will spin out of the merged DowDupont entity will likely be highly focused, well-incentivized, lean, and appropriately capitalized; but those characteristics do little to change the low ‘economic margin’, cyclical nature of the underlying businesses. (2) These types of ‘game changing’ mergers generally top-tick market and business cycles. In other words, while the merger likely make operational sense, it appears it is simply two fully valued entities getting together late in the cycle.
Again, these are preliminary thoughts. Post-merger, it may be off to the races from a corporate performance standpoint, and the stock price follows suit. But at this point in the cycle, a Materials company trading at 9.1x EBITDA and 13.8 times earnings is not cheap, in my opinion…particularly when I can go buy Johnson Controls (NYSE: JCI) for less than 11 times earnings with a relatively similar operational/event catalytic backdrop.
The ideal investment set-up would be the pro forma DowDupont entity trading at 5-8 times earnings within six months of the three-way break-up. Plenty of time to observe and analyze in the interim…
In December 2015 Dow Chemical (NYSE: DOW) and DuPont (NYSE: DD) announced an all-stock merger – projected to close in 2H16 – in which DOW and DD shareholders will receive 1.0 and 1.282 shares in DowDupont (DowPont). Within 24 months of closing DowPont intends to take approximately $3 billion out of the cost base + split into three companies via tax-free spins: Agriculture, Specialty Products and Material Science.
DowPont will have a combined BOD comprised of 16 directors, split 50/50, with two independent co-lead directors. DOW CEO Andrew Liveris will be named Executive Chairman and oversee MaterialCo; and DD CEO Ed Breen will be named CEO and oversee the AgCo and SpecialtyCo.
- Deal Signed: 12/11/15
- HSR Filing: 1/27/16
- Initial S-4: 3/1/16
- ROW Competition Filings: 1/2Q16 – in process
- Shareholder Vote: 2Q16
- Close: 2H16
Pro Forma 2015 Financials
(PF financials do not include synergy estimates.)
- Revenue: $73,836
- EBITDA: $14,767
- Net Income: $8,716 (to common)
- EPS: $3.68
- Net Debt: $13,500
- EBITDA Leverage: .91 times
Anticipated cost synergies of $3B allocated by segment:
- AgCo: $1.3
- MaterialCo: $1.5
- SpecialtyCo: $.3
- COGS: 40%
- SG&A: 30%
- Leveraged Services: 20%
- R&D: 10%
The estimated cost of synergies is $3.5 to $4.1 billion.
DowPont also outlined potential ‘growth’ synergies of approximately $1 billion. My guess would be the bulk of growth synergies would come from the highly complementary Ag businesses, given the likely customer base overlap.
2015 Segment Sales
- AgCo: $16 billion
- DD: $10
- DOW: $6
- SpecialtyCo: $12 billion
- DD: $10
- DOW: $2
- MaterialCo: $45 billion
- DD: $5
- DOW: $40
Two product segments: Seeds (Germplasm/Traits) and Crop Protection.
DowPont cites a robust innovation pipeline, enhanced scale, and multiple routes to market as key strengths of the pro forma entity.
A 5/13/16 Financial Times article on the Bayer/Monsanto deal news provided the following Ag and Seeds 2015 market share data.
- ChemChina/Syngenta: 25.8%
- Monsanto/Bayer: 24.6%
- DowPont: 15%
- Other: 34.6%
- Monsanto/Bayer: 30.1%
- DowPont: 22.7%
- ChemChina/Syngenta: 7.9%
- Other: 39.3%
Two product segments: Specialty Materials and Bio-Based Solutions. Sub-segments are:
- Specialty Materials: Electronics, Safety & Protection
- Bio-Based Solutions: Nutrition & Health, Industrial Bio Sciences
Key operational themes include: connectivity, protection, wellness and renewables.
Three pillars of MaterialCo: (1) advantaged back-end integration; (2) world-class science and engineering capabilities; (3) narrower, deeper end market presence.
Building Blocks/Back-End Integration: ethylene + propylene + silicones
85% of revenue focused in three key end markets: Packaging, Transportation, and Infrastructure.
* * * * * * * * * * * *
Is this segment potentially the most interesting given the long-term outlook for cheap natural gas in the US? Is there significant ‘hidden’ earnings power that has yet to come online given the long-lead nature of Chemicals projects? Do PSX/CVX become involved somehow?
Extremely high level comp analysis using 2015 data pulled from Factset.
- Revenue: $51.4 billion
- EBITDAM: 22%
- 5ya EV/EBITDA: 10.24 times
- High: 12.6x
- Low: 7x
- Sales Segments: Consumer Care, Medical Care, Animal Health
- Revenue: $15 billion
- EBITDAM: 32%
- 5ya EV/EBITDA: 11.87 times
- High: 12.8x
- Low: 10.8x
- Sales Segments: Corn Seed and Traits, Agriculture Productivity, Cotton Seeds and Traits
- Revenue: $78.1 billion
- EBITDAM: 13.7%
- 5ya EV/EBITDA: 7.5 times
- High: 9x
- Low: 5.52x
- Sales Segments: Chemicals, Functional Products, Agriculture Chemicals
- Revenue: $13.4 billion
- EBITDAM: 21%
- 5ya EV/EBITDA: 12.4 times
- High: 13.3x
- Low: 10x
- Sales Segments: Crop Protection, Seeds
- Regulatory risk – potentially via AgCo
- Non-GAAP accounting – pension accounting/restructuring
- Synergies – level and cost realistic?
- Tax rate – is sub-20% long-term economic?
- Pension – accounting; impact on leverage calcs
- Ed Breen – big benefit if he stays on post break-up; does he leave once restructuring is done?
- Deal activity – does race for share lead to further deals prior to break-up?