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A Case of Asbestos Exposure at Dow?

For 18 months, government antitrust lawyers blocked Dow Chemical's $11.6 billion deal to acquire Union Carbide after the plan was announced in August, 1999. The transaction was finally allowed to go through last February, after Dow agreed to a package of divestitures limiting its market clout. Today, many Dow (DOW) shareholders may be wishing the Federal Trade Commission had never relented.

The reason for their discontent? By buying Union Carbide, Dow not only became the world's biggest chemicals company but it also picked up a docket of asbestos liability cases that industry analysts warn could eat into earnings for years to come. This isn't just a mild case of investor jitters. Since Jan. 9, when Dow settled a Texas lawsuit against Union Carbide, its share price has skidded 23%, to close at $26.83 on Jan. 18. The plunge wiped out $7.16 billion in equity and put Dow shares back where they were in October, 2000.

The panic could hardly have come at a poorer time for Dow. Only a week before the settlement, the company disclosed it wouldn't meet its earnings forecast of $91 million in the fourth quarter, excluding one-time items, because of falling demand and lower prices for its basic chemicals and plastics. As a result, Merrill Lynch analyst Michael Judd now figures Dow's core profit dropped to $600 million last year, down nearly 65% from 2000's $1.67 billion. Factor in charges related to the Union Carbide takeover, and Dow may have lost $300 million in 2001, Judd reckons.

NEGATIVE OUTLOOK. That's not all. Dow is weighted down with $9.2 billion in long-term debt, much of it from the Union Carbide purchase, and $3.4 billion in short-term debt. Noting that Dow's profits probably won't be much better in 2002, credit-rater Fitch Inc. on Jan. 16 lowered to negative its rating on Dow's debt and its outlook. Dow is scheduled to report 2001 results and update its balance sheet on Jan. 31.

This isn't the first time the company has been threatened by product liability. Its 50%-owned Dow Corning affiliate declared Chapter 11 in May, 1995, dragged under by lawsuits over silicone breast implants. While Dow wrote off the investment and has set aside reserves to cover losses at Dow Corning, it continues to caution investors that the company still could be on the hook for big payouts as litigation wends its way through the courts.

Dow management insists that its asbestos liability won't reach anywhere near the Dow Corning level. The Midland (Mich.) company won't disclose how many lawsuits it faces or how much it has paid in settlements or legal fees. It also won't say how much it paid the 10 plaintiffs in the just-settled lawsuit in Beaumont, Tex. However, given Dow's size -- revenues were estimated at $28 billion last year -- and its insurance coverage, the asbestos liability is "immaterial," says spokesman John Musser.

DUELING SCENARIOS. Analyst Judd concurs. Under his worst-case scenario, Dow would have to pay $10,000 per case to settle 100,000 claims a year over the next decade. That would slash annual earnings by $640 million, which could make Dow a pariah among investors. But Judd asserts the hit likely will be much less. Dow probably could escape, he says, by paying $5,000 per case to settle 25,000 claims a year over the next decade.

He believes Dow has insurance covering $875 million to $1.5 billion in liability, leaving it to pick up just $18 million to $36 million a year in additional costs. As Dow shares sank, Judd upgraded his opinion on Jan. 14, and now has a strong buy on the stock.

Don't go there, counter analysts Andrew W. Cash of UBS Warburg and Stephen H. Latz of A.G. Edwards & Sons. Both told shareholders to get out after the Jan. 9 settlement. Latz concedes that Dow probably can handle its current exposure to asbestos liability. But he points to what has happened to other big companies that made products with asbestos or assumed liability through an acquisition. So far, more than two dozen have been driven into bankruptcy, including Federal-Mogul, USG, and W.R. Grace, which declared Chapter 11 in 2001.

DOW "STANDS OUT." Because of the quirks of asbestos litigation, these bankruptcies could increase the potential liability at Dow. Typically, plaintiffs don't have to prove they were exposed to asbestos produced by a specific manufacturer. All they must prove is that they were exposed or there are indications they might get sick, and that the corporate defendant produced or sold a product containing asbestos. So if an auto-parts maker like Federal-Mogul or a building-products giant such as USG shields itself though a bankruptcy filing, plaintiffs can simply sub in Dow as a defendant. "If you're looking for [companies] to be sued, Dow certainly stands out," notes Latz.

Of course, it won't get tagged with every claim. Dow's Musser notes that 94 companies were named as defendants in the Beaumont case. Meanwhile, Dow isn't the only defendant seeing scared investors dumping its stock. Halliburton shares plummeted more than 40% in December after the oil-services company in six weeks lost a string of asbestos lawsuits with judgments totaling $122 million. 3M shares slid as much as 10% following the Dow settlement, as analysts raised questions about its asbestos liability. "We are involved," says 3M Chairman and CEO W. James McNerney Jr., "because of our size and our deep pockets."

Despite the litigation morass Dow acquired from Union Carbide, the company says it has had no second thoughts about the takeover. Dow claims it now boasts unmatched economies of scale and market reach. The company has a catalog of more than 2,500 products and 171 factories in 35 nations.

In the year since the deal closed, the combined company has shucked 3,600 employees, with 900 more expected to go. Dow says its restructuring has already reduced expenses by $550 million and should save $1.1 billion a year by early 2003. But given the open-ended legal bill Dow has assumed, it may need to sock away a lot more than that to make the takeover worthwhile. By Michael Arndt in Chicago

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