Finance

Stephen Gandel is a Bloomberg Gadfly columnist covering equity markets. He was previously a deputy digital editor for Fortune and an economics blogger at Time. He has also covered finance and the housing market.

Corporate executives might want to think twice before relying on hedge fund matchmakers. It appears they are not even patient enough to stick around for the wedding.

Last week, Daniel Loeb of Third Point released a presentation indicating the plan to combine and then break up industrial giants Dow Chemical Co. and DuPont Co. no longer had his blessing. Never mind that Loeb backed the $143 billion megamerger when it was announced in December 2015, or the fact that he was pushing for a break up of Dow or some sort of deal for a year before that.

And he's not the only activist hedge fund manager getting cold feet. Nelson Peltz of Trian Fund Management, who all but rammed DuPont into Dow's arms, like Loeb seems to have lost his enthusiasm for the deal he helped create. Peltz has sold just more than 11 million shares of DuPont, or more than half his stake, in the past year. It's not clear if he plans to stick around to see the deal through. Peltz, through a spokesperson, declined to comment. Loeb has reduced his stake in Dow as well, though he hasn't cashed out as much as Peltz.

The Activist Retreat
Hedge fund managers Nelson Peltz and Daniel Loeb have pared their holdings in Dow Chemical and DuPont since the merger was announced

Activist hedge fund managers, once called raiders, have long advocated for acquisitions, breakups and other restructurings. But the Dow-DuPont deal was different, seen as a high-water mark. The Wall Street Journal said the deal "cemented" the rise of activists. Trian was apparently so pleased with that characterization that it posted the article on its website. The difference with the Dow-DuPont deal was that not only were the hedge funds pushing for a deal, they basically negotiated it. It was not just that the barbarians were finally inside the gates. The Dow-DuPont deal showed that the barbarians owned the gates and it was the corporate executives who were ringing the buzzer to get inside.

Peltz first met with Dow CEO Andrew Liveris in 2014 to gauge his interest in a deal with DuPont. He later helped push out DuPont CEO Ellen Kullman, who was cold to the idea. Ed Breen, who succeeded Kullman, met with Peltz soon after taking the job and let him know he was on board. Peltz invited Dow representatives to his Palm Beach, Florida, mansion to hash out the details of the deal, specifically what business units would go where after Dow and DuPont were split up into three companies after the merger. It does not appear any representatives of DuPont were present. Loeb's two board nominees signed off on the deal.

But it now seems clear that the plan hatched by the activists will produce a lot less value than what Peltz and others promised. Shareholders of both companies are questioning the breakup plan. The companies have said their future combined board will launch a formal review after the deal is completed. Loeb says the current plan will cost the combined company $20 billion in value. In early 2015, Peltz said his plan would make DuPont's shares worth as much as $120 by the end of 2017. Nonetheless, he has been dumping his stake even though the stock has mostly stayed below $80.  

The problem is the deal math never really added up. When Peltz first proposed the breakup plan, his $120 stock price for DuPont rested on the company reaching a 23 percent profit margin. To get there, it would have to cut about $1.8 billion in costs. But the plan, even by Peltz's estimate, would most likely cost the company about $1 billion in revenue from lost cross-selling and other opportunities. That meant the annual savings DuPont actually needed was more like $3 billion, or about triple what the company said was possible. So Peltz needed a bigger pool to cut from. Enter Dow.

No Merger Boost
Shares of Dow Chemicals and DuPont have underperformed the wider materials sector since announcing their merger
Source: Bloomberg

The Dow-DuPont merger announcement did come with a pledge of cutting as much as $3 billion in expenses. But it wasn't clear how combining two giant companies and then slicing them up into three would lower costs. Three companies would need, among other things, three accounting teams, three legal departments and three executive suites. The three-is-better-than-one argument seems to break the laws of economies of scale.

Loeb's new plan proposes to break the combined company up into six. He says doubling the number of companies again will equal even more savings. He doesn't say how, or how much. What's more, Loeb ignores the cross-selling issue, or how disruptive breaking up the business will be. He predicts the six new companies will have a higher combined revenue by the end of next year than Dow-DuPont would be estimated to have if it stayed together.

Where Loeb gets most of his proposed additional value is from shuffling businesses. He says Dow's food and water purification operations, for instance, should be paired with DuPont's nutrition and biosciences division, instead of heading, as they are slated now, into the materials division. That makes sense. But presumably Peltz and the others involved in the Palm Beach powwow had some logic in the original pairing. The customers, for example, of Dow's water purification business are largely industrial companies and not the giant consumer food companies that are the customers of the DuPont's nutrition business.

Nonetheless, Loeb says his nutrition and biosciences pairing should trade at a multiple of 15 times cash flow, creating a new company worth $34.5 billion, roughly doubling the value of those divisions.  Will it? Not likely. Rival Monsanto trades at 15 times. But it has much higher profit margins, and to achieve those the newly formed company would have to cut an additional $370 million in costs from a considerably smaller pie. But don't expect Loeb to hang around long enough to have to deal with the shortfall. Instead, there will likely be another activist investor ready to shuffle Dow-DuPont's deck chairs once again.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Stephen Gandel in New York at sgandel2@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net