Dow Chemical Breakup Is Better Than Status Quo: Real M&A

Dow Chemical Co. stands to return more for shareholders by taking activist investor Daniel Loeb’s advice to break itself up than by pushing ahead with its own plan for more limited asset sales.

Loeb’s Third Point LLC disclosed a stake in Dow last week and called for a spinoff of its petrochemicals business to improve profitability at the $53 billion company. Analysts put Dow’s value at about $51.40 a share in a breakup, according to the average of 10 estimates compiled by Bloomberg. That’s 18 percent more than the closing price on Jan. 24.

While Dow has plans to divest as much as $4 billion of units to focus on more profitable operations, Argus Research Co. said the chemical producer should be more aggressive and consider a full breakup. Dow’s disparate businesses from plastics to genetically modified seeds make it difficult for shareholders to value the Midland, Michigan-based company, according to Barclays Plc.

“They’ve been heading in that direction, but there’s clearly more that can be done,” Aaron Clark, a fund manager in Boston at Tetrem Capital Management Ltd., which oversees about $5.2 billion, including Dow shares, said in a phone interview. “That’s the opportunity. I definitely see the potential to unlock some pretty significant value” by breaking up the company.

Breakup Benefit

Third Point last week urged Dow, the largest U.S. chemical maker by sales, to hire outside advisers to review the potential benefits of splitting its petrochemical business from its specialty chemical divisions. The spinoff would generally consist of Dow’s feedstocks and energy, performance plastics and performance materials units, according to a letter sent to Third Point’s investors.

“We welcome all constructive input with a common goal of enhancing long-term value,” Rebecca Bentley, a spokeswoman for Dow, said in an e-mailed statement after Loeb’s position was disclosed. “We intend to continue an open dialog to further enhance value for all of our shareholders.”

Bentley didn’t respond last week to a request for any further comment. A representative for Third Point didn’t respond to an e-mailed request for comment.

By cutting costs and improving operations, the spun-off petrochemical unit could generate more than $9 billion in earnings before interest, taxes, depreciation and amortization - - more than the entire company makes currently, the hedge fund said. Then, with management able to focus more on specialty chemicals, those divisions could boost Ebitda to as much as $5 billion in the next three to five years, up from a base of about $2.8 billion in 2013, Third Point said.

‘On Board’

Pursuing a breakup would be “a very good strategy for the company to initiate,” Bill Selesky, a New York-based analyst at Argus Research, said in a phone interview. “What Dan Loeb is doing is very consistent with the way we were thinking. We’re on board.”

Loeb’s push comes after Nelson Peltz’s Trian Fund Management LP amassed a stake in chemical producer DuPont Co., which now plans to spin off the unit that makes titanium dioxide.

Dow’s complex structure and diverse businesses make it harder for investors to value the company, Duffy Fischer of Barclays wrote in a Jan. 22 report. It also makes it harder for Dow executives to manage the chemical maker, according to Charles Neivert, a New York-based analyst at Cowen Group Inc.

‘Little Connection’

“These assets have little connection to each other and the breadth of the business segments frequently leads to a significant misallocation of resources,” Neivert wrote in a Jan. 22 note to clients. “The current construct of the company does not allow full potential to be realized.”

Neivert said that instead of spinning off the petrochemical businesses, Dow should keep that unit and divest everything else.

Dow has a lower return on assets than 93 percent of global chemical makers valued at more than $20 billion, according to data compiled by Bloomberg. Even though its shares climbed about 27 percent in the 12 months before Loeb disclosed his stake, Dow trailed more focused peers including LyondellBasell Industries NV and Westlake Chemical Corp.

The breakup Loeb is suggesting would allow a more focused management team at the petrochemical spinoff to make operational and cost improvements, according to Todd Lowenstein, a Los Angeles-based fund manager at HighMark Capital Management Inc., which oversees about $17 billion and has owned Dow stock in the past.

Pure Plays

At the same time, the specialty chemical operations would fetch a higher multiple if they weren’t being weighed down by Dow’s conglomerate structure, said Clark of Tetrem Capital.

“The market tends to like purer plays, especially if there’s some really good businesses buried within, which in this case, there are,” Clark said.

Sum-of-the-parts estimates from 10 Dow analysts ranged from about $45 to $64 a share, based on projected earnings. That compares with a closing price last week of $43.41.

Today, Dow shares fell 0.7 percent to $43.10.

Simply reducing costs at the petrochemicals business may do more to create value than a breakup, Jeffrey Zekauskas, a New York-based analyst at JPMorgan Chase & Co., wrote in a Jan. 22 report.

Either way, with Third Point’s move sparking a discussion about how to get more out of Dow’s businesses, shareholders will probably benefit in the end, Cooley May, an analyst at Macquarie Group Ltd., wrote in a report last week.

“They were a bit of a sitting duck for an activist,” said Clark of Tetrem. “Hopefully the management will be willing to listen and create more value.”

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