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Let’s Make a Deal: Breaking Down the DuPont-Dow Merger

The $130 billion merger between 213-year-old DuPont (NYSE: DD) and 118-year-old Dow Chemical (NYSE: DOW) is the biggest tie-up by far in the history of the chemicals industry.

And it’s not your run-of-the mill merger, either. In a unique twist, the two companies will join, but then split into three more-focused companies. Three new entities will be created in agricultural products, bulk petrochemicals and plastics, and specialty chemicals. In effect, it’s gaining weight as a way to get fit.

Based on the companies’ recent results, agricultural products would account for 23% of combined revenue; performance materials and chemicals 48%; and specialty products 29%.

DuPont-Dow merger

Source: Oilpro.com

Both companies are trying to get into better shape, thanks to prodding from activist investors. The thorn in the side of Dow is Dan Loeb of Third Point Management, while DuPont has been pressured by Nelson Peltz of Trian Partners.

But the 1 + 1 = 3 strategy was likely formed not only to fend off activists’ concerns, but to combat pressures the two chemicals giants face.

Chemicals Industry Duress

Both companies have shed lower-profit businesses to focus on higher-growth sectors such as electronics and packaging. Yet revenues across the remaining business lines still face pressure from a weak global economy, strong U.S. dollar and sinking prices.

Another headache is China.

As with other commodity-related businesses, China has ambitions to become a major global player in chemicals. That has led to overcapacity in some parts of the chemicals industry.

Overcapacity translates to heavy exports of certain chemicals from China. This directly affects both firms, which have major operations in Asia. It’s another reason behind the move to merge, in my view.

There is one bright spot though for DuPont and Dow. China is still dependent on imports for complex chemicals that only overseas companies can supply. DuPont’s sales actually rose 4% in China last year.

The 3-for-1 DuPont-Dow merger should be able to capitalize on this dynamic.

Deal Synergies

Looking at the deal overall, there are definite pluses.

Estimates from most analysts put cost synergies at a healthy $3 billion within the first two years. That’s a good percentage of the combined $10.3 billion in operating profits of the two firms last year.

Some savings will certainly come in the form of the elimination of overlaps and duplications in areas like administration. But there are other obvious benefits from joining forces.

For example, DuPont’s ethylene copolymers are used in everything from food packaging to road construction to golf balls. Dow provides the necessary petrochemicals used in the production of DuPont’s ethylene copolymers. It’s a much cheaper proposition when the two are combined.

Another plus is that the deal creates a big player in the rapidly growing solar power industry. The new specialty products company will be a major provider of solar photovoltaic materials.

Approval and Aftereffects

All of this assumes the deal will receive approval from regulators.

I believe it will. The two once-great rivals no longer really compete directly against one another. Their ethylene-based products target different niches. There is little overlap.

And in the few areas where they do compete, assets can be sold off. For instance, Dow’s U.S. seed business could be sold off to German competitors eager to expand in the United States, namely BASF SE (OTC: BASFY) and Bayer AG (OTC: BAYRY).

Another factor in favor of approval is the already announced three-way breakup. That should alleviate concerns about having one chemicals behemoth dominating the market.

What will be the aftereffects of this earthshaking mega-merger?

The biggest tremor will occur in the already hot agrichemicals and seeds sector. As I discussed before, the cyclical downturn is hitting hard. Now everyone is talking to everyone in the industry about possible merger combinations. The creation of a new powerhouse in the sector will only accelerate the consolidation trend there.

Depending on how long the regulators take, the 1 +1 = 3 split should occur in 18-24 months. When that occurs, it creates a win-win-win for shareholders. As Wells Fargo (NYSE: WFC) analyst Frank Mitsch said, it’s the “deal of three centuries.”

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