FDx Advisors Blog

Dow Chemical and DuPont to Merge

January 4, 2016 Written by Justin Pinto

On December 11, 2015, Dow Chemical and DuPont announced they will be merging in the second half of 2016 and then, approximately two years later, subsequently splitting the combined entity into three separate companies. The companies will be split into agriculture, material science, and specialty products. The new entity will be called DowDuPont and the two companies agreed to merge in an all-stock deal that values the combined company at $130 billion. DuPont Chief Executive officer Edward Breen will become CEO of DowDuPont while Dow Chemical’s CEO Andrew Liveris will serve as Executive Chairman. Dow and DuPont shareholders will own approximately 50% of the new entity DowDuPont. The two companies are expecting an estimated 3 billion in cost synergies. In a separate statement, DuPont said it would cut $700 million in costs in 2016.

Dow Chemical was founded in 1897 by Canadian-born chemist Herbert Henry Dow, who invented a new method of extracting the bromine that was trapped underground in brine at Midland, Michigan. Dow originally sold only bleach and potassium bromide. Today, Dow Chemical is one of the world’s largest chemical and materials companies which manufactures and supplies a wide variety of intermediaries and building blocks to many different industries including automotive, agriculture, industrial, construction, etc. DuPont was founded in 1802 by Éleuthère Irénée du Pont, using money raised in France and gunpowder machinery imported from France. It began as a manufacturer of gunpowder. The company grew quickly, and by the mid-19th century had become the largest supplier of gunpowder to the United States military, supplying half the powder used by the Union Army during the American Civil War. Today, DuPont is a diversified chemical company operating in over 80 countries. DuPont is best known as a chemical producer, but over the years, its focus has shifted to agriculture, nutrition, and biosciences. In particular, the agriculture business has been projected to make up more than 40% of DuPont’s operating profit following a recent spin-off. The company is introducing new genetically modified seed and crop chemical offerings to market. This introduction is being done using a similar approach to the way a pharmaceutical company researches and develops new drugs.

Dow Chemical has acknowledged that the basic chemical business has certain characteristics that make it difficult for plain vanilla companies to earn their cost of capital over a full economic cycle. Characteristics such as low barriers to entry, high capital intensity, and the steep cyclical nature inherent in the chemical business are just a few examples. As a result, the companies that differentiate, or specialize, their products tend to be more successful. Dow Chemical recognizes the company’s exposure to the difficulties of operating in the basic chemical business and as a result has taken a two-pronged approach to overcome these challenges. First, Dow has secured low-cost feedstocks through partnerships with companies in cost-advantaged regions, such as in Saudi Arabia where their new facility will benefit from some of the lowest cost feedstocks in the world. Second, Dow continues to push its product mix towards specialty chemicals. Historically, the leaders in the chemical industry manufacture specialty products using lowest-cost inputs. Specialty chemicals demand elevated margins, have higher barriers to entry, and tend to create stickier customer relationships. Dow is a major petrochemical producer and is exposed to the ups and downs of the oil and natural gas markets. Typically, hydrocarbon feedstocks and energy account for approximately 40% of the company’s production costs and operating expenses. Approximately 70% of sales are outside of the U.S., which means the company is exposed to fluctuations in foreign currencies as well.

DuPont does have more of a specialized niche that differentiates their business. As an example, Kevlar, a proprietary DuPont product, has become the material of choice for military and law enforcement. The agriculture business is the biggest contributor to DuPont’s differentiation. DuPont has a strong seed bank and a very capable distribution and marketing operation. DuPont is still second to Monsanto in many ways but maintains a portfolio of patented traits that are difficult to replicate and should help it maintain its competitive positioning. DuPont faces solid competition in the crop and seed chemical markets with no guarantee its investments in researching and developing the next generation of biotech traits will be successful. DuPont faces other agricultural risks as well including things like consumer sentiment turning against bioengineered crops in the United States and South America. Consumer sentiment in Europe is already shifting in that direction.

On the surface this deal appears to add value for both companies but only time will tell. In reality both companies bring different types of risk to the table. As far as the projected $3 billion in cost synergies, I am skeptical that the newly formed company will really reap such an enormous cost savings. One of the reasons that I am skeptical is the fact that within two years three completely new companies will be created and DowDuPont will no longer exist. That being said, I do believe that this in an attempt of two companies with similar lines of business to consolidate efforts and bring the newly formed company to the next level as well as to catapult this company away from its competitors with new innovative product lines and offerings.

This blog post was written by Justin Pinto, Research Analyst for FDx Advisors.

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