24 August 1998 00:00 [Source: ICB Americas]By Joseph Chang
E. I. du Pont de Nemours & Co.'s planned metamorphosis into a leading life sciences company is taking shape with the upcoming partial IPO or outright sale of its $26 billion Conoco energy unit and the goal of hiking life sciences earnings to 30 percent of its total earnings in the next four or five years versus 20 percent today.
In a speech to the investment community in New York earlier this month, DuPont president and CEO Charles O. Holliday reaffirmed DuPont's strategy of becoming a faster-growing, more profitable and less cyclical company.
"We are already implementing our strategy to transform the company," Mr. Holliday said. "We have decided to exit the company's wholly owned energy subsidiary Conoco, acquired Merck's interest in our pharmaceutical joint venture, are seeking other acquisitions in the life sciences area, and are building on the strongest components in DuPont's chemicals and specialties businesses."
Speculation has run rampant on negotiations between DuPont and French energy giant Elf Aquitaine regarding a sale of Conoco, pushing DuPont shares up $2.94 to $56.19 during last Monday and Tuesday's trading. Conoco has already filed a registration statement with the SEC in connection with its planned initial public offering (IPO), but many view the planned IPO as an invitation to potential buyers to preempt the offering.
Wall Street analysts agree that an outright sale of the Conoco unit at the right price would be favored over a lengthy IPO or spinoff process despite the inauspicious timing of coinciding with historically low energy prices.
"That would speed up the process of DuPont getting a life sciences multiple rather than still owning 80 percent of Conoco for the next year and a half," says Janney Montgomery Scott analyst Christopher Crooks.
"An asset swap with Elf Aquitaine may make sense," says Mr. Crooks. "Whatever would get the best price and best tax advantages would be the best route, and an outright sale with some asset swaps could accomplish that."
The analyst says that an asset swap could involve Elf Aquitaine pulling out its pharmaceutical businesses (Sanofi) and "foundation" businesses within Elf Atochem in exchange for Conoco. "Interestingly, in DuPont's analyst meeting, Mr. Holliday did mention that the world is changing and that DuPont may need to look at asset swaps and other options in the future," notes Mr. Crooks.
Elf Aquitaine's sales totaled FF 254 billion ($42.1 billion) in 1997. Its 55-percent-owned Sanofi health division recorded sales of FF 25.7 billion ($4.3 billion), with FF 19.1 billion from pharmaceuticals. Sanofi develops and markets therapies in the areas of cardiovascular disease, internal medicine, oncology and central nervous system disorders. Elf Atochem's 1997 sales totaled FF 58 billion ($9.6 billion) with more than half derived from performance products, intermediates and fine chemicals.
"An asset swap involving Conoco has been an idea that's been dangled out there for years," says HSBC Securities analyst Paul Leming. "The rationale for the asset swap is that, under IRS rules, you can swap 'like assets' on a tax-free basis." However, he cautions that it could be difficult to conduct a tax-free swap involving energy, chemical and pharmaceutical assets.
Peter Young, president of the New York City-based investment bank Young & Partners, says that from the tax angle, "There would be relatively little savings on the actual swap itself because the definition of 'like assets' is very narrow, and even narrower for cross-border swaps."
He adds that the real benefit of a simultaneous sale of assets is "that you have some leeway on the value you can declare to the tax authorities." Companies involved in such a transaction can sell their businesses to each other at the lower range of fair market prices, resulting in reduced capital gains taxes.
After announcing its intention to divest Conoco last May, DuPont's stock jumped $5.44 to $79.50 and eventually hit a high of $84.44 as analysts hoped shedding the unit would lead to a price/earnings multiple closer to "Monsanto-like" life sciences multiples of around 45x forward earnings.
Since then, disappointing second quarter earnings stemming from the Asian economic crisis and warnings of a difficult third quarter have sparked a 35 percent decline in DuPont shares to around $55. "The DuPont life sciences story has been wildly over-hyped over the last two years," says HSBC's Mr. Leming.
He says DuPont is moving too slowly in reshaping its business portfolio and stresses the need for bold, decisive steps such as divesting the Conoco unit outright and spinning off its commodity fibers business.
"DuPont acquired 20 percent of Pioneer Hi-Bred and is planning on selling 20 percent of Conoco. Why not do all of something instead of half-quarter steps," he asks. "We believe this company needs to 'do a Monsanto' [spin off commodity businesses] now, divest all of Conoco and get on with growing its life sciences businesses." Mr. Leming notes that while DuPont has been studying what to do in life sciences, "Monsanto has acquired every major seed company in sight."
While JMS's Mr. Crooks believes DuPont's pace has been satisfactory, he says that underperforming fibers businesses such as Dacron and Nylon could be divested or spun off to enhance focus on life sciences and improve DuPont's multiple.
"I wouldn't mind seeing some low-end businesses being targeted for faster turnaround or divestiture," Mr. Crooks says. "I think a lot of people are disappointed that [the transformation] is not happening faster, but for DuPont, it's a large ship to turn and not easily done. That Conoco is even being divested is a major step in the right direction." The analyst expects more life sciences acquisitions to be announced in the next 12 months.
Another Wall Street analyst says DuPont "has more of an impetus--now that the stock has crashed--to possibly pick up the pace and get some events going near term." He notes that Monsanto also hit some bumps in the road on its transformation into a life sciences company. "When you go through this transition, it's very difficult--earnings may get hit and people get skeptical, but this is clearly the right strategy, and DuPont is on track."
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