FocusWall Street mixed on Dow petchems spin-off

21 January 2014 22:40  [Source: ICIS news]

Activist shareholder buys $1.3bn Dow stake, urges petchem spin offBy Joseph Chang

NEW YORK (ICIS)--Wall Street analysts on Tuesday were mixed about whether US-based Dow Chemical could create additional shareholder value by spinning off its petrochemical business as suggested by high-profile activist investor Dan Loeb and his hedge fund, Third Point.

“Favourable valuations of basic chemicals and specialty peers could make the timing right,” said John Roberts, analyst at investment bank UBS.

LyondellBasell and Westlake Chemical – more commodity-oriented companies – are respectively trading at EV/EBITDA (enterprise value/earnings before interest, tax, depreciation and amortisation) multiples of 6.9 times and 7.7 times next 12-month estimates. These valuations are close to 7.8 times for Dow, which is far more diversified, he noted.

Without the petrochemical business, “Dow would look more like DuPont, which trades at 9.2 times,” said Roberts.

Loeb announced on Tuesday that Third Point has taken a $1.3bn stake in Dow and is calling for a strategic review to determine if a spin-off of its petrochemical business would create value.

Third Point did not disclose how many shares it owns, but a $1.3bn equity stake would represent about 2.5% of Dow’s outstanding shares based on its previous closing price of $43.07 on 17 January. Shares of Dow surged $2.86, or 6.6%, to close at $45.93 on Tuesday.

“The review should explicitly explore whether separating Dow’s petrochemical businesses via a spin-off would drive greater stakeholder value,” said Loeb on Tuesday in Third Point’s quarterly investor letter.

UBS’s Roberts estimates that Dow’s commodity chemical businesses, excluding joint ventures, will generate $39.0bn in sales and $5.3bn in EBITDA in 2014, while the specialty chemical units would have sales of $20bn and EBITDA of $3.3bn.

Hassan Ahmed, analyst at Alembic Global Advisor, points out that Dow’s shares appear undervalued in both scenarios – one where no portfolio changes occur and one where businesses are separated – as investors are not taking into account the earnings potential from major new projects and the upswing in the ethylene cycle.

The start-ups of Dow’s Sadara joint venture project in Saudi Arabia and its new cracker and propane dehydrogenation (PDH) unit in Texas, along with the commodity upcycle, could add $4.05bn to Dow’s base case annual EBITDA, said Ahmed.

‘What’s old is new again’
Wells Fargo analyst Frank Mitsch points out that the proposed spin-off is reminiscent of what two Dow senior executives were planning in 2007.

“What’s old is new again. Back in 2007, two senior Dow executives were allegedly involved with investment bankers looking at ways to split Dow into two components – a commodity and a specialty portion,” noted Mitsch.

In 2007, Dow senior executives Pedro Reinhard and Romeo Kreinberg allegedly met with bankers to plot a major transaction involving Dow, Oman’s sovereign wealth fund and private equity firms, unbeknownst to Dow CEO Andrew Liveris or the rest of the board of directors.

Reinhard and Kreinberg were fired from Dow once the plan was revealed that same year and later settled lawsuits on their termination.

“In reading Third Point’s letter, this avenue [a split] is strongly encouraged as a way to unlock shareholder value,” Mitsch added.

However, Dow has highlighted vertical integration as a key part of its strategy in the past, the analyst noted.

“Furthermore, applying a 9 times multiple on expected 2014 specialty EBITDA and a 7 times multiple on expected 2014 commodity EBITDA, derives a $45 current combined share price – essentially in line with the current share price,” said Mitsch.

The analyst noted that after activist investors took stakes in DuPont and Air Products earlier in 2013, there has been increased speculation on similar interest in Dow.

“Dow’s Q3 conference call in October was rife with references to ‘shareholder remuneration’, suggesting that Third Point’s motives perhaps may have been known to management for some time,” said Mitsch.

Upstream/downstream strategy
Loeb criticised Dow’s strategy of moving downstream to specialties while making large capital investments in upstream commodities assets.

“We suspect that Dow’s push downstream has led the company to use its upstream assets to subsidize certain downstream derivatives either by sacrificing operational efficiency or making poor capital allocation decisions, or both,” said Loeb in his letter.

That echoes concerns raised by analyst Paul Christopherson of investment firm Gilford Securities, who on 9 January downgraded Dow’s stock from “neutral” to “sell” with a 12-month price target of $36 – about $10 below the current stock price.

“There has been no transformation. Dow’s upstream concentration is further reflected in the company’s capital plans. These include chiefly Sadara …, described as supporting downstream growth but amounting to a big upstream investment; and a big new [ethane cracker] project at Freeport, Texas, for 2017,” said Christopherson.

“Capital spending elsewhere in the company has been cut back to reflect the fact that the company is not growing, but not on these projects. Our attitude is unsophisticated, certainly, but it is that investment in ethylene is investment in ethylene,” he added.

While the analyst acknowledged the commodity projects are meant to support investments downstream, “the overall asset composition is shifting upstream”.

“Obviously, there is nothing inherently wrong with being a commodities player. Our point would be only that, that is what Dow remains, that is how investors will continue to see it, and 13-14 times 2014 earnings might be about right for such a situation,” said Christopherson.

By: Joseph Chang
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