FocusBreaking up Dow into specialties, petchems may unlock value

22 January 2014 22:31  [Source: ICIS news]

Breaking up Dow into specialties, petchems may unlock valueBy Joseph Chang

NEW YORK (ICIS)--Wall Street analysts are revising stock price valuations for Dow Chemical above current levels based on a sum-of-the-parts or break-up analysis.

Cowen & Co analyst Charles Neivert likened the situation at Dow to the fabled Gordion Knot, and said slicing that knot with assets sales would unlock great value.

John Roberts, analyst at UBS, raised his 12-month price target on Dow’s stock from $44 to $50, based on a sum-of-the-parts analysis. Shares of Dow closed at $45.68 on 22 January.

Roberts used a 12-month forward EV/EBITDA (enterprise value/earnings before interest, tax, depreciation and amortisation) multiple of 7.5 times for Dow’s basic chemicals businesses and a 10.0 times multiple for specialties.

“We… use a relatively high valuation for specialties, since Dow’s seed unit is just achieving sufficient scale for profitability and solar and electronic materials results are cyclically depressed,” said Roberts.

The analyst included equity income from Dow’s joint ventures in the analysis. While proportionate EBITDA from the joint ventures would be higher, lack of control accounts for using the discounted equity income numbers, he noted.

Wall Street’s valuation, or re-valuation exercises, are being spurred by high profile activist investor Dan Loeb announcing a $1.3bn (about 2.5%) stake in Dow through his Third Point hedge fund on 21 January.

Loeb is calling for an overall strategic review, and in particular of the spin-off of Dow’s petrochemical business, to “accelerate Dow’s transition to a true specialty chemicals company focused on attractive end markets such as agriculture, food, pharmaceuticals and electronics”.

Cowen & Co’s Neivert is going the other way, presenting a break-up strategy calling for the “new” Dow to focus on commodity chemicals.

“Our breakup suggestion includes divesting the Agricultural Sciences, Electronics and Functional Materials, Coatings and Infrastructure and parts of the Performance Materials segment,” said Neivert.

“We see a conflict trying to run commodity or commodity-like businesses along side of specialty/performance businesses. The strategies do not mesh well, the customer demands are divergent and the capital needs are nearly opposite. In addition, we do not see a core competency for Dow in the performance business,” he added.

Neivert estimates Dow’s break-up value to be $64/share – around 40% above current levels.

“We believe other companies will be able to capture value where Dow cannot and it is also our opinion that Dow can capture some of the upside value in the sale of its businesses,” said the analyst.

The sale of the above mentioned businesses, along with some joint venture assets such as its 50% stake in Dow Corning, could bring in $40bn-48bn in gross proceeds, and about $35bn in net proceeds. Dow could pay off all debt, buy back $250m-325m of its shares and still have net cash on its balance sheet, noted Neivert.

“The ‘new’ Dow would become a highly focused chemical company with global assets, exceptional integration and low-cost raw materials. We would not sell the chlor-alkali businesses, except perhaps Epoxy and Chlorinated Organics,” he added.

Neivert compares the situation at Dow to the fabled Gordian Knot.

“The Gordian Knot represents an intractable problem that has resisted any and all attempts to solve it. The solution comes not via a nuanced, finessed approach but a brute force assault,” said the analyst.

In a popular account, in the 4th century BC, Alexander the Great attempted to untie a knotted rope that tied an ox cart to a pole in the city of Gordium that held great symbolic importance in the city’s history. After failing to find the ends of the knot to untie it, Alexander simply cut it with his sword.

“Dow Chemical shares seem to present just such a conundrum. They have resolutely resisted all attempts to bring value to shareholders. As such, the solution we see is not trying to meticulously untie this knot, but to simply hack it apart,” Neivert said.

“Simply working through a sum-of-the-parts [analysis] based on current or normalised earnings may not be a reasonable assessment of Dow’s value,” said the analyst.

Instead, the analysis should take into account the potential value of various businesses to new owners, especially since “in many product lines, in part as a result of misallocated capital and resources, Dow assets significantly under-earn their potential in large part simply as a result of being part of Dow”, argued Neivert.

Thus, certain segments could earn higher profits and be of greater value to another company, he suggested.

The analyst estimated potential EBITDA from synergies or corporate upside for each segment suggested for sale, and then applied the following multiples: 15.5 times for ag science, 9.0 times for coatings and infrastructure, 7.0 times for performance materials, 10.0 times for electronics and functional materials, and 12.8 times for Dow’s 50% share of Dow Corning’s equity income.

After net proceeds of around $35bn, followed by debt paydown and share buybacks, Neivert arrives at a potential value of $64/share for Dow.

By: Joseph Chang
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