INSIGHT: Dow challenged to prove that integration matters

22 January 2014 17:08 Source:ICIS News

By Nigel Davis

LONDON (ICIS)--Will Dow Chemical chairman and CEO Andrew Liveris and shareholder activist Daniel Loeb meet this week at Davos in Switzerland?

Possibly. Both men are in town for the World Economic Forum – and they have a great deal to talk about

Loeb’s challenge to Dow management to spin off petrochemicals and complete the big push to specialities, started with the acquisition of Rohm and Haas in 2009, appears to be being taken seriously. Loeb has been in contact with Dow before although he and Liveris have reportedly not met.

Third Point said on Tuesday that it had taken a $1.3bn stake in the chemical company. Loeb said Dow had underperformed but could do better and suggested that the logic behind the chlor-alkali spin off, which Dow announced in December, needs to be extended to petrochemicals.

Dow’s share price climbed by more than 5% on the news.

So the debate about what creates long-term value in chemicals, and who benefits from that value, is joined, again.

Specialty chemicals are attractive because they are tied to end use markets more easily understood by investors such as agriculture, food and electronics.

Petrochemicals aren’t necessarily a mystery but they can produce some nasty shocks. Some US petrochemical stocks currently are doing very well. For various reasons, that may not always be the case.

Dow has been caught in a trap since its bid for Rohm and Haas was accepted and its agreement with Kuwait’s Petrochemical Industries Company (PIC) foundered at the peak of the financial crisis.

The company continues to run highly integrated businesses and has been tempted by the shale gas revolution in the US to play down its asset light strategy and to invest heavily in petrochemicals.

Undoubtedly, Dow will benefit if it makes its own low-cost intermediates in America. But the money being spent to capture a greater advantage in petrochemicals may leave the specialty businesses short. Loeb certainly thinks so.

“We suspect that Dow’s push downstream has led the company to use its upstream assets to subsidise certain downstream derivatives either by sacrificing operational efficiency or making poor capital allocation decisions, or both.” Third Point says.

“Our analysis suggests that Dow’s downstream migration strategy within petrochemicals has not yielded material benefits so far and instead may be a significant drag on profitability.”

Not surprisingly, the investment group criticises “Dow’s opaque and inconsistent transfer pricing methodology for internally sourced raw materials,” in other words its segment reporting within which Hydrocarbons and Energy represents the operations that procure cracker feedstocks and supply monomers to other parts of Dow.

A stand alone petrochemical company could focus on profits and not integration, Third Pont suggests, while the split would accelerate Dow’s shift to specialties.

The Dow petrochemical business could well reap the benefits of the planned Gulf Coast cracker, the propane dehydrogenation (PDH) unit and the significant investment in Sadara in Saudi Arabia, and produce earnings before interest, tax depreciation and amortisation (EBITDA) of €9bn, it adds, even before any upturn in the ethylene cycle.

Based on the recent share price, Dow’s full year EBITDA for 2013 would be about $8bn, it says.

No comment is made on the implications of the inevitable petrochemicals down cycle on a much smaller Dow petrochemicals business or its longer-term viability, however. Size matters in petrochemicals as numerous companies have demonstrated before and a shift in olefins economics in North America, driven by rising ethane costs or overcapacity could hit a standalone business hard.

Such sharp criticism of Dow’s current strategy, nevertheless, is likely to produce a reaction and one which stresses the benefits of integration.

Dow’s push towards specialities was slowed by the shale revolution but its specialties businesses can be enhanced by it. The company needs to convince investors that it remains on the right track and can better profit from the unique hydrocarbons and energy situation in the US, the nation’s manufacturing renaissance and its ability to serve growing markets worldwide.

Read Paul Hodges’ Chemicals and the Economy blog
Bookmark John Richardson and Malini Hariharan’s Asian Chemical Connections blog

By Nigel Davis