DowDuPont nears merger completion amid tailwinds

The DowDuPont merger and subsequent spin-offs are all about value creation – value for shareholders and value for customers. And, not unsurprisingly, the clamour for more is growing louder, as the short-term gains expected from the series of transactions possible following the merger are scrutinised. The fiduciary duty of Dow Chemical and DuPont board members is to establish the new companies to continue to deliver value from the products they make with the support of adequate investment in people, products and production facilities. Their job will not be made any easier as arguments and counter arguments swirl in the post-merger aftermath – the merger is expected to close on 31 August.

On the plus side, DowDuPont will hit the ground running. Chemical companies are performing strongly in competitive but tight markets. Volume growth, particularly for the sort of sophisticated materials that both companies make, is underpinned by expanding world economies.

FAVOURABLE ENVIRONMENT

Both Dow and DuPont and Dow produced strong, consensus-beating second quarter financial results. In a favourable chemicals and materials market environment, they would be expected to be performing close to the top of their game. A good level of operating performance might be expected for the remainder of the year as long as there is no collapse in the oil price or in customer confidence.

It has been possible to use the time between the merger announcement and now well. Dow has been investing heavily in new, advantaged, shale-based US Gulf Coast production. The big Sadara joint venture in Al Jubail, Saudi Arabia, has largely come on-stream.

That project, particularly, first envisaged a long time ago, illustrates the sort of chemicals investment timescales that can never sit well with investors.

While they tend to have short or relatively short investment horizons, chemical industry investment decisions made now will generate cash for their owners for decades to come.

The same can be said of the sort of integrated product lines that will underpin the new Dow Chemical as it emerges from DowDupont and, indeed the smaller specialty chemicals companies.

The portfolios will require investment in research and development (R&D), marketing, sales and information technology, including the new aspects of digital technologies that will be required to drive value creation and growth.

SILICONES WITH MATERIALS SCIENCE

Some of the more aggressive investment funds have set their sights on Dow Corning and the silicones businesses just integrated into Dow Chemical. Here is new, fertile ground for public debate and investor pressure.

Dow Chemical stressed on its second-quarter earnings conference call that Dow Corning fits hand-in-glove with its materials science business, laying out an extensive case. The silicones and siloxanes it makes have opened up new market opportunities in Dow’s electronic solutions and consumer materials segments.

The Dow mindset has helped boost Dow Corning’s bottom-line growth, according to Dow executives. Dow talks now about its key building block chemicals being ethylene, propylene and silicone.

“The power of our key building blocks of ethylene, propylene and silicone is amplified by our market-back approach and by leveraging the complexity of molecular and physical integration,” said president and chief operating officer (COO), Jim Fitterling, on the conference call. Dow has big plans to expand its silicones business, including through its Sadara joint venture with Saudi Aramco.

“There is no question silicones will be in the future of our Sadara Saudi relationship. We are very, very confident that we will continue to grow what is an incredible franchise with the Saudis,” said Dow chairman and CEO Andrew Liveris on the conference call.

Dow views the silicones business, now brought fully under its control from the Dow Corning joint venture, as integral to the Materials Science company it plans to spin off following Dow’s merger with DuPont. Silicones would sit with its other Materials Science chemistry platforms of acrylates, urethanes, polyolefins and cellulosics, helping create new solutions in the key end markets of infrastructure, consumer, transportation and packaging.

“Silicones is my poster child… This is such a fit into the Materials Science company,” said Liveris.

Dow also raised its annual cost synergy target in integrating the Dow Corning business to over $650m from its previous target of $400m. It expects to achieve this target by the end of 2018 and is already at a run rate of more than $500m, said Dow chief financial officer Howard Ungerleider.

And Dow also sees greater earnings potential from growth initiatives related to silicones.

“In addition to our $100m growth synergy target, we now see $500m of additional Dow-enabled bottom-line growth across the enterprise, driven by volume and mix benefits from integrating silicones into the Dow portfolio and going narrower and deeper into our four market verticals,” said Ungerleider.

“We now see EBITDA (earnings before interest, tax, depreciation and amortisation) increasing to $2bn at full run rate at the end of 2019 – more than double our initial projection,” he added.

“It is at its core an organic chemistry capability… Manufacturing is a multi-step, asset intensive process” which is back integrated to its building blocks, he noted.

The timescale of the post-merger spin-offs are not known yet and there has been criticism of the decision to involve consultants McKinsey in the portfolio analysis that will underpin the final decision-making process.

PORTFOLIO REVIEW

DuPont has said that the boards of both companies support a comprehensive portfolio review. “Dow and DuPont leadership are committed to maximising the tremendous value-creation potential of the merger and anticipated spins,” it said in a statement. “If the results of our review demonstrate there is net greater long-term value creation to be realised through a change in the portfolio, it will be pursued.”

And, of course, once created, it will take time for the new companies to become established and to fully understand and realise their full potential.

DuPont gave 2017 market commentary for each of its segments in its Q2 earnings call but said it would be inappropriate to give guidance for DuPont itself, on a stand-alone basis, for the remainder of 2017. The adjustments to segment results once DowDuPont is created will cloud the picture.

Dow Chemical CEO, Andrew Liveris, said Dow remains well positioned to capture consumer-led demand. “Our track record of disciplined execution and outperformance these last several years underscores the resilience, agility and value creation power of our business model,” he said.

“Looking forward, our team remains focused and disciplined, with a sharp execution mindset on the successful close of our merger with DuPont, rapid achievement of the synergies and realising the value-creation of the intended companies, as well as a strong focus on delivering the materials science company, with a portfolio that will be unrivalled versus its peer group.”