The $130 billion mega-merger announced late last week between Dow and DuPont is just the latest agreement in what has become an environment of increasing consolidation across all industrial and commercial markets. This deal is unique because once the merger takes effect then the companies plan to split into three separate publicly traded companies.
The rationale behind the three-way split is for tax efficiency purposes and will take nearly 24 months to complete just one phase of this complex transaction, which some on Wall Street believe will invite further regulatory scrutiny. In fact, regulators have been hitting the pause button on several merger deals in recent weeks. The most high profile being the Staples merger with Office Depot which is being blocked currently by the FTC (Federal Trade Commission) creating a saga where most recently the Staples-Office Depot legal team has filed a countersuit which is expected to be heard in federal court in March 2016.
Those who track and analyze M&A activity are bracing for another contentious scenario with the proposed merger between Dow and DuPont, two of the oldest and largest American companies in the chemical and agricultural products industries. The obvious prevailing theory being that if the FTC is giving Staples a huge amount of pushback over their proposed merger in the office supply industry, just imagine the type of scrutiny they could enact on the largest merger deal ever in the chemical space.
The Importance of EBITDA
The CEOs of both companies, Dow and DuPont respectively, were on all the financial cable network shows last week trying to get their corporate PR version of why the merger should move ahead in an attempt to set the narrative before the FTC and other regulators provide the public with their version.
In particular they were pressed by the financial media as to the rationale behind the merger followed by the split into three companies. The concerns are due to the regulatory process involved in that type of complicated transaction as well as the sheer amount of time required to complete the entire transition into three distinct and publicly traded companies.
Both CEOs explained that the most tax efficient method was to complete the transaction in this manner. In their view this protocol could actually reduce overall regulatory scrutiny and anti-trust concerns because the mega conglomeration would essentially be split into three parts.
The concerns from the side of the average stock holder, big investor, or the Wall Street firms analyzing this deal hinge on what this type of transaction will mean for earnings growth. This measurement of performance is always paramount, but takes on added significance if this deal gets cold water thrown on it by the FTC or other ant-trust regulatory bodies.
In order to address some of that potential reticence the two CEOs from both of these iconic American corporations discussed the importance of EBITDA to this overall transaction. I interpreted this emphasis to be driven by the strong value of the US Dollar which has stripped away the revenues for giant companies such as Dow and DuPont, so shifting the focus to EBITDA is being done to demonstrate the cash flow overall for the combined entity prior to the 3 way split.
In my own view, I would caution investors on that rationale because EBITDA can be manipulated in a variety of ways to present an unrepresentative picture of the financial health of any given business. I am in no way insinuating that this is the case with Dow-DuPont, no evidence of that exists at this point, but as a general rule of thumb I would tread lightly and not use that one measurement to determine the overall viability of a company.
Moreover, the bigger issue for this proposed Dow – DuPont entity is twofold:
- The flattening curve in the commodities pricing market
- The potential creation of a “duopoly” in the seed industry
The decreasing demand for agricultural products is also an issue here but the commodities markets that both companies have large stakes within have been beset by falling prices.
The creation of a “duopoly” has been mentioned in other media reports regarding this mega-merger. The eventual 3 way split into three companies would result in an agricultural products entity that would combine Dow and DuPont’s seed and crop protection product lines.
The major anti-trust “red flag” would result because in that scenario Dow-DuPont and Monsanto, just two companies would control a huge portion of that industry segment. They would be able to set pricing and enact inventory controls that could have enormous consequences to farming and access to commodity products and the food supply. That could be the cause of significant regulatory concern especially if the public is informed and expresses those concerns to their elected representatives in Washington.
Three Way Split
The three way split of the company, provided the merger is approved by the summer of 2016, should take place according to the reports anywhere from 18 to 24 months from that point. The three companies proposed in this merger announcement are:
- Agriculture Company – see above explanation
- Material Science – combines product lines from material sciences and performance plastics divisions and performance materials/chemicals
- Specialty Products Company – nutrition, health, industrial bioscience, safety, and communications product lines merged for this company to form
This merger is seen as necessary for the ultimate survival of both companies between the commodity market issues I raised earlier to the strengthening of the US Dollar, the unpredictability of agricultural product sales, and falling crop prices; Dow and DuPont were individually facing some difficult hurdles to their future growth.
DuPont was rumored to have been mulling a variety of staff reduction plans in order to slash costs due to the negative impact of market conditions on their business units. Meanwhile, Dow was said to be reviewing the repositioning of some of their product lines in the marketplace as well as exploring other options in the event that the proposal to merge with DuPont was met with resistance.
In my view, as one who has reported on mergers and acquisitions across many industry types and for a few large news organizations, this particular transaction will face some significant regulatory hurdles on the path to approval. The rationale behind that reality exists on a multitude of levels, from the obvious (the sheer size of the two conglomerates involved) to the subtle (the impact on the commodities markets for certain agricultural products).
The most pressing issue involved is the potential for a duopoly in the seed business with the potential merged Dow-DuPont and Monsanto. The consolidation of market share of any single industry into the hands of two corporations is usually, but in no way an absolute, death knell for M&A activity on this scale.
In recent history some exceptions to this rule have been made but the seed business is a different scenario and it will be viewed in that regard during the regulatory process. It may not necessarily scuttle the deal, but a revision to how that proposed merged business unit will operate will likely be the resolution. The sale of current Dow or DuPont brands or business units to other competitors is also a likely outcome in order to usher the merger through the regulatory approval process.
In addition, it is important to note that this merger, if approved, will not completely insulate the current staff head count. The financial news media has reported that job cuts from various divisions of both companies will come in order to position “the books” from an accounting perspective and enhance the profitability of this acquisition.
It is also my opinion that the merger into a one company followed by the 3 way split into multiple publicly traded entities could likely derail this merger from the way it was intended. The complexities involved in the transaction coupled with the longer period of regulatory review needed for this deal to process successfully are factors in forming my opinion in this regard. That is not to say that will not eventually happen (with this much money involved that seems unlikely) but the manner in which the companies are split may change, and the market conditions will dictate how that will all eventually come to fruition.
In the end analysis, this announcement of the proposed merger of Dow and DuPont, two enormous and iconic American corporations, is just the beginning of a lengthy process toward a potential merger. In the interim, we will read and see reports detailing tax efficiency, earnings, commodity pricing, market conditions and a myriad of other terms detailing the road either to consummation or perdition for this merger. It is a sad, stark reminder that even the big fish are not immune to the rough waters of a constantly changing global economy.