Dow's Rohm & Haas Acquisition: Simple Math

Co-written by Patrick Kirts

Facing fierce domestic opposition, the Kuwaiti government this weekend scuttled a deal, first unveiled a year ago, between state-owned Petrochemical Industries and Dow Chemical (DOW) to create K-Dow Petrochemicals. Wall Street reacted on Monday by sending not only DOW down 20%, but expressed a great deal of pessimism about another DOW deal. In July, it announced that it would purchase specialty chemicals producer Rohm & Haas (ROH) for $78 per share. This acquisition is essential to DOW’s long-term strategy as it incorporates a new and diverse product pipeline. ROH itself tumbled more than 16%, sending a clear message to investors: Kuwait has killed the Dow-Rohm merger. A closer look, however, suggests a very different account.

Let’s examine the key facts of the Rohm & Haas acquisition. It has two financing sources. The first is $4B of new convertible preferred stock, $3B of which is being committed by Warren Buffett’s Berkshire Hathaway (BRK.A) and $1B by the Kuwait Investment Authority, a sovereign wealth fund which, although unconnected to the K-Dow deal, may be a cause for concern. The second source of funding is a fully committed $13B bridge loan syndicated by nineteen banks, led by Citigroup (C), Merrill Lynch (MER) and Morgan Stanley (MS). In its October 23 conference call Executive VP and CFO Geoffrey Merszei said that it planned to draw only $4-6B from this facility.

DOW was set to make $7.5B from the Kuwaiti deal, and the loss of these funds seems to be what has given Wall Street the spooks about ROH. Suppose the $6B from the credit facility would be used along with all of the $7.5B. That adds up to only $13.5B, only half of a billion more than the amount of committed and syndicated credit already in place. Even if all of this money were needed for the purchase, it is hard to imagine both companies, Berkshire, and the banks would allow the deal to unravel for such a small amount, even if the Kuwaiti billion disappears.

Discussing the ROH acquisition during the October 23 conference call, Merszei said,

I believe Warren Buffett chose to invest in Dow, because 1) we have a good brand, 2) an excellent management team, and 3) a sound strategy and business position in our industry. And I also believe his involvement in this transaction is a sound endorsement of our transformational strategy and, most importantly, the long-term value it will create.

While that was said in October, we still agree, and we view this sudden drop in Rohm & Haas’ valuation as an opportunity to speculate on pessimism. We understand the deal could be renegotiated or canceled. However, all available information today points to nothing but more debt drawn from the bridge loan facilities.

Disclosure: Portfolio, LLC is long ROH and DOW at the time of this writing.

Comments

[Jonathan Liss:]

Shares of ROH are up nearly 11% today - nice call and timely analysis! Thanks

2008 Dec 30 02:20 PM

[jimSH:]

If Dow can not renegociate a lower price with ROH, it will simply get the compensation from KPI and pay part of it to ROH as the breakup fee and walk away. Dow is cutting its work force for cost saving using ROH merging as an excuse already anyway. Besides, paying ROH at $78/share in this economy makes no sense at all.

2008 Dec 30 05:40 PM

[mkreisel:]

If ROH deal falls apart, does that mean BRK's 3 billion convertible deal is also gone?

2008 Dec 31 06:45 PM

[Brandon Ban...:]

It seems to me that the CEO of Dow is to blame for this. Lets look at it like this... He knew he needed the money from the Kuwait deal to make the buy of ROH, he cornered himself in a position that he can now not get out of. Instead of entering into this "drug deal" where he is relying on the money from the Kuwaiti deal to close the ROH deal, he should have waited to make sure that the deal was sealed with the Kuwait company before moving on the ROH deal! Instead he offered up almost double the stock price for the ROH deal before a legal committment was made by the Kuwaities.
So who is going to get the bath of the year? The entire Dow company,from the employees right throught the investors. It seems that the only option is to make cuts in personnel and somehow increase sales with a rise in production.
If this is the case maybe we should start at the top! This is a terrible deal and may utlimatley cost the workers. Shame on You!!

Jan 06 01:14 PM

[Lee Eugene ...:]

The BRK 3 billion was financing for the ROH deal in particular, not just general financing for DOW.


On Dec 31 06:45 PM mkreisel wrote:

> If ROH deal falls apart, does that mean BRK's 3 billion convertible
> deal is also gone?

Jan 16 05:40 PM

[Lee Eugene ...:]

Just an update: $78 per share today. The lesson is not to have the news, your emotions, or crappy CEO's shake you of a position.

Mar 17 05:52 PM