Dow Plus Rohm & Haas: Not Pretty, But it Would Work

Dow Chemicals (DOW) is off 20% or more on news of the cancellation of the K-Dow deal with Kuwait. The pending deal to acquire Rohm & Haas (ROH) at a premium price of 78 per share looks difficult without the substantial amount of cash that was expected from K-Dow. I am long DOW, and the following represents my efforts to re-evaluate the position and make a decision to either take a loss or continue to hold for price appreciation:

I compiled these figures from Reuters Pro-Vestor reports and Dow presentations and took a guess that financing costs would get to 8.5% somewhere in the course of paying things off. The Debt/EBITDA and EBITDA/Interest ratios aren't anything to rave about, particularly when looking into the depths of a worldwide recession.

However, after considering the synergies available from Rohm & Haas, the annual savings from Dow's restructuring, and the extra cash Dow intends to squeeze out of operating capital, I believe Dow can do the deal under its present terms and come through as a profitable, adequately capitalized, and strategically well-positioned organization.

The two years after the deal would not be pretty – I would look for a 20% reduction in EBITDA due to economic conditions to be offset by the annual savings on synergies and restructuring, with the 2 billion from operating capital reduction providing a cushion. Assuming a recovery after two years, combined EBITDA goes to about 9 billion and good things follow.

When the smoke clears, DOW could be earning 4 per year, with EPS increasing steadily as debt and interest are reduced. At a P/E of 12 that would be 48 per share, a very tidy profit from today's price in the 15 area. If the Rohm & Haas deal falls through, Dow can pay the penalty and go on from there. Based on this thinking, I will plan to hold my position.

Disclosure: Author holds a long position in DOW

Comments

[victoryjc:]

Your debt/EBITDA of 4.03 might likely go higher
than 4.25 in 2009 which would be a default under
the $13 billion loan agreement. See 8-K filed 9-9-08.
If Buffett is used to cure the default, the aid will be
more costly than it was for GE.

Jan 01 05:28 PM

[Tom Armistead:]

In confirming that the Rohm and Haas deal would not be consummated in a timely manner, Dow characterized is as "untenable." Liveris in an interview said Rohm and Haas would be OK standalone but in combination with Dow it would be an "economic disaster." So, the deal is not doable under its initial terms.

After listening to Liveris a few more times and looking at how margins have been developing over the past two years, I no longer believe DOW is well managed. Basically I think Liveris has been too busy on big deals and believe he would have done better to stick to his knitting and reduce capacity incrementally rather than doing draconian surgery at this late date while wasting time and money on litigation over busted deals.

I closed my position.

Jan 27 11:22 AM