Dow Chemical Company (DOW)

Rohm and Haas (R&H) approached Dow Chemical and two other companies in early June to gauge their interest in acquiring R&H, a move that resulted in Dow’s July 10 acquisition agreement, says a recent R&H SEC filing. The surprise move late last year by the Haas family trusts, which control 32% of R&H shares, to seek the sale of its stake was the driver behind the R&H sale. Dow’s $18.8-billion, or $78/share, bid bested a $75/share offer from another chemical maker identified in the filing only as “company A.” BASF told CW last month that it placed a bid but declined to reveal the amount of its offer (CW, July 7/14, p. 7).Dow responded with an initial offer of $74/share on June 16, which prompted R&H to conduct a “targeted process” among Dow and the two other potential acquirers, the filings say. Company A responded with an offer of $70/share. R&H requested definitive acquisition proposals, which resulted in a $76/share bid from Dow, and a $75/share bid from company A. R&H once again contacted the two companies seeking higher bids.

Dow submitted a $78/share bid on July 9, and company A submitted a revised agreement that improved certain terms but did not increase its offer, R&H says. Dow and R&H signed a definitive agreement that included a voting agreement with the Haas trusts.

In the very near future shareholders will be sitting back enjoying the fruits of this deal....very near...

sells its products to a vast array of industries, so it is not crippled by slumps in individual industries

Dow is offically no longer a commodity chemical company after April 1. 70% of 2008 EBITDA will be from specialty products. This will cause immediate PE expansion from high single digits that commodity producers tend to have the mid to high teens the specialty ones enjoy to to their more consistent earnings. Dow will be cash flow positive in 2009 and have the term loan used to settle the transaction paid off withing the year.

Interestingly enough, only $4.3 billion of the loan reduction will come from asset sales. Remember Dow was looking at $9.5 billion from the Kuwait JV that Kuwait bailed on essentially at the signing. Let's also not forget that Dow is entering arbitration with Kuwait over damages in the case. Dow has said in the past they are owed the $2.5 billion breakup fee in the deal. There is also a scenario is which Kuwait decides to renter talks with Dow for some of the businesses they were originally suppose to buy. Neither of these scenario's are baked into current projections yet are very real possibilities.

But lets look around. Negativity is everywhere. Few would question the operational ability of the combined entity and the global powerhouse it now is. But, management at Dow does have a real credibility problem. For the price paid for this deal, to the failed Kuwait JV and the dividend cut, investors are left wondering "what's next?".

That is going to be a bit of a cloud over the company until they can report some positive news. We need some unexpected good news, not bad. Yes, I know that Rohm & Haas is a one of a kind company and that Dow's was not even the highest offer in the auction for it. Yes, I know Dow had no control over the Kuwait decision. Yes, I know that the dividend cut had to happen and were it not for the Kuwait decision, would not have happened. I know all this and all of it is true.

Knowing that does not change perception, it helps us rationalize the bad news. We need something to happen we do not expect that is good. I want to hear they win in arbitration and are awarded $1 billion plus. I want to hear the global de-stocking that happened in Q3 is over and orders and pricing are firming at a faster than expected pace. I want to hear that Kuwait has come back to the table or Sabic (Saudi Basic Industries) want the commodity business and the proceeds are far more than currently projected. I want to hear that because of any of these the dividend is going to be partially restored. We see the projection for debt reduction, come back to us in 6 months and tell us you are ahead of pace paying off the bridge loan.

Any of these will tell investors that the rationalizing the bad news was not insane but logical and that the events that happened could not be avoided. More bad news tells us that perhaps management is not taking into account various alternative scenarios when planning or if they are, not putting enough stock in them possibly happening and not preparing appropriately for them.

I see one of two books being written about Dow CEO Andrew Liveris down the road. One is about how the global slowdown forced a poorly planned merger on the company and eventually cost him his career. The other is a book about how he deftly managed the company through the worse economic conditions in over 80 years, completed the merger and created the world's preeminent specialty chemical company accomplishing the vison he had when he took it over. Either one could be written now. We are at the proverbial fork in the road.

Personally, I am rooting for the second one...

Natural gas is raw material input to Dow's products

attains its revenue from several regional economies

operates in a cyclical industry meaning its revenue is often predictable