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Hedge fund Third Point pushes Dow for petrochemical spin-off
11:49 AM MST | January 24, 2014 | —Robert Westervelt
Hedge fund Third Point (New York), on 21 January, revealed a “significant” investment in Dow Chemical and promptly urged management to consider spinning off its petrochemical operations.
In a letter to investors, Third Point, run by investor Daniel Loeb, called on Dow to hire advisors to conduct an assessment of whether its petrochemical strategy maximizes profits and aligns with Dow’s goal of transforming into a specialty chemicals company. “The review should explicitly explore whether separating Dow’s petrochemical businesses via a spin-off would drive greater stakeholder value,” says Third Point. On 21 January, Dow shares jumped 6%, closing at $45.92, on the news.
Sources put the size of Third Point’s investment at $1.3 billion, a 2.3% stake based on Dow’s current market capitalization. Third Point has $14 billion in assets under management.
A Dow spokesperson says the company welcomes “all constructive input with a common goal of enhancing long-term value” for shareholders. “We believe our investments have yielded sustainable value for our shareholders and will continue to in the near and long term,” she says. “We constantly review our company at the management and board levels to increase our shareholder value and competitiveness. We intend to continue an open dialogue to further enhance value for all of our shareholders.” Third Point says in the letter that cost-cutting and operational improvements could generate several billion dollars in annual Ebitda for Dow on top of the estimated $8 billion generated in 2013. “We suspect that Dow’s push downstream has led the company to use upstream assets to subsidize certain downstream derivatives either by sacrificing operational efficiency or making poor capital allocation decisions, or both,” Third Point says.
Third Point notes that Dow has underperformed versus its peers over the past decade, generating a return of 46% including dividends compared to a 199% return for the S&P 500 Chemicals Index and a 101% return for the S&P 500. The results reflect a “poor operational track record across multiple business segments, a history of underdelivering relative to management’s guidance and expectations, and the ill-timed acquisition of Rohm and Haas,” Third Point says. “The company’s weak performance is even more surprising given that the North American shale gas revolution has been a powerful tailwind for Dow’s largest business exposure, petrochemicals.” Dow’s relative performance over the past five years, which include the impact of shale, has been stronger with a 212% gain since January 2009, versus a 115% gain for the S&P 500.
Third Point argues that a significant step-up in earnings from investments already started by Dow, including the Sadara joint venture with Saudi Aramco, as well as US propane dehydrogenation and US cracker plans, could translate into future Ebitda “well in excess of $9 billion on a stand-alone basis” for Dow’s petrochemical business. Dow’s specialty operations could ramp up Ebitda to $4–5 billion over the next three to five years compared with a 2013 base of $2.8 billion, Third Point says. “We believe the benefits from a spin-off, including financial uplift from operational improvements at Dow’s petrochemical operations and the potential valuation uplift from increased business focus and disclosure, far outweigh the supposed integration benefits,” Third Point says.
Dow’s portfolio moves
Dow has taken recent steps to focus its portfolio, noting recently that it has divested $10 billion in non-strategic businesses since 2009. In December, Dow announced plans to sell or spin off its global epoxy, global chlorinated organics, and US Gulf Coast chlor-alkali and chlor-vinyl assets. The businesses have annual revenue of roughly $5 billion. “Our portfolio optimization decisions are grounded in our market strategy, which is focused on stronger participation in select, key markets,” Dow CEO Andrew Liveris said when the divestments were announced in December 2013. Portfolio moves, including the R&H acquisition, have positioned the company well in “attractive markets, such as electronics, coatings, packaging, agriculture, consumables, infrastructure, and transportation,” Liveris said.
Charles Nievert, analyst with Cowen & Co. (New York), says Dow’s challenges extend well beyond the past 10 years and back to multiple portfolio shifts since the 1980s. “Dow has spent so long trying to transform itself that it has lost its way,” Nievert says. “The company keeps trying different directions but seems to be focused on the wrong targets.” Dow’s stock performance has lagged the S&P 500 since the 1980s despite multiple attempts to transform the company through portfolio realignment, Nievert says. There is a conflict trying to run commodity or commodity-like businesses alongside specialty and performance businesses, he says. “The strategies do not mesh well, the customer demands are divergent, and the capital needs are nearly opposite,” he adds.
Jeffrey Zekauskas, analyst with J.P.Morgan, argues that any benefit from a Dow split would be small relative to the benefit from the $2.5-billion improvement in petrochemical Ebitda that Third Point’s strategy proposal advises. “The potential value from cost reduction... could be $18 billion, or $15/share given a 7.5-times multiple for the petrochemical business,” Zekauskas says. The value creation in specialties is about $3 billion, or $2.50/share, assuming a one multiple point increase in the valuation of Dow’s specialties business.
“The effects of the cost reductions in petrochemicals would have a far larger effect on the creation of value at Dow than a change in multiple for the specialties,” Zekauskas says. “Whether the petrochemical businesses are separated does not much matter so long as the costs are removed as far as value creation. Should the costs not be removed, we think it does not matter whether there is a separate specialty entity because the value creation is too small.”