On Dec. 11, Dow Chemical (DOW, Financial) and DuPont (DD, Financial) announced both its boards had approved an all-stock merger of equals that will create a combined company called DowDuPont, which will have a market cap of $130 billion as of the announcement.
GuruFocus provides several checklists on each stock page that allows users to analyze companies and save their checklists on the website. Along with a customized checklist feature, one of the predefined lists is John Paulson (Trades, Portfolio)’s Merger Arbitrage Checklist. Paulson’s investment firm specializes in event-driven situations, including mergers and acquisitions.
Do the merger parties have definitive agreements instead of agreements in principle?
Dow and DuPont state that they have definitive agreements in their joint press release of the deal.
Does the merger have strategic rationale behind it?
After the two companies merge, DowDuPont plan to split into three publicly-traded and independent companies in agriculture, material science and specialty products. This is expected to happen 18 to 24 months after the initial merger.
The companies expect the deal will deliver long-term shareholder value through the creation of three “strong, focused, industry-leading businesses,” said DuPont CEO Edward Breen.
There are numerous advantages and disadvantages to splitting a company, as has been written and explored by countless finance blogs and websites. One powerful advantage to the company’s plan to split into three businesses is that each unit’s management will be able to focus solely on its own operations. In addition, investors are likely to have more thorough information, as each company will have a separate financial disclosure.
Though the merger and subsequent split will certainly be a long-term plan in creating shareholder value, it is necessary for companies as large as Dow and DuPont. The combined entity would be too large to operate efficiently and maximize value.
The deal has no financing condition
Since the deal is a merger of equals, Dow and DuPont have no financing condition due to the fact that neither is the acquirer or target. Shareholders of both companies will surrender their shares and receive new shares of the combined company. Dow shareholders will receive one share of DowDuPont per Dow share, while DuPont shareholders will receive 1.282 shares of the combined company per DuPont share. As such, the merger is rated as “Best” on the checklist for this criterion.
The deal has no due diligence condition
Because Dow and DuPont have a definitive agreement for a merger of equals, it is assumed both companies have completed their due diligence procedures.
The deal has a solidly performing target
Neither company is the target in this merger; therefore, it is rated as “Neutral” on the checklist. But investors can and should evaluate both companies in the deal.
Dow’s stock is up 15% year to date, trading at 13.5x earnings. Due to its size, Dow’s revenue per share growth has only been 1.3% per year over the past five years. EPS growth was 48.7% per year over the same time frame. In the third quarter, Dow earned $1.09 per share, up from 71 cents in the year-ago quarter.
DuPont’s business predictability is rated 3 out of 5 stars by GuruFocus based on revenue and earnings growth. Revenue per share has grown by 4.7% over the past five years, while EPS grew by 9.1%.
DuPont’s operating margin has also been increasing since 2012, reporting at 13% for the trailing 12 months. This is double the industry average of 6.7%.
The deal has a reasonable valuation
This criterion is rated as “Neutral” on the checklist due to the fact that there is no purchase price.
There is limited regulatory risk
The size of DowDuPont today would be $130 billion, which may initially give pause as to whether it will attract close scrutiny from regulators. Dow and DuPont do not generally compete with each other, however. While both produce various agricultural products, Dow also produces chemicals and performance plastics, and DuPont develops materials like synthetic rubber, nylon and Teflon. What regulators will be looking at instead, as NPR reports, is how large and influential the resulting three companies will be after the split.
The agriculture business is likely to draw the most questions, since the two companies each produce products in the industry. As there is already much consolidation in agriculture, regulators will look at whether choices and prices will be affected. On the checklist, this criterion is rated as one notch above “Neutral.”
Imputing these scores into the John Paulson (Trades, Portfolio) Merger Arbitrage Checklist gives a rating of 4.3 out of 5 for the deal.
