Dow Halts A $500 Million Divestment Amid Valuation Concerns

by Trefis Team
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The Dow Chemical Company
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The Dow Chemical Company (NYSE:DOW) has decided not to sell its plastics additives business after failing to find a buyer willing to pay the desired price. Speaking at the Credit Suisse chemical & agricultural science conference earlier this week, CEO Andrew Liveris mentioned that the business was not being fully valued by buyers in the market currently, and so Dow would continue running it rather than pursuing a desperate sale.

The plastics additives business was a part of Dow’s divestiture plan, which the company announced in March, aiming proceeds of around $1.5 billion over a period of one and a half years. Also, during its second quarter earnings call in July, the company announced that it might divest in slow-growth, low margin businesses worth $6 billion in revenue over the next 12 months. Through these divestments, Dow aims to divert cash towards its more profitable segments that leverage its integrated value chain and innovative end products for higher margins. [1]

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Why Divestiture?

The plastics additives business manufactures additives that are used for processing and modification of thermoplastic and thermosetting plastic materials. These are primarily used in the building and construction, consumer goods, electronics, packaging and transportation industries. Due to higher commoditization, Dow earns just 12% adjusted EBITDA margins from the plastics additives and other non-core businesses that it plans to sell. This compares to more than 20% adjusted EBITDA margins that the company earns on its performance plastics business where Dow is investing heavily to leverage lower feedstock costs in the U.S. [2]

With the shale gas supply boost in the U.S. resulting in a cheap source of ethane, there has been a divergence in operating margins between naphtha and ethane based ethylene production plants in the U.S. Dow is therefore pursuing huge investments (more than $4 billion) in the U.S. Gulf Coast region to tap into this opportunity. The company expects to generate incremental EBITDA of $2.5 billion by ramping up its plastics operations in the U.S. Gulf Coast region. [3]

Dow is growing its ethylene capacity in the U.S. while improving feedstock flexibility of its existing ethylene production facilities to leverage the favorable feedstock scenario. The chemical giant currently has 70% of its ethylene production in cost-advantaged regions. Last year, Dow restarted its St. Charles Olefins 2 plant in Louisiana, in a bid to lower its operating costs by reducing the amount of ethylene purchased. The company plans to increase its ethylene production capacity by ~20% over the next three years. [3]

Valuation Concerns

Dow’s plastics additives business generated around $680 million in sales and $80 million in adjusted EBITDA during 2012. According to our estimates, the segment’s average cash indirect expense, which includes adjusted taxes, capital expenditures and changes in net working capital, as a percentage of its adjusted EBITDA has been around 40% over the past four years. Assuming a similar rate of cash indirect expenses and a 3% annual top-line growth going forward along with the weighted average cost of capital and terminal growth rates of 10.5% and 2% respectively, we believe that the business is fairly valued at around $550 million. However, going by the tepid response to this relatively stable stream of cash flow amid a weak global economy, we believe that it would not be easy for Dow to achieve its aggressive divestiture targets on-time, and that there might be more joint venture formations through partial stake sales rather than complete sale of units. [2] This could potentially slow down the company’s restructuring plans and even impact the rate of investments in its high-growth segments.

We currently have $37 price estimate for Dow, which is ~10% below its market price.

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Notes:
  1. The Dow Chemical’s CEO Presents at Credit Suisse Chemical & Ag Science Conference, seekingalpha.com []
  2. Dow 2012 Databook, dow.com [] []
  3. Dow’s Performance Plastics Advantage, dow.com [] []
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