Last July I wrote a blog entry that discussed the possibility of margin and multiple expansion at Dow Chemical (DOW). The thesis of this recommendation centered around Dow Chemical’s acquisition of Rohm & Haas (ROH) and the company’s ability to pass on price increases and its ability to hold these price increases should the price of oil retreat. While I still hold shares in Dow Chemical, the investment story behind the company has clearly deteriorated. This has been caused in large part by the collapse of the company’s deal with Kuwait, further deterioration in the credit markets and by the U.S. economy’s significant turn for the worse. While I am thoroughly convinced that the company would have done quite well had economic growth only slowed and not collapsed and had the company been able to complete the sale of a select group of low performing units to the Kuwaitis, it is clear that the company is facing a completely different environment then it was six months ago.
Given how awful the earning reports from Eastman Chemical (EMN) and Nova Chemicals (NCX) have been, it is clear that Dow Chemical will likely not be able to fund the repayment of the debt taken on to complete the Rohm & Haas acquisition. Without the cash from the Kuwaiti sale, Dow Chemical simply cannot risk a purchase of Rohm & Haas in this economic environment. Should the acquisition of Rohm & Haas go through, the bridge loan that the company will be forced to take out will be crippling. It is clear that if Rohm & Haas had been trading freely, without Dow Chemical’s support, that it would be trading at a level well below its 52 week low of $44 dollars and no where near its current price per share. More likely then not, Rohm & Haas’ business has suffered a significant hit as its specialty chemicals, with their considerable ties to electronics, has likely been disproportionally impacted by a significant slowing of consumer spending.
Should the management of Dow Chemical still wish to complete the deal or if they are not able to escape the confines of their agreement with Rohm & Haas, it is evident that the purchase price must be significantly reduced. In addition, the terms of the deal must be changed so that a significant amount of the purchase is in the form of Dow Chemical stock instead of cash. The company’s dividend, while considered sacred by most because of the company’s ability to either raise or maintain it for the last 389 quarters will likely need to be cut in any event. However, if the Rohm & Haas acquisition is called off completely it will assuredly not need to be reduced to a mere pittance of its current value.
The deal between Rohm & Hass and Dow Chemical simply does not work in today’s world. The economic situation will likely prevent the combined company from paying back the bridge loan that would be needed to complete the purchase given the failure of the company’s deal with Kuwaitis. The management team of Dow Chemical and the company’s shareholders simply cannot want to be faced with the task of raising billions of dollars as the bridge loan approaches expiration, especially when the company’s core business is in a free fall. It is time for the company to hunker down, conduct small niche acquisitions, retool plants and pay down debt. A blockbuster acquisition cannot be supported given the current shape of the economy.
Upon the next quarterly report by Dow Chemical, we will likely see a company that has been battered by a slowing U.S. economy. The stock will undoubtedly come under significant pressure, when this happens it will be a clear buying opportunity as it will likely signify the abysmal shape of Rohm & Haas’ business and the subsequent calling off of the acquisition.
Disclosure: Long DOW
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