By: Frank Esposito
January 21, 2014
MIDLAND, MICH. (Updated) — Hedge fund Third Point LLC is calling for Dow Chemical Co. to consider spinning off its petrochemicals business — including its massive plastics operations.
New York-based Third Point — which owns an undisclosed stake in Midland-based Dow — was severely critical of Dow’s recent performance in a Jan. 21 letter to investors.
In the letter, Third Point officials said that Dow shares have generated a return of 46 percent in the past decade, compared to a return of 199 percent from the S&P 500 Chemicals Index and of 101 percent from the S&P 500.
“These results reflect a poor operational track record across multiple business segments, a history of under-delivering relative to management’s guidance and expectations and the ill-timed acquisition of Rohm & Haas,” Third Point officials said. “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.”
In a statement released later on Jan. 21, Dow officials didn’t comment directly on the Third Point letter, but said that they “believe our investments have yielded sustainable value for our shareholders and will continue to in the near and long term.
“We constantly review our company at the management and board level to increase our shareholder value and competitiveness,” Dow added. “We intend to continue an open dialogue to further enhance value for all our shareholders.”
Third Point’s comments had an immediate impact on Dow’s per-share stock price, which closed at $45.92 on Jan. 21 — a one-day jump of almost 7 percent on a day when the broader Dow Jones industrial average was down 0.3 percent.
The price then declined a bit, falling near $44.25 as part of a broader market selloff in late trading Jan. 23.
Dow’s profit in the first nine months of 2013 doubled to $3.8 billion vs. the year-ago period, even as the firm’s sales were flat at $42.7 billion. The firm employs 54,000 worldwide and ranks as one of the world’s largest plastics and chemicals makers.
In early December, Dow announced plans to spin off or sell most of its chlorine value chain businesses, including epoxy and units that make PVC feedstocks. Those businesses have annual sales of about $5 billion. In its letter, Third Point described the chlorine spin-off as having “intelligent logic.”
Third Point is led by activist investor Daniel Loeb. In its letter, the 19-year-old hedge fund said that Dow was its largest holding. Loeb and Third Point have been known over the firm’s history for writing extremely critical letters to the management of companies they invest in.
The Third Point letter describes a split of Dow into two separate firms. Dow Petchem Co. would include Dow’s current Performance Plastics, Performance Materials and Feedstocks & Energy units. Those units posted sales of $48.8 billion in 2012. All of Dow’s plastic-related businesses — including its massive polyethylene operations — are included in those first two units.
Through the first nine months of 2013, Performance Plastics and Performance Chemicals were Dow’s two largest business groups, based on both sales and pretax profit. Each saw slight nine-month sales decreases. Pretax profit rose almost 30 percent for Performance Plastics in that period, while Performance Materials saw a slight decline in that area.
The second Dow company would be Dow Specialty Co. and would include the firm’s Agricultural Sciences, Coatings & Infrastructure and Electronic & Functional Materials segments, according to the Third Point plan.
Dow’s plans to add ethylene and PE capacity in the U.S. Gulf Coast, as well as its plans to build a propane dehydrogenation plant to make propylene feedstock and its Sadara pertrochemicals joint venture in the Middle East — and overall product optimization — could make future pretax profits of $9 billion per year for a stand-alone petrochemicals company, Third point officials said.
“Despite Dow’s best efforts to migrate downstream and become a specialty chemicals company, the market remains unconvinced,” they said. “By creating Dow Petchem Co., the strategic direction of those businesses would no longer be dictated by the broader Dow strategy of becoming more specialty-focused.”
Aside from PE, other plastic-related products made by Dow include specialty elastomers, epoxy, polyurethane, plastic additives, EPDM and film. Dow’s film sales are estimated at $120 million, making it one of the 60 largest film and sheet makers in North America, according to a Plastics News ranking. The firm is also a major producer of ethlylene monomer, a feedstock used to make both PE and PVC resins.
Market analyst Phil Karig said he wasn’t surprised by Third Point’s actions toward Dow.
“Large Wall Street investors are always reviewing public company stock performance in search of upside opportunities,” Karig said in an e-mail. “And one of the first things they look at is whether a company with several business units might benefit from being divided into several standalone ‘pure play’ companies.”
The theory behind a pure-play company — in this case a standalone Dow petrochemical unit — is that, according to Karig, investors are more willing to pay a premium for a company with a narrow business focus that is simple to understand than they are for the same earnings stream within a larger diversified company.
He cited Monsanto as a pure-play company that’s enjoyed recent success. In Monsanto’s case, they did so by transitioning from plastics and chemicals to agriculture, said Karig, who’s managing director of the Mathelin Bay Associates LLC consulting firm in St. Louis.
In the case of Dow, Karig said that CEO Andrew Liveris “is already carving out” the chlorine business and in 2008 was willing to move forward with putting Dow’s plastics business into a joint venture with a Kuwaiti partner before that deal fell through. Liveris also is “one of the most visible proponents of nurturing U.S. shale gas for the benefit of U.S.-based resin producers — and Dow is putting its money where its mouth is by quickly moving along a large low cost ethylene cracker” on the Gulf Coast.
“The bottom line is: Do standalone business units tend to get more love and higher market valuations than diversified companies?” Karig asked. “The answer is normally yes, but it is important to remember that every diversified company is not the same.”
Karig and other sources compared Dow’s recent situation to DuPont Co.’s announcement in late October that it planned to spin off its Performance Chemicals unit — including Teflon-brand fluoropolymer and Ti-Pure brand titanium dioxide — into a separate public company.
One long-time market watcher said that Dow went astray when it paid $15 billion for Rohm & Haas in 2009. Rohm & Haas “was a one-product company — they had the acrylate molecule,” the contact said. “But Dow was so enamored with Rohm & Haas that they lost the fact that to be successful, you need to manage your portfolio with a variety of commodities, differentiated commodities and specialties.
“Dow is now busy trying to get rid of their commodities, but they have no specialties. They’ll end up like DuPont soon — a chemical company that has no chemicals in their portfolio.”
Another industry veteran said that splitting Dow as Third Point has suggested might not allow the firm to take advantage of its existing infrastructure in areas such as electricity generation.
“Both [Dow companies] can be competitive,” he said. “But doing so might not unlock value for shareholders.”