Description

Dow Chemical and DuPont merged to become DowDuPont on August 31st, 2017, creating the world’s largest public chemicals company. Within the next year DowDuPont will be broken into three pieces through two spin-offs in the first half of 2019.

DowDuPont is cheap because it reflects a conglomerate discount given to three businesses with very different characteristic – an Agriculture company (similar to Monsanto), a Materials Science company (similar to Lyondell and other commodity plastics companies), and a Specialty company.

For a 150b market cap company there is plenty of opacity to the earnings power of each business: segments and subsegments have been reorganized and stuck in the three new businesses (the Specialty Co has over 30 distinct sub-segments to go through) and the final form (and capital structure) of the three businesses hasn’t been decided. Because of this I think investors are on the sidelines as they wait for Form 10s (filed this fall), investor days (also this fall), or the actual spins.

DowDuPont is ably led by Ed Breen of Tyco fame. Though I think some analysts are overzealous with the comparisons to Tyco, it is worth mentioning that after DowDuPont will be broken up into three companies, the Specialty Co will probably be further broken apart.

The Businesses

I’ll provide a brief overview of each business here and in the comments I’ll post my efforts at proforma historical financials for each. Because this write-up encompasses what will become three separate companies, one of which will probably undergo further separation, I don’t want to put a book report here when anyone interested can refer to the filings or dig deeper in comments.

(For basic financial data on each segment and its businesses refer to my SOTP table below)

Agriculture

The combination creates a global #2 in seeds and crop chemicals. Corn seeds are around 37% of revenue, which is similar to MON, followed by Herbicides at 23%, Soybeans at 11%, Insecticide at 11%, Fungicides at 9% and other seeds at 9%.

Crop prices and U.S. Net Farm Income aren’t supportive right now, but DWDP’s Ag business is a good business and it will be the only global scale pure play company of its kind, so I’m comfortable assigning it a multiple close to where peers were acquired.

Materials Science

Most of this segment is comprised of Dow businesses based around world scale ethylene crackers in the US as well as Europe and the Middle East, derivatives of the process, and downstream uses of ethylene/PE and related chemicals. U.S. based ethylene crackers are low on the cost curve and (semi?) permanently advantaged because they crack low cost NGLs from domestic shale production whereas competitors use naphtha, which closely tracks crude oil prices.

Performance Materials & Coatings:

Coatings & Performance Monomers - acrylics, adhesives, emulsions used in architectural and industrial coatings; Consumer Solutions - silicone and acrylic adhesion, dispersing agents, surface modifiers used in personal care, consumer goods, silicone elastomer industries.

Industrial Intermediates & Infrastructure (10-K description below):

Packaging & Specialty Plastics (10-K description below):

Specialty Co

Electronics & Imaging:

This segment encompasses a variety of technologies for circuit fabrication, finishing, photovoltaics, flexographic printing, and LED/OLED display materials.

Nutrition & Biosciences:

This business serves food and beverage, pharma, personal care, and animal nutrition markets. Products include ingredients to improve taste and texture of foods, probiotics, pharma excipients, and enzymes, biocides and antimicrobial solutions for industrial uses.

Transportation & Advanced Polymers (10-K description below):

Safety & Construction:

SOTP

The $3.3b synergy target laid out by the company is achievable and in line with past chemicals transactions. We should exit 2018 with a run rate at 75% of the total. It’s worth noting that when you look past companies that have come out of Dow or DuPont (Axalta, Chemours, Trinseo) it’s easy to believe that the businesses have plenty of fat to cut.

Other Ways to look at Valuation

Price Paid for Specialty Co:

Specialty Co has the best and most diverse set of businesses, whereas Ag and Materials are easier to understand (and with Materials, easier to hedge). If you take Ag at 11x instead of the 13x in my SOTP, Materials at the same $82b as my SOTP, and Corporate at -$7.9b you’re paying $55b for Specialty Co. That translates to <9x EBITDA and <13x NOPAT while peers trade 5 turns higher on EBITDA and more on NOPAT.

Price to Normal Earnings:

If you take 2018E EBITDA of $18.4b, add remaining synergies of $1.9b, give half credit to growth synergies (so $500mm), subtract D&A of $4.45b (excludes DuPont amortization), interest expense of $1.325b, taxes of $3b, you get earnings power of $5.20/share, or under 13x today’s price.

Risks

E-PE cycle has a steeper downturn than expected.

Synergies aren’t realized.

Catalyst

Form 10s filed this fall

Investor days this fall

Spins in the first half of 2019