Activists? Lack of global growth? Diminishing new markets? Unfulfilled promises? Globalization? Egos? Bigger returns?
Today, you are going to hear many reasons why Action Alerts PLUS charity portfolio holding Dow Chemical (DOW) and DuPont (DD) have to get together to create one gigantic chemical company that can compete more effectively in a world of diminishing growth.
You can tick them down.
Dow, run for more than a decade by Andrew Liveris, has been dogged by the Third Point, activist Dan Loeb's firm, to the point where it has two members on the board as part of last year's threatened proxy fight.
DuPont had recently won a proxy battle against activist Nelson Peltz, but the CEO who managed that battle, Ellen Kullman, lost the war, as the company's stock went down sharply after defeating Peltz and she surrendered her job to Ed Breen, an established turnaround and break-up expert.
Dow has shed less profitable divisions and moved up the food chain of proprietary chemicals. DuPont has done the same.
Both have had to fire and reshape and fire and redo and fire and reconfigure every single quarter. But with the world's growth relentlessly slowing, each day was just another day to figure out who to let go and how to cut back while still trying to invest and renew.
Yet, no matter what they did, neither the deposed Kullman nor the fortified Liveris could do the one thing that managers really want: get credit for making their companies less commodity-oriented and more proprietary-based. They were, in the end, stuck with knocking heads, taking share, and staying one step ahead of the European and Chinese posses.
For Liveris, it's been nothing but frustrating. He has done amazing things to get his company to grow during a period when there is little to no growth at all. He has created so many new materials and brought his company's costs down to where they are among the lowest in the world. He has totally divorced the company from its old "sink or swim," cyclical mentality. He has done a remarkable job of buying back stock, boosting dividends -- albeit after a disastrous stretch during the Great Recession -- and shedding non-core assets, most recently the departure of the pure commodity chlorine business in a novel deal with Olin (OLN).
And what's it done?
Yesterday, before news of this deal was announced, the stock was below where it was a year ago, and this has been a remarkable year where Liveris has done everything right. In some ways that, and the fact that the stock is up 11% this year, are big victories. In the old days, Dow's stock used to go down with oil as the materials it made with that feedstock would be pressured down in price by customers demanding discounts.
Plus, the downturn in the emerging markets, the slowdown in China and the collapse of the agricultural markets, where Dow has a huge business, have made it just a hellacious affair to get to where the company can still have rising earnings.
DuPont has tried to embrace the same playbook, but with far more mixed results. It sold off its auto paints business to private equity firm Carlyle for $9 billion three years ago, at a time when DuPont thought the auto cycle might have peaked. Instead, it accelerated.
It spun off a commodity company, Chemours (CC), loaded it down with debt and a host of environmental problems, making it one of the nastiest and least attractive spinoffs I have ever come across. It was value destruction from the get go.
Plus, the big push into agricultural chemicals and seeds ran right into the agricultural downturn buzz saw, while other materials and science divisions, including its $5.8 billion acquisition of Danisco in 2011 to expand non-pharma biotech, could not pick up the slack.
And rather than embrace some very good ideas about how to grow faster with less fat that were suggested by large shareholder Nelson Peltz in a pretty fair-minded and intelligent way, CEO Kullman took the whole affair personally. Unlike Liveris who, after a lot of back and forth, welcomed two of Loeb's people to the board, Steve Miller, a very good turnaround expert and Ray Milchovich, Kullman led a scorched earth campaign against Peltz.
That would have been fine if she had been delivering numbers that exceeded street expectations, which was the case with Dow. But it was just plain lousy to have endless number cuts and disappointments while an activist with a pretty smart track record kept suggesting some very non-personal ways to make the company better.
In the end, because of the bizarre control of index funds over much of the market, Peltz lost his fight and didn't get his people on, but not before Kullman decided to appoint Ed Breen, who successfully broke up Tyco (TYC), to her board. After Kullman declared her pyrrhic victory, the board ushered her out and put in Breen first as a temporary CEO and then as the real deal -- in retrospect a Trojan horse board member if there ever was one.
All of these different tussles and breakups and rationalizing were meant to do one thing and one thing only, which was to create outperformance in the stock market, returning wealth to shareholders. I have already heard a ton of cynical comments about how these deals are all about outrageous ways to compensate CEOs and make insiders rich. Sure, if you are at these levels of corporate America, you make a lot of money. That's the rule of the game. While it can be a motivator, believe me, in each of these situations the desire to produce the best returns drove the processes.
And, in the end, that's what really drove this deal. I think Breen looked at his hand and recognized that no matter what he did with all of those great performance materials and enzyme factories and proprietary products that DuPont's famous for and agricultural innovations, it just didn't matter. He wasn't going to get rewarded for taking share from other companies, including Dow, in a low-growth world. Not only that, but his DuPont had both a shrinking price-to-earnings multiple and some businesses that I think would, once again, miss targets -- and I am not just talking about missing targets because of a strong dollar, the perennial story of DuPont. I am talking about missing them because many of its markets are getting worse, not better, especially agriculture.
Liveris has to be exasperated at this point. He has delivered quarter after quarter and year after year of consistent growth and been a serial returner of capital while driving costs down through joint ventures in Kuwait and new construction in Freeport, Texas that allow him to have the lowest cost feedstocks in the world. It hasn't mattered. When I saw the stock, which we own for my charitable trust, drop to $50 yesterday, I couldn't believe it. Just the other day it had looked to be challenging new highs. Now it looked like it was part of the industrial vortex downturn that's been going on since the cognoscenti has declared it all but certain that we'd get a rate hike.
Now, there is talk about what the new $120 billion company will look like and it is very reminiscent of the Allergan (AGN) -- Pfizer (PFE) tie-up, with the idea being that the merged company can become multiple companies. A completed Pfizer -- Allergan deal will have the benefit of a better tax regime but it will also be able to split, à la AbbVie (ABBV) -- Abbott (ABT), into a high-growth science company and a lower-growth cash cow. The new Dow -- DuPont can now become an agricultural powerhouse to butt heads with and take share from Syngenta (SYT) and Monsanto (MON), the plastics business can do battle with European giant BASF with a lower cost, more predictable feedstock, and the industrial highly-valued chemicals businesses can invent and reinvent and come up with innovations that drive value. You can take your pick.
The important thing to remember though, is that all of the other combinations yielded nothing special, no big returns, not outsized performances, in a world that is strictly "what have you done for me" lately. This deal and its aftermath will solve that. That's why, in the end, credit where credit should have been given by this market will finally get its due with this colossal merger and its subsequent instant value creation.