The following commentary was originally sent to Action Alerts PLUS subscribers on Dec. 9, 2015, at 3:07 p.m. ET.
The Wall Street Journal reported yesterday that Dow Chemical (DOW) and DuPont (DD) are in advanced merger talks, and CNBC followed up on the report this morning, noting that a deal could be announced as soon as tomorrow morning. (Read Jim's comments on the deal.)
We note that Dow CEO Andrew Liveris had pursued a deal with DuPont (during the tenure of former DuPont CEO Ellen Kullman), but was never able to reach an agreement. Neither company has released any commentary as a follow-up to the article. As we have mentioned, Dow has been exploring options for its agriculture business (and it has been no secret that everybody has been talking to everybody within that space), but it hadn't made any comments on a major transaction such as the one suggested by these reports.
The reports say the merger would be quickly followed by a three-way breakup of the newly combined company to allow the different businesses to operate separately. Liveris is expected to be the chairman of the new company while DuPont CEO Edward Breen, an established turnaround and breakup expert, is expected to remain as CEO of the combined entity. No specific deal terms have been released, but it is reported to be a merger of equals, which essentially means no significant premium for shareholders of either company. That being said, the significant benefits would likely come from powerful synergies, both on the revenue and cost levels.
The reported deal -- which may or may not go through -- reflects the sectorwide consolidation theme within chemicals. The potential Dow-DuPont merger (and subsequent split) is a continuation of this trend, driven by portfolio rationalization, end-market diversification and powerful synergy opportunities within commodity-exposed business segments that have experienced a prolonged period of volatility. In particular, the potential for major cost efficiencies across the combined entity's agricultural businesses would help offset the onslaught of macro-level headwinds, including weakening pricing power, end-market demand and the resulting profitability squeeze.
To that point, the new entity would be able to compete with the largest players in the agricultural business -- especially important in the case of a Syngenta (SYT) and Monsanto (MON) merger -- would boast a strong plastics business with low costs, and would bring an innovative industrial chemicals business to the market. Combining the reach of these two companies would unlock meaningful value and accelerate productivity across the entire business economic model.
For these reasons, we are not surprised shares of both companies are trading sharply higher in today's sessions. That said, while we welcome the news, we do not want to get ahead of ourselves for several reasons: 1) Neither company has confirmed the report; 2) if the deal is confirmed, antitrust risk could provide an intermediary overhang; and 3) valuation is a concern (shares of DOW are up 30% since Sept. 14, with today's double-digit percentage move representing the stock's biggest intraday jump in over 40 years).
This is not to say we are not excited, but we would rather await further details and clarity before jumping to conclusions. We would be inclined to trim the position if shares cross $57.