The following commentary was originally sent to Action Alerts PLUS subscribers on Dec. 11, 2015, at 12:00 p.m. ET.
This morning, Dow Chemical (DOW) and DuPont (DD) announced they have agreed to merge in a $130 billion deal (among the 20 largest ever) that will create a chemical and agricultural titan. The combined entity -- which will be named DowDuPont -- is expected to close in the second half of 2016 and would be a merger of equals (vs. a traditional takeover). Once combined, DowDuPont plans to split into three separate companies: agricultural chemicals, material sciences and specialty products.
While shares of both stocks are trading lower (DOW is down roughly 3% and DD 5%), we see tremendous value, especially after listening to this morning's conference call. That said, we expect volatility between now and the deal close as investors express concern around antitrust risk.
Each of the three business will be a leader in its respective industry. The $19 billion agricultural company will offer among the most comprehensive and diverse portfolios in the industry, reaching a broad range of end markets. Management specifically pointed out that the seeds and crop protection businesses would offer the most powerful operating leverage and scale, as it combines DD's industry-leading seed business with DOW's innovative growth opportunities across soy and other crops.
The $50 billion material sciences business will combine technology offerings that can provide innovative solutions for customers involved in packing, construction, durable goods and a wide range of other end-market verticals. Dow's performance plastics, materials, chemicals and infrastructure solutions businesses will be coupled with DuPont's leading performance materials portfolio. The complementary nature of the two businesses appears compelling, with the merging of global networks leading to production cost efficiencies.
The third business -- specialty products -- will combine Dow's electronic materials business with DuPont's electronics and communications business, creating a $13 powerhouse in electronics and communications.
On a managerial level, current Dow CEO and Chairman Andrew Liveris will serve as executive chairman and oversee the specialty materials company, while current DuPont CEO Ed Breen will be CEO and oversee the other two companies.
Management sees tremendous opportunity for substantial growth synergies -- to the tune of $3 billion -- beyond the respective companies' existing cost reduction programs, with all cost synergies to be achieved within two years of the deal closing. They are confident in the three-way split as well, as it will empower each business with a clear line of focus as well as distinct investment and operational autonomy.
The deal will inevitably undergo intense antitrust scrutiny for all three companies, particularly the agricultural chemicals company. When asked about this risk on the call, management stated that they do not believe any major divestments will be required, and suggested minor divestments in non-core areas would be more likely if any regulatory concerns happen to arise.
A transaction of this magnitude has integration risk around synergies (putting two enormous companies into one combined entity and then breaking it up into three separate businesses). That said, management across both companies is top-tier. Assuming they can successfully integrate the businesses, we see substantial upside to both synergy targets and ultimate value creation.
If we were not restricted on trading DOW, we would be buyers of the stock under $53 (only if investors are willing to withstand inevitable volatility between now and next summer when the deal closes). Our long-term conviction is quite high, though tempered by our expectation for short-term volatility.