Sell DuPont on Boost from Possible Dow Deal

DuPont's (DD) recent elevation of Ed Breen to the CEO spot quickly is paying dividends to the beleaguered DD shareholders. The stock price essentially had imploded (down 35%) after reaching new multiyear highs in the spring. The news just kept getting worse after DuPont's victory over Trian Partners in a proxy fight for directors; that spat was followed by a sneaky dividend cut during the summer related to the Chemours spin-off, and then by worsening fundamentals in the fall. The sky (and stock price) just kept falling. Thankfully, the board woke up and replaced the old CEO with the highly regarded Breen, already on their board. While the stock has been moving higher on investors' confidence in Breen and his focus on shareholder value, it got an additional bump this week with the news leak that Dow Chemical (DOW) and DuPont were close to inking a mega-merger that could happen imminently. The hiring of Breen and the likely benefits of a deal with Dow have caused the stock to move to the $74-plus level from last summer's low of $47.11. Based on the rumors, it looks like the deal will allow DOW and DD to combine in a tax-free merger, after which the company would be split into three separate companies -- Agriculture, Specialty Chemicals and Commodity Chemicals. The deal should generate up to $3 billion in cost synergies as Dow and DuPont combine their respective operations and gain more scale. Also, by committing to split the businesses up, the deal is more likely to navigate the Federal Trade Commission's anti-competitive trade restrictions. Some asset sales might be required, but the plan to merge and then split up has a much better chance of being approved than if the Dow and DuPont kept all their business segments together as one mega-global chemicals and life sciences company. The deal is a win for both DD and DOW as they would get to build upon their global scale while at the same time reducing their cost structures to enhance shareholder value. We like the deal, and it makes immense sense to shareholders. In particular, the Agricultural and Specialty Chemical businesses were facing building negative business headwinds. These trends were only going to increase in 2016 as the U.S. dollar further strengthens, China weakens and agricultural fundamentals continued on a downward trajectory. Investors rightly bid up both stocks more than 10% on the rumors of the deal. DD's purported merger with DOW reflects how a fresh look from a smart, creative leadership team dramatically can alter a company's fortunes. As an aside, it also points out the harm that an underperforming CEO can do, as this opportunity also was available to Ellen Kullman during her tenure as DuPont's previous CEO. Again, we like the rumored deal as we think it will go a long way to enhance shareholder value. We think Breen is a masterful cost-cutter and great manager, with a strong emphasis on doing what's best for shareholders. That said, we think there are a number of headwinds and uncertainties. A number of DD's and DOW's end markets, such as agricultural products, are facing cyclical slowdowns. The deal also has significant regulatory risk. Even assuming all goes well, the time to complete the combination, prep for the split and then consummate the split could take up to two-and-a-half years. We haven't seen hard sum-of-the-parts numbers on the combined companies yet, as details of the deal have not been disclosed. However, we guess they will come out in the $85 to $90 range for DD shareholders. Giving the valuation the benefit of doubt, investors potentially could see up to $95 per share. However, that's at least two years out. Discounting that back and taking into account the uncertainties (regulatory, business and execution risks), we get a Net Present Value of something around the mid-$70s. When we weigh all the positives of the deal (and there are many) versus the risk and extended time to pull it off, we think it makes sense to declare full or partial victory in the names. On Wednesday in the Columnist Conversation, we suggested taking profits at the $74 level or better on DD. We think that still makes sense. If the stock bounces on the actual deal announcement, we suggest selling into that strength.

Sell DuPont on Boost from Possible Dow Deal

DuPont shareholders should take their profits rather than wait a long time for a merger to finalize.

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