Chemical titans DuPont and Dow Chemical Co have agreed to combine in an all-stock merger valued at $130 billion in a first step toward breaking up into three separate businesses, a move that pleased activist investors and could trigger more consolidation.
The "deal of three centuries," as Wells Fargo analyst Frank Mitsch dubbed it, combines two of the biggest and oldest U.S. chemical producers and will generate cost and tax savings.
Dow and DuPont shares fell on Friday after spiking earlier in the week following reports of negotiations.
The deal, announced on Friday, will face intense regulatory scrutiny, analysts said, especially over combining their agricultural businesses, which sell seeds and crop protection chemicals, including insecticides and pesticides.
Executives from both companies said the agrichemicals businesses have little overlap and any asset sales would likely be minor.
Potential tax savings were one reason for the complicated merger-before-breakup deal, analysts said. "They need to merge first in order for the subsequent spinoffs to qualify as tax-free transactions in the United States," said SunTrust Robinson Humphrey analyst James Sheehan.
Dow shareholders would own 52 percent of the new company after preferred shares are converted, the companies said. The agreement includes a $1.9 billion termination fee under specified circumstances, such as rejection by shareholders.
The merger, one of the biggest of the year, would allow Dow and DuPont to rejig assets based on the diverging fortunes of their businesses.
The companies have been struggling with falling demand for farm chemicals due to slumping crop prices and a strong dollar, even as their plastics businesses thrive thanks to low natural gas prices.
Activist investor Nelson Peltz of Trian Partners, who has pressed DuPont to separate its businesses, said he "fully supports" the transaction and sees the combination as "a great outcome for all shareholders."
The chemical majors felt compelled to combine due to a lack of growth opportunities, said Key Private Bank analyst Rob Plaza.
"I think the big catalyst would have been (DuPont Chief Executive Ed) Breen coming in, his track record of extracting value from companies, and the fight that DuPont had gone through with Nelson Peltz," Plaza said. "We may see more consolidation."
"Game Changer"
DuPont, which is 213 years old, makes products used in petrochemicals, pharmaceuticals, food and construction. Its brands include Kevlar and formerly Teflon, now part of Chemours Co, which it had spun off.
The 118-year-old Dow makes plastics, chemicals, hydrocarbons and agrichemicals. It manufacturers Styrofoam insulation products and chlorine products, used in paper, pulp and soap. Dow also will assume full control of silicone products maker Dow Corning, its joint venture with Corning Inc.
The three-way split into material sciences, specialty products, and seeds and agrichemicals, is likely to occur 18 to 24 months after the merger deal closes.
Credit rating agency Moody's reaffirmed its A3 rating for DuPont, but changed its outlook to negative, citing among other factors the complexities of combining the agricultural businesses. It kept Dow's ratings at Baa2 and outlook stable.
"Very supportive"
The proposed merger puts pressure on rivals such as BASF and Bayer AG to consolidate as falling crop prices curb sales.
"The biggest impact will certainly be in the agriculture market, where the seeds and crop chemical industries are to undergo rapid consolidation," SunTrust's Sheehan said.
It could also prompt a renewed flurry of takeover bids for European rivals, with Syngenta AG the most likely target.
Monsanto Co may take another shot at Syngenta, according to analysts. It abandoned a $45 billion offer for the Swiss company in August.
Monsanto said Friday it would not act rashly and likes its position in the marketplace.
Rivals such as Bayer, BASF, Solvay SA and Eastman Chemical Co might benefit in the near term while Dow and DuPont integrate, said Nomura analyst Aleksey Yefremov. He noted the two companies' cultures differ, with DuPont more "research and growth-driven" and Dow focused on tight cost controls and reasonable innovation.
"There is a big execution risk," Yefremov said. "It's a very large transaction."
One DuPont shareholder described the deal as merely "OK."
"Our initial take is, given the commodity nature of Dow's business and the resulting low barriers to entry, the valuation is not obviously attractive," said Grayson Witcher, portfolio manager at Mawer Investment Management Ltd.
DuPont, part of the Dow Jones industrial average, closed down 5.5 percent to $70.44 on Friday. Dow Chemical was off 2.8 percent at $53.37. Major market indexes closed down about 2 percent and posted their biggest weekly losses since August.
Regulatory scrutiny
U.S. antitrust enforcers will not look at the deal as simply a combination of two conglomerates but examine their many products to determine where competition will be lost. Regulators will be especially concerned about the agricultural sector, which could see big divestitures, antitrust experts said.
"It's hard to know whether the fixes would work," said John Taladay of law firm Baker Botts LLP.
Diana Moss, president of the American Antitrust Institute, said there could be problems in dominance of seed sales.
"The (seed) market is already dominated by Monsanto. You're almost creating a duopoly in the market, and that's a problem," she said.
The U.S. Senate Judiciary Committee, which has jurisdiction over antitrust policy, will listen to farmers' concerns, Chairman Chuck Grassley said in a statement.
"DuPont and Dow are two titans of American industry and the proposed merger demands serious scrutiny," he said.
Klein and Co, Lazard and Morgan Stanley are Dow's financial advisers. Evercore and Goldman Sachs are advising DuPont.
