Dow Chemical’s Acquisition of Rohm & Haas
(2008-2009)

MGT 4066
Professor Jayaraman
December 7, 2010

Joseph Dennis
Kunal Parbadia
Robert Pirkle
Will Weston
Yash Ghogre

Overview

In mid 2008, Dow Chemical found itself in an industry that had recently been experiencing some consolidation. As one of the giants in the chemical material industry, it needed to maintain its position as an industry leader or else it would probably lose its foothold near the top. Then there is the target, Rohm & Haas, a smaller chemical materials firm, yet still considered a rival of Dow Chemical. Both companies had been in operation for a combined 200 years and have been creating innovative materials that each and every one of us see or use in our everyday lives without even noticing.

On July 10, 2008, Dow Chemical announced the acquisition of Rohm & Haas, which had been approved by the Rohm & Haas Board of Directors. This deal occurred during one of the toughest economic times in recent history, which eventually had a profound effect on not only the financial structuring, but also the final execution of the deal, as you will see in the pages to come.

About Dow Chemical

The Dow Chemical Company was founded on May 18th, 1897 when Herbert H. Dow established a plan to both manufacture and market bleach and potassium bromide on a factory scale level. In the early years of the company’s existence there was a series of pricing wars between both British and German manufacturers of bleach which drove Dow to expand its business to include a wide variety of products. Its ability to rapidly differentiate its product lines would later be considered Dow’s greatest tradition and asset.

In the 1940’s Dow was responsible for construction of the first plant to produce magnesium from seawater. Soon after this project, the corporation entered into its first joint venture with Corning to produce silicones for use first in the military, and later in civilian enterprise. Also, in the 1940’s the corporation began the construction of its Canadian branch, Dow Chemical of Canada, located in Sarnia, Ontario as well as construction of its largest plant in Freeport, Texas.

In the 1990’s Dow Chemical underwent a dramatic change in its structural hierarchy in which the managers and presidents were organized by product rather than by region as they had previously been. In the years following this restructuring, the company found itself under a considerable amount of stress from the numerous lawsuits filed against the firm related to the adverse effects from some of Dow Chemical’s products.

Prior to the Rohm & Haas announcement, the company had 8 joint ventures and 2 subsidiaries. Dow Chemical’s two acquisitions were Dow AgroSciences LLC and Union Carbide Corporation (UCC). UCC controversially became part of the company following the Bhopal disaster, the worst industrial catastrophe in the world that involved the death of over 3,700 people. This merger made Dow the largest producer of plastics in the world and is now considered a market giant in the petrochemical industry. One of Andrew Liveris’ first act as CEO in 2004 was to further diversify the company, which he did through additional joint ventures and acquisitions in order to free up capital for development in more specialized areas, differentiating their product lines even more. Dow Chemical has a wide variety of products that represent 11 different industries. The agriculture and food department specializes in the production of pest management and food preservation.

The CEO of Dow, Andrew Liveris who took over in 2004, succeeding William Stavropoulos, played the largest role in the acquisition of Rohm and Haas. Liveris graduated from University of Queensland in 1976 with a degree in chemical engineering. His 34 year career with the company has spanned from manufacturing and engineering to sales and marketing with his work environment changing from Asia to now being stationed in Michigan at the headquarters.

Geoffrey Merszei, the CFO at the time of this acquisition, is now the Executive Vice President of the company and has worked for the company since 1977; but, unlike Liveris, Merszei took a hiatus from Dow Chemical to become CFO of Alcan Inc; a position to which he returned from in 2005. Other members of the board of directors include John Hess, CEO of Hess Corporation; Arnold Allemang, Paul Polman, CEO of Unilever PLC; Jacqueline Barton, Professor of Chemistry at the California Institute of Technology; Dennis Reilley, James Bell, CFO of Boeing Company; James Ringler, chairman of Teradata Corporation; Jeff Fettig, CEO of Whirlpool Corporation; Ruth Shaw, former Executive Advisor of Duke Energy Corporation; Barbara Franklin, CEO of Barbara Franklin Enterprises and former U.S. Secretary of Commerce; and Paul Stern, chairman of Claris Capital.

The corporate strategy of the firm is very similar to that of many of the other firms in its industry; Dow maintains that they will “invest in a portfolio of technology-integrated, market-driven performance business that create value for our shareholders and growth of our customers.” Also, one of the main strategies they have maintained as well is the increase and differentiation of the company’s product lines. The diverse product lines described above show the dedication that the firm has taken to achieve diversification in an industry that has cyclical movements of expansion and decline.

About Rohm & Haas

The Rohm & Haas Company is a chemical materials manufacturing company originally founded in 1907 in Germany. In 1909, Rohm & Haas established its American business based in Philadelphia, Pennsylvania. During World War I, the company’s first big break came in the form of a synthetic material it developed that aided in the leather bating process. The significant demand for leather during the war caused rapid growth for the company, which then developed Plexiglas that was used for aircraft canopies in the Second World War.

While both of these products helped make Rohm & Haas a Fortune 500 type of company, sales began to shrink after the wars and the company eventually developed Plexiglas for use in commercial products such as taillights and signs. Two of the other main innovations of the firm were an “acrylic emulsion” that improved acrylic paint and chemicals used to improve the quality of water supplied to our homes.

The final breakthrough of Rohm & Haas is their agricultural chemicals such as 1-MCP, which helps prevent fruit from ripening too quickly. The agricultural unit of Rohm & Haas was one of its largest assets, something that the firm’s eventual acquirer noticed. In 2001, seven years prior to Dow Chemical’s takeover of Rohm & Haas, Dow Chemical acquired Rohm & Haas’ Agricultural Chemical unit for roughly $1 billion. However, as part of the deal, Rohm & Haas retained the intellectual property of 1-MCP, its most valued asset in that part of the business. Clearly it can be safe to assume that aside from the synergies the 2008 acquisition provided Dow Chemical, the remaining agricultural chemical business Rohm & Haas ran was of attraction to the chemical giant.

In October of 1999, Raj Gupta took the reigns as the firm’s CEO, a long-time employee who started as a financial analyst in 1971. From the year before, the company he was now in charge of had doubled in size with the acquisitions of Morton Salt and LeaRonal. Mr. Gupta’s vision for the company involved expanding its electronics materials division, which made materials that are used in objects such as the silicon chips in computers. Upon completion of the acquisition, Gupta expressed that he would not continue serving as Rohm & Haas CEO under Dow Chemical ownership. At first glance, one may think Mr. Gupta had something against Dow Chemical; however, it is merely that he had already expressed his plans to retire the next year as CEO.

Mr. Gupta’s vision to expand the Electronic Materials Group for the firm has proven successful, with the group accounting for 17% of the firm’s overall sales in 2005 to 20% in 2008. This growth in the Electronic Materials Group did not account for all growth, the rest of the company continued to produce strong results for the economic environment. From fiscal years 2006-2008, Rohm & Haas sales had increased by more than $1 billion, from $8.2 billion in 2006 to $9.6 billion in 2008. Looking deeper into Rohm & Haas’ 2008 10-K, you will see that the earnings per share declined from prior years. The main reason for a decline in the earnings on the income statement is the line item “Other Expenses”. The two primary costs included in this line item are $40 million related to the Dow acquisition as well as $19 million related to foreign exchange. Both costs are understandable, due to the nature of the economy during 2008.

As you can tell from the description of Rohm & Haas, it is a highly diversified company with seven business segments divided into two groups, the Electronic Materials Group and Specialty Materials Group. This diversity should have been seen as attractive to Dow Chemical because of the nature of its industry, generally cyclical, with exposure to fluctuations in the energy markets.

The Offer

After thorough financial analysis of Rohm & Haas as a possible acquisition, Dow Chemical made an announcement on July 10, 2008 that it would acquire the Philadelphia-based chemical manufacturer to expand its specialty chemicals and increase its global footprint. The all-cash offer of $78 per share or 74 percent premium on Rohm & Haas’ closing price of $44.83 per share on the previous trading day sent a hard message to the market of Dow’s strong desires to acquire its smaller rival. The market reacted negatively to the deal absorbing $18.8 billion equity and debt due to the current market conditions and extremely high premium of the offer. Dow’s counterattack to the shares downgrade from “buy,” to “hold,” predicting the deal may weigh down Dow’s share price in the near term, composed of a statement saying the deal was “appropriately conservative” on the level of savings it will generate. The high premium of the offer was justifiably necessary to convince the Haas Family to go forward with the transaction. This blockbuster proposal disclosed how essential the acquisition of Rohm & Haas was to Dow’s long term strategy of broadening its range of product offerings that feed into a wide range of end markets. The deal was expected to close in 2009.

The economic outlook at the time of this year was bleak, to say the least. From January 2008 until the end of the year, the Dow Jones Industrial Average fell over 30%. For the first half of 2008, crude oil prices soared well above $100 per barrel. Unemployment rates were beginning to rise significantly, by the end of the year the United States unemployment rate reached near 7.5% according to Bloomberg, and are currently still well in excess of 9%. With such conditions, firms in the chemical industry were bound to struggle because they are cyclical in nature. This cyclicality of the chemical industry is due to its exposure to oil and gas prices, which are necessary to production of chemical goods. Additionally, each firm produced painting materials used in paints such as Sherwin Williams. The rising mortgage defaults and overall housing crisis obviously affected the ability of these divisions of chemical firms to remain profitable.

Michael Judd of Greenwich Consultant questioned the high premium by saying, “I just think paying a 25 percent premium to the high in the stock in the current environment – Well it just makes one scratch one’s head.” Dow Chemical’s stock fell 4.2 percent to $33.15 due to the losses the deal would create in the near term from the high premium offer. Rohm & Haas closed $28.79 higher, a 64.22 percent increase from $44.83 to $73.62. Dow’s Chief Executive Andrew Liveris’ response to the market’s reaction of the deal stated that, “A one day premium is a fascinating topic, which I hope in a week or two will be irrelevant. Rohm & Haas’ stock has dropped 16 percent during negotiations and that is not the value of Rohm & Haas. This is a jewel and there aren't many jewels out there.”

The financial proposal of the deal had to be very creative in the conditions of the credit market during the time of the deal announcement. The proposal included two financing sources: new convertible preferred stock and a bridge loan syndicate. Of the $4 billion convertible preferred stock, $3 billion was committed by Warren Buffet’s Berkshire Hathaway and $1 billion by the Kuwait Investment Authority, a sovereign wealth fund. A bridge loan proposal of $13 billion syndicated by nineteen banks led by Citigroup, Merrill Lynch, and Morgan Stanley was the other credit facility. Dow Chemical planned to draw only $4-6 billion from this loan because the company expected to receive $7.5 billion from a deal to be finalized in late 2008 with Kuwait’s Petrochemical Industrial Company (PIC).

Deal Complications

On December 29, 2008, Kuwait’s government called off the value adding $17.4 billion K-Dow joint venture after oil prices collapsed in the fall. The breakdown of this deal prompted funding difficulties for the proposed Rohm & Haas deal and market pessimism of the deal set off. After plenty of speculation, Dow Chemical, on January 26, 2009, announced that it could not close on the deal with the current state of the economy. In a statement Dow pointed out that “recent material development” had introduced “unacceptable uncertainties on the funding and economics of the combined enterprise” with the end markets like housing and automotive industries in recessions. Later that day, Rohm & Haas filed suit alleging Dow was intentionally breaching its obligation to complete the deal. Dow said that it remained interested in discussions to find a way to complete the deal.

The chemical conglomerate explored alternatives to finance the deal as both companies prepared for a public argument in the courts. Liveris’ number one priority was to maintain its investment-grade credit rating, which had not been cut since 1912. Drawing more money from the bridge loan was not an option since this could push forth a downgrade in Standard & Poor’s and Moody’s credit ratings to junk level vastly increasing its cost of funding. The banks balked at the idea of renegotiating the debt agreement by increasing the maturity of the bridge loan to a company could likely default on initial loan offered. Cutting dividends had historical implications as Dow Chemical was the only company in the Fortune 200 to regularly pay out cash dividends without reduction or interruptions since 1912. Liveris had no desire to be the CEO that cut dividends, but something had to give since the dividend yield at the time was a remarkable 16.3 percent. Dow also had no legal basis to try to renegotiate the $78 per share offer. Rohm & Haas felt that Dow did not need to find financing alternative, rather raise cash by selling noncore assets, lowering dividend payments by one percent to raise $1.5 billion, selling $4 billion in new common equity, raising $5 billion by issuing bonds, and still pulling only about $4 billion from the bridge loan, all of which Dow acted on to finalize the deal.

After successfully delaying the court proceedings of the lawsuit, outlining the risks of a forced deal by the courts, Dow Chemical was able to continue negotiating the final deal financing proposal. On March 09, 2009, Dow agreed to go through the purchase of Rohm & Haas reaching a settlement on the $78 per share offer divided into $63 per share in cash and $15 per share in face value of perpetual preferred equity securities issued by Dow. The preferred equity, totaling $2.5 billion, was bought by the two largest shareholders of Rohm & Haas, Haas Family Trusts and Paulson & Co. Dow also had the option of paying out additional $500 million in preferred equity to the Hass Family that was eventually exercised. Berkshire Hathaway and Kuwait Investment Authority agreed to stay on the deal contributing $4 billion in convertible preferred stock. Dow negotiated with the banks for a one year extension on $8 billion of the bridge loan, which was reduced to $12.5 billion to compensate. The plan was to use proceeds from the equity issuances, long-term debt sells, and divestitures sell-offs to reduce the amount it would draw from this loan to $4 billion. Dow hoped to retire the loan by the end of 2009. The deal finally closed on April 01, 2009 and Dow shares fell 11 percent to close at $6.33, while Rohm shares closed up 16 percent at $74.00.

Ultimately a friendly acquisition, the deal resulted in the creation of a new Advanced Materials division of Dow Chemical that hoped to achieve $3.0 billion in additional value growth opportunities, as well as annual cost synergies of $1.3 billion representing nine percent of Rohm & Haas’ revenue. The deal valued at 18.5 times Rohm and Haas’ earnings and 15.3 times EBITDA, a significant premium to the 12.4 times earnings and 6.7 times EBITDA which chemical companies trade at. This acquisition was essential to DOW’s long-term strategy as it incorporated significant cost savings and synergies to offer new and diverse products to its customers.

Valuation

As mentioned, Dow Chemical paid a total purchase price of $18.8 billion. Upon conducting our own valuation, we found this price to be out of our range. We conducted two different analyses: a comparable transaction analysis, as well as a discounted cash flow valuation. The discounted cash flows method gave us a price that fell well below the price per share of Dow Chemical’s offer for Rohm & Haas, while the comparable transactions seemed to justify a high premium.

|Financials |ROH Pre-Merger |Dow Pre-Merger |ROH & DOW Post-Merger ‘09 |
| |FY ‘08 |FY ‘08 | |
|Revenues |$9.57 Billion |$57.5 Billion |$44.9 Billion |
|Operating Income |$882 Million |$1.88 Billion |$1.31 Billion |
|Operating Income (as percent of |9.20% |3.23% |2.92% |
|revenue) | | | |

A price of $64.56 was reached from the discounted cash flow analysis. Attached you will see a spreadsheet covering some of the assumptions made and the projected cash flows. Research from Bloomberg provided us with a beta of 2.37 for Rohm & Haas, which, while it reflects the risks involved particularly for Rohm & Haas, it also reflects the risks involved in the chemical materials industry. Its acquirer, Dow Chemical, currently has a beta listed at 2.27, only a slight difference. Projecting out our financials for 10 years and calculating a constant growth rate for the terminal involved using a growth rate, which we assumed at 3.5% for a company that is largely mature but had been expanding under Raj Gupta. Other percentages used in our calculation include the risk-free rate, market risk premium, and effective tax rate. Normally the tax rate is assumed at either 35% or 40%; however, we used 23.4%, a value that we extracted directly from the Rohm & Haas 2007 10-K. Additionally from the 2007 10-K we assumed that rates the firm used for fair value of long-lived assets could be applied to our valuation. Here, the company listed a risk-free rate of 5.1% and a market-risk premium of 4.0%.

From the debt and equity costs, which were 6.7% and 14.58%, respectively, we were able to calculate a weighted average cost of capital of 12%. Once again, please see attached to see our values of equity and debt used in the WACC calculation. The net present value of our 10 year projections came to $8.8 million with a terminal value multiple of 12.18. Considering these values plus a terminal value of $12.6 million and average shares outstanding of 195 million, we arrived at our stock price, $64.56.

A comparable transaction analysis provides another perspective on the value of Rohm and Haas. The acquisitions used to compare were BASF and Engelhard, Akzo Nobel and Imperial Chemical Industries, and PPG and SigmaKalon. Only using the firm value and the EBITDA from the last twelve months, our analysis gives the multiple for Rohm and Haas as 11.5. This is close to the average of 11.65. The only lower multiple was for Imperial Chemical at 10.9. Incorporating the estimated synergies, Dow has a multiple of 7.7 which is the lowest of the group followed closely by SigmaKalon at 7.8. The average multiple with synergies is 8.4. Comparing the offer to similar transactions suggests that Dow offered an appropriate premium given the high expected cost savings of $800 million. Because Dow expected to save so much as a result of this acquisition, they we willing to offer a significant amount above the market price per share.

Reasons For and Results of the Acquisition

One of the main reasons behind Dow Chemical’s acquisition of Rohm and Haas was to establish it as a global firm by expanding into emerging markets. Prior to the announcement, Rohm and Haas had proven to be a leading chemical company in Europe and recently had been expanding into Asian markets as well. Dow Chemical saw this as a prime opportunity to take advantage of the position Rohm and Haas had already established in other countries worldwide.

Rohm and Haas had become a major company in the chemical industry mainly due to its coatings, electronic, and specialty materials businesses. At the time of the acquisition, Dow Chemical was exploring different options to improve in specialty materials division. Since Rohm and Haas excelled in this business, Dow Chemical agreed to create a separate subsidiary known as “Rohm and Haas Advanced Materials.” The subsidiary is still run by Rohm and Haas management and has been able to generate significant revenues for Dow Chemical by its continuous production of quality products.

In a highly innovative chemical industry, it is vital for companies to have sufficient funds for research and development to help them remain competitive in the market. One of the major synergies following the deal was the additional value worth $1.7 billion that was created for R&D. Furthermore, Dow Chemical was also able to create as much as $1.3 billion (pre-tax) and cut down on overall operating costs.

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Following the deal, Dow Chemical went through more corporate restructuring, which cost them $957 million. One of the outcomes of this restructuring was the elimination of 3,500 jobs. Since Rohm and Haas had a successful coatings business, the Antitrust Division of the United States Department of Justice ordered Dow Chemical to shut down several acrylic monomer and polymer plants around the country to comply with United States anti-monopoly regulations. Complying with the government’s request saved the firm over $375 million in operating costs.

As previously stated, the deal cost Dow Chemical a hefty sum of money, a majority of which was funded through loans by various banks. In order to repay the bridge loan, Dow Chemical executed the sale of Morton Salt to K+S for $1.7 billion. In addition, the Calcium Chloride business was also sold off for $210 million to a strategic chemical industry buyer. Even though the deal was considered a successful one, Dow Chemical posted losses in the second quarter of 2009. One of the reasons for this was the continuing recession. Mid 2009 was one of the worst times of the recessions, and a drastic drop in demand for chemical products occurred. The housing market crisis severely impacted the painting business. In addition, the sale of Dow Chemical’s subsidiaries did not take effect until the latter part of 2009. As a result, the debt incurred from the Rohm and Haas deal reflected poorly on their balance sheet as the cash inflow from the sale of their subsidiaries had not taken effect yet.

Conclusion

Through our analyses we came to several important conclusions. Our comparables analysis tells us that a premium on the market price is justified because of substantial synergies. However, the discounted cash flows suggest that the premium may have been too high. Following the deal, several Wall Street analysts were skeptical about the deal and criticized Dow Chemical for paying such a hefty price. While the final terms may not have been exactly what Dow Chemical had wanted, the acquisition was necessary to maintain status as a leader in the industry. Dow Chemical justified its acquisition of Rohm and Haas by strong performances a few months after the deal and produced stiff competition for its competitors. The deal paved the way for Dow to become a global company and a leader in the production and supply of specialty chemicals and advanced materials. It also helped the firm create a world-class portfolio with significant growth synergies. Revenue and growth margins were predicted to increase from 3.5% to 6%. All in all, the deal met Dow Chemical’s acquisition criteria and was a successful one. CEOs often confidently justify the deals they pursue and are often found biting their tongues when these deals fail. Andrew Liveris, however, may have been right when he said that Rohm & Haas was “a jewel”.

Sources

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