Executive Summary
In July 2008, Dow Chemical announced an acquisition of Rohm and Haas, a specialty chemicals producer, in an attempt to implement its new strategy of pursuing high growth businesses. The financial crisis that hit in the fall and the termination of PIC joint venture called into question Dow’s ability to finance the deal. Based on the valuation models, paying $78/share for Rohm and Haas remained a good value for Dow post financial crisis as the combined company retained its ability to generate synergies. Dow should proceed with the deal as announced to prevent costly litigations and aim for maximizing long-term shareholder value. To avoid being downgraded to junk status and incurring other concerns of financial distress, Dow should attempt to renegotiate the terms of its financing, particularly its $13 million bridge loan.

Table of Contents

I. The Firms…………………………………………………...…….p. 3 a. Dow Chemical b. Rohm & Haas c. Petroleum Industries Company II. The Acquisition……………………………………………..……p. 3-5 d. The Rationale e. The Valuation f. The Financing III. The Risks……………………………………………………….…p. 5 IV. The Financial Crisis……………………………………….……...p. 5-7 g. The Macroeconomy and Industry h. The Firms i. The Post-Crisis WACC j. The Post-Crisis Valuation k. The Post-Crisis Financing V. The Recommendations……………………………………………p. 7-8 l. The Options m. The Recommendations VI. The Results………………………………………………………..p. 8-9 VII. Exhibits………………………………………………………..…..p. 10-12

I. The Firms

A. Dow Chemical

Dow Chemical Company is a chemical manufacturing company that was founded in 1897 as a bleach manufacturing. Over the years, Dow came to be known for its product innovation, creating products such as Saran wrap and Ziploc bags. From 1983 to 2007, Dow had divested 166 businesses, made 95 acquisitions, and took stakes in 58 other companies. Andrew Liveris, a long-term employee of Dow, became chairman and CEO in 2004. He announced a “Dow of Tomorrow” strategy that shifted Dow’s focus from cutting costs to pursuing high-growth and high-value-added businesses.

B. Rohm & Haas

As a rapidly going producer of specialty chemicals and advanced materials, Rohm & Haas seemed like a good target for Dow. Rohm and Haas , based out of Philadelphia, Pennsylvania, is led by CEO Raj Gupta who has been working to implement a strategy of expanding sales in overseas markets, especially China, developing new specialty chemicals products, and cutting costs in the more mature American market. Rohm & Haas, like Dow, had a diverse product portfolio that included Morton Salt, a very profitable business unit. In late 2007, the Haas family, who owned 32% of the shares, told Gupta that they wanted to sell virtually all of their shares in the next year to year and a half. Thus, Gupta began exploring the options and speaking with 3 companies about an acquisition. Two companies, Dow and BASF, submitted bids. Dow submitted the higher bid with more favorable contract terms.

C. Petroleum Industries Company

The final party in this deal is Petroleum Industries Company (PIC), a subsidiary of Kuwait Petroleum Corporation (KPC). KPC is a state-owned holding company that controlled all of Kuwait’s hydrocarbon business. Dow had signed three major joint venture agreements with PIC since the mid 1990s.

II. The Acquisition

A. The Rationale

In order to generate higher revenue and earnings, with less cyclicality in the business, CEO Andrew Liveris signed various deals that could help transform Dow. First, he signed a joint venture agreement with PIC, in which Dow would sell stakes in several chemical plants in order to pursue a light-asset approach and generate more cash. With an enterprise value of $19 billion, the deal would provide Dow with an additional $7.2 billion of after-tax cash. This joint venture, known as K-Dow Chemicals, would help combine Dow’s technology with Kuwait’s low-cost feedstock. Dow would also have the flexibility to invest in other projects that further implement Liveris’ new strategy and direction for the firm.
In 2008, Liveris announced the deal to merge with Rohm and Hass. Dow indicated in 2008 that it would pay $18.8 billion for Rohm’s existing shares while also assuming all its debt. Dow referred to Rohm as “beachfront property” as it would help broaden Dow’s geographical reach and create better growth opportunities. The deal is projected to generation at least $800 million of cost synergies resulting from shared services, governance, supply chains, and warehousing. The deal would also provide $2.0 to $2.6 billion in revenue synergies due to new technologies, an expanded product portfolio, and greater geographic reach. It would also help Dow reduce its cyclicality, which was one of Liveris’ main objectives when he assumed the position.

B. The Valuation

Dow had hired Goldman Sachs to help analyze the potential deal. Dow won the auction with a $78/share offer, which was a 74% premium over Rohm’s previous day share price. Goldman used 8.5% WACC to discount projected cash flow for Rohm and Haas; however a 7.675% WACC is more appropriate due to the difference in risk free rate, equity risk premium, and tax rate. A 10-year treasury is more appropriate than the 30-year used in the case because of its relevance and ability to reflect recent market movement while still representing market trend overtime. The market risk premium should be adjusted to 4.5% in July 2008; this number amore accurately reflected market returns and risks at the time of transaction. The 26% short-term tax rate should be used instead of the 35% long-term sustainable tax rate to determine whether Dow has the ability to finance this deal in the short time rather than its long-term growth. After making these adjustments, the more accurate WACC is found to be 7.675% as seen in Exhibit 1. The revised DCF, shown in Exhibit 2, values Rohm at $73.05/share without synergies. Various sensitivity analyses seen in Exhibit 3 demonstrate that there is a range of values for Rohm depending on market conditions and outlooks. According to Dow’s projection and the revised analysis, the combined company would generate synergies of $10.76 billion, or $55.08/share (Exhibit 4). This price per share would then be $128.14, which was higher than the bid price and could benefit Dow’s growth. Though the bid price and the premium were higher than market average, the analysis showed that Dow would still benefit from the deal regardless of the purchase price. The sensitivity analysis in exhibit 3 demonstrated predicted potential WACC and growth rate changes. The original DCF model used a modest 2% revenue growth per year and the sensitivity analysis presented the positive effect on Rohm’s value if growth rate increases. The sensitivity analysis also demonstrates the effect on valuation by calculating Rohm’s value with a wide range of WACC. Since WACC varies with the macro market movements (systematic risks) and industry movements (unsystematic risks), the analysis reflects how Dow could proceed with the acquisition. The analysis showed that $78/share as the purchase price represented good value if Rohm could keep its WACC below 7.5% while maintaining its growth at 2%.

C. The Financing

Dow would finance this deal by taking a bridge loan of $13 billion from a 19-bank consortium, and issuing $3 billion convertible preferred equity and $1 billion to Kuwait’s sovereign wealth fund. This most concerning financing option is the 1-year bridge loan as it required Dow to fulfill and maintain certain financial standards. Dow also would rely on the PIC deal to generate cash that help finance this deal as well.

III. The Risks

Any major acquisition presents risks. These include inaccurate synergy projections, self-interested management, anti-trust and other regulatory hurdles, and general market or industry disruptions. The Dow acquisition of Rohm & Haas is risky for several reasons. First, the chemical industry is cyclical, therefore revenues, and thereby earnings, are not always able to accurately forecasted. This inability to accurately measure revenue and growth is exacerbated by the fact that Rohm & Haas is expanding into emerging markets such as China that present additional uncertainty and volatility. Dow is also undertaking a new strategy and therefore changing its pattern of operations. The ability o properly execute this new strategy is another risk of the deal.

IV. The Financial Crisis

A. The Macro-economy and Industry

In the fall of 2008, a global financial crisis struck. The 2006 downturn in the US housing market spread to the US Capital markets, causing several banks – most notably Lehman Brothers – to declare bankruptcy. This crisis caused the S&P index to fall by almost 40% by the end of November. Furthermore, capital markets froze and many financial institutions began to fail.
The chemicals industry was especially hard hit by the recession. The downturn caused chemical demand to fall sharply so firms cut production, closed plants, and laid off workers. The third largest chemicals company in the US, LyondellBasell, and another large producer, Tronox, filed for Chapter 11 Bankruptcy in January 2009. S&P reduced the credit ratings of many chemical companies to junk status. Overall M&A activity fell sharply in the fourth quarter of 2008 due to lower deal values, failing capital markets, financing difficulties, and general fear around the overall economic outlook. M&A volume was at $2.39 trillion, the lowest since 2005. This is in stark contrast to today’s thriving M&A market that has seen high activity in technology and healthcare, with an increase in the number of spin off and tax inversion deals.

B. The Firms

Dow’s share price plunged by more than 50% with the onset of the financial crisis. It’s operating rate hit a 25-year low and its year-on-year sales decline of 23%. The enterprise value of the K-Dow Joint Venture with PIC fell $2 billion to $17 billion, causing Dow to lose $500 million in pre-tax cash flow. The deal was terminated in late December 2008. Dow’s shares fell another 21% and the S&P cut Dow’s rating to BBB. Dow responded by announcing a restructuring plan in 2009. They cut 5,000 jobs, closed 20 facilities, idled another 180 plants, and divested several non-core businesses. Rohm was also negatively affected by the financial crisis. It’s share price fell sharply and Rohm was forced to eliminate 900 jobs and most discretionary spending. Revised forecasts showed a 20% decline in sales.
The global financial crisis significantly impacted the value of Dow’s acquisition of Rohm & Haas. The WACC increased to reflect the additional project risk because of the restricted capital markets; this in turn decreased the overall value of both Dow and Rohm & Haas, hurting the benefits of the acquisition. Finally, the originally expected synergies were in jeopardy of not being fully realized.

C. The Post-Crisis WACC

The post-financial crisis WACC increased to 7.894%. With the onset of the financial crisis, the US government cut the rate on US treasuries to incentivize increased spending. Additionally, the Equity Risk Premium increased after the crisis. Investors demanded a higher return on investments because of the increased risk due to the collapsing capital markets and resulting decrease in consumer spending. Rohm’s Beta also increases. Beta measures how a firm moves relative to the overall market and is partially based on a given firm’s capital structure. To account for this capital structure, Beta is levered by the Debt-Equity ratio, which is based on Market Values of Debt and Equity. Before the announcement of the acquisition, Rohm & Haas’s share was roughly $45. It jumped to $75 after the announcement, but in February 2009, it had fallen to about $52, of 31%. It can thus be approximated that without the announcement, Rohm & Haas’s share price would have fallen to $31.50 after the financial crisis. The market value of equity decreased over $2 billion while debt stayed the same so the Debt-Equity increased, causing the post-crisis Beta to be higher. These three factors increased the Cost of Equity to 9.583%. It also decreased the amount of equity compared to the total value. Thus, the debt-to-value ratio increased. These things together increased the WACC to 7.894%. These calculations can be seen in Exhibit 1.

D. The Post-Crisis Valuation

The financial projections for Rohm & Haas also changed. Most notably, revenues, Capex spending and the Change in Net Working Capital decreased. These revised financials, combined with the higher discount rate, decreased the price of Rohm & Haas to $50.38, assuming a 2% growth rate and 7.894% discount rate, as seen in Exhibit 5. If growth surged unexpectedly to 2.75% and the market adjusted its outlook on risk causing the WACC to fall to 6.75%, the price would spike to $73.21. On the other hand, if growth was lower than expected at 1.75% and risk was perceived to be even higher resulting in a WACC of 8.25%, the price would drop to $45.89. These various sensitivities can be seen in Exhibit 6.
Finally, the synergies will be negatively affected by the financial crisis. Rohm & Haas’s financials show an 18-20% decline in revenues, so it is unlikely that the combined company will be able to realize the full value of the projected revenue synergies. Additionally, the combined firm may not be able to spend $1.3 billion to fully realize the cost synergies associated with the acquisition because of already constricted balance sheets. If Rohm & Haas can achieve 70% of the synergies, the share price will be 87.90. If Rohm & Haas is only able to recognize half of the originally projected synergies, the price per share would be $77.18 versus the $128.14 before the crisis Exhibit 7. Even if Rohm & Haas can only recognize half of the projected synergies, the $78/share acquisition price that Dow has agreed to pay is only slightly too high and thus the deal remains valuable.
Dow tried to seek a loophole to void its commitment to acquire Rohm and Haas. One thing it pointed to was the Material Adverse Effect clause which would void a deal if there were adverse effects from a specific, significant change to Rohm’s operations and finances. However the case clearly states that this clause does not apply to a general economic downturn and therefore is not applicable.

E. The Post-Crisis Financing

Another concern of the financial crisis is around Dow’s capital structure. Because the PIC Joint Venture was cancelled, Dow no longer has access to the $7.2 billion of cash that they were expecting. The post-crisis environment was one in which obtaining loans was very difficult because banks did not have the cash to loan. Dow was planning on issuing $3 billion of preferred equity to Berkshire Hathaway, $1 billion of preferred equity to Kuwait’s sovereign wealth fund, and obtaining a one-year $13 billion bridge loan. When the PIC agreement was cancelled, Dow’s stock price fell 21% and it’s debt was downgraded to BBB. This increased Dow’s cost of debt and called its capital structure into question. Obtaining the bridge loan or offering any more debt put the company at risk of being downgraded to junk bond status.

V. The Recommendations

A. The Options

Upon the cancellation of the K-Dow venture, Dow took legal action in order to receive the break-up fee of $2.5billion from PIC. With the deal terminated, Dow found it particularly difficult to finance the acquisition of Rohm. Since Rohm’s share price was trading at about a 23% discount of the purchase price, Dow could potentially bring a lawsuit in court to attempt to nullify its obligation according to the Material Adverse Effect Clause.
Rohm had also had different options—requiring Dow to complete the deal right away or renegotiate the terms. Though it was in Rohm’s best interest to finish the transaction as soon as possible, it was apparent that forcing the deal to go through could cause an economic disaster for the combined company and the industry. However, Rohm also understood that Dow had several financing options including issuing long-term corporate bonds and cutting its dividends that could generate $1.6 billion/ year. These options also raised different agency problems—Do Gupta, the CEO of Rohm at the time, had a duty to maximize shareholders’ value and was thus obliged to negotiate the best deal possible for Rohm’s shareholders. Since this was a cash deal, Rohm shareholders do not necessarily have an interest in the combined company or Dow’s financial performance afterwards, which incentivized the shareholders and Rohm to push the deal through as soon as possible even if it needed to take legal action against Dow in court.
However, since the contract requires no financing out and availability of specific performance, it would be difficult for Dow to prevail in court. Dow had to show that specific performance, an alternative to rewarding equitable remedy when monetary relief is not available, would not be appropriate in this case. Dow had also no possibility of winning this case due to state precedents. Therefore, it could be more beneficial for Dow to forego the litigation and explore other financial opportunities.

B. The Recommendation

The qualitative and quantitative analyses discussed have shown that regardless of the macro environment, Rohm is still a great strategic fit and revenue-generating firm that could benefit Dow in the long term. If Dow had the ability to manage its increase in debt, it should still pursue the acquisition. Dow could negotiate with banks for the bridge loan terms and amount. Since it was very difficult for any company to borrow, or for banks to lend, Dow could use its historical revenue and high coverage ratios to show their ability to repay short-term loans. This could benefit both Dow and the banks in the US since most of them also suffered a 50% loss in market cap. Dow might also be able to extend the loan terms from one to two years and decrease interest rate to maintain financial stability.
Dow’s main concern was to maintain its investment grade credit rating to ensure that institutional investors could still invest in the company. After the termination of PIC deal, S&P downgraded Dow to BBB, which was slightly above junk bonds status. If Dow could maintain the status (or Baa3 in Moody’s rating) by demonstrating that they have the ability to cover its short-term loan. According to Dow’s Post-acquisition Financial Forecast, it would be able to maintain at least the current ratio at 1.15x after acquiring Rohm, which was still above average. This number might be able to convince S&P and Moody’s to keep Dow at investment grade and thus avoid losing institutional investors.
Dow should also rely more on equity financing rather than debt financing by issuing more equity to Berkshire Hathaway, Kuwait’s International Funds, and possibly Rohm’s major investors. This could help Dow maintain the leverage required by bridge loan terms and keep its capital structure more flexible.
By exploring and negotiating with different financing options and sources, Dow should be able to finance the acquisition that would be beneficial strategically and financially in the long run. If the acquisition could realize more than 50% of the projected synergies, Dow should be able to break-even on the M&A project (Exhibit 7). Rohm was a great fit strategically and Dow had great experience and record integrating subsidiaries in the past; therefore, Dow should have the ability to realize the synergies even post financial crisis to reconcile the high price premium.

VI. The Results

Dow Chemical followed through on its acquisition of Rohm & Haas in March 2009. Dow was still burdened with high debt and interest payments, falling revenues, and drastic cuts to its operations. In order to complete the deal, the banks providing the bridge loan made the terms more lenient. The bridge was extended for one more year with 12.5 billion due in the first year, and 8 billion due in the second year. The interest rate for the first year was set at LIBOR + 1.25%. Dow had a strong plan to repay the bridge loan, including cost reductions, divestiture of non-core businesses, new equity raisings. In the third quarter of 2009, it publicly offered $2.75 billion of debt securities and used the proceeds to repay part of the loan. It sold the Morton Salt division of Rohm & Haas and used the proceeds to repay the remaining balance of the loan. Despite these concessions, both Standard & Poor’s and Moody’s lowered the credit ratings on Dow to the lowest level of investment grade bonds, BBB- and Bbb, respectively. Dow has since recovered from this distress and as of December 5, 2014 was trading at $50.16. As of February 14, 2014, Standard & Poor’s assessed Dow’s long term credit rating at BBB and Moody’s assessed it at Baa2, both of which are improvements over 2009.

VII. The Exhibits

Exhibit 1: The WACC

Exhibit 2: DCF Valuation, July 2008

Exhibit 3: Sensitivity Analysis, July 2008 DCF

Exhibit 4: Synergies, July 2008

Exhibit 5: DCF Valuation, February 2009

Exhibit 6: Sensitivity Analysis without synergies, February 2009 DCF

Exhibit 7: Synergies, February 2009

Bibliography

“5 Year Treasury Rate by Month,” Multpl, http://www.multpl.com/5-year-treasury-rate/table?f=m.

Annual Report. Dow Chemicals. 2009. http://www.dow.com/ investors/pdfs/2013_Full_Report.pdf

Capaldo, Antonio, David Cogman, and Hannu Suonio. “What’s Different about M&A in this downturn?” McKinsey. January 2009. http://www.mckinsey.com/insights/corporate_finance/whats_different_about_m_and_a_in_this_downturn.

Duarte, Fernando and Carlo Rosa. “Are Stocks Cheap? A Review of the Evidece.” Liberty Street Economics. May 8, 2013. http://libertystreeteconomics.newyorkfed.org/2013/05/are-stocks-cheap-a-review-of-the-evidence.html#.VH-mWb4yHww.

Hall, Jessica. “Global M&A falls in 2008.” Reuters. December 22, 2008. http://www. reuters.com/article/2008/12/22/us-dealyear-idUSTRE4BL36B20081222

James, Steve. “Dow Chemical buys Rohm and Haas. ” Reuters. April 1, 2009. http://www.reuters.com/article/2009/04/01/us-rohmandhaas- idUSTRE53073720090401

Moore, Heidi N. “Dow Chemica/Rohm&Haas: Problems Solved? Hardly.” Wall Street Journal. March 11, 2009. http://blogs.wsj.com/deals/2009/03/11/dow-chemicalrohm-haas-problems-solved-hardly/.

--------------------------------------------
[ 1 ]. “5 Year Treasury Rate by Month,” Multpl,
[ 2 ]. Fernando Duarte and Carlo Rosa, “Are Stocks Cheap? A Review of the Evidence,” Liberty Street Economics, May 8, 2013,
[ 3 ]. Antonio Capaldo, David Cogman, and Hannu Suonio, “What’s Different about M&A in this downturn?” McKinsey, January 2009,
[ 4 ]. Jessica Hall, “Global M&A falls in 2008,” Reuters, December 22, 2008,
[ 5 ]. Heidi N. Moore, “Dow Chemica/Rohm&Haas: Problems Solved? Hardly,” Wall Street Journal, March 11, 2009.
[ 6 ]. Dow Annual Report, 2009.
[ 7 ]. Steve James, “Dow Chemical buys Rohm and Haas,” Reuters, April 1, 2009.
[ 8 ]. Dow Annual Report, 2009.