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DowDuPont Faces Challenges as Businesses Shift to Specialties
Posted on September 28th, 2017 by Al Greenwood in Chemicals Industry News and Analysis
The decision by DowDuPont to transfer more businesses from its pending Materials Science spin-off to Specialty Products will leave the former more exposed to commodity markets and the volatility inherent in them, an analyst with Moody’s Investors Service said.
DowDuPont plans to spin off its Materials Science, Specialty Products and Agriculture divisions into three publicly traded companies. Materials Science will be the first to go, and it will inherit the Dow name.
DowDuPont has since decided to shift more businesses from Materials Science to Specialty Products, following the recommendations of the consultancy McKinsey.
The businesses below will leave Materials Science and become part of Specialty Products:
– The adhesives and fluid platforms of Automotive Systems
– The Building Solutions business
– The Water and Process Solutions business
– The Pharma and Food Solutions business
– The Microbial Control business
– The Performance Polymers business
– Several silicones-based businesses.
The silicone-based businesses make materials used in industrial LEDs, semiconductors, and medical products. They also include Molykote lubricants for automotive and industrial equipment and Multibase, which makes products used in thermoplastic compounding.
The table below shows how Specialty Products and Materials Science will be organised:
The businesses being transferred from Materials Science to Specialty Products represents more than $8bn in sales and about $2.4bn in operating earnings before interest, tax, depreciation, and amortisation (EBITDA), based on DowDuPont’s forecast for 2017.
DowDuPont did not release its 2017 forecasts for the spin-off companies.
Nonetheless, the loss of those earnings for Materials Science will be a challenge for the company, said John Rogers, senior vice president at Moody’s.
The businesses being moved to Specialty Products will leave Materials Science more exposed to commodities and their inherent volatility, Rogers said. Prices for downstream products being transferred lack the same degree of volatility. That stability would even out the ups and downs of the commodity products of Materials Science.
However, the danger in keeping these higher margin downstream businesses with Materials Science is the potential loss of value creation.
Specialty-chemical companies typically command an EBITDA multiple premium of 3.8x versus their commodity peers, according to Vertical Research Partners, an equity research-firm.
Prior to DowDuPont’s announcement, Vertical identified businesses within Materials Science that could be moved to Specialty Products based on their higher margins, higher growth and the value their goods bring to customers.
Using that 3.8x EBITDA multiple premium, DowDuPont could create $3.8bn in value for every $1bn it transfers from Materials Science to Specialty Products, Vertical said. Those transfers would be limited to the ones identified by Vertical.
If DowDuPont shifts the businesses identified by Vertical, that total could be $7bn-8bn of additional value, the firm said.
With some exceptions, the businesses identified by Vertical ended up in Specialty Products.
The challenge is achieving that larger multiple while limiting any downside to Materials Science.
Vertical Research expects Materials Science will see only a modest decline, which would be more than offset by the gains it would achieve by transferring the businesses to Specialty Products, said Kevin McCarthy, a partner at the research firm.
For Specialty Products, the extra earnings should make it easier for the company to issue more debt and maintain investment-grade ratings, Rogers said.
Also, the additional businesses share some applications, Rogers said. For example, the silicones being transferred to Specialty Products are used in electronics as well as in the construction and industrial businesses.
“I think there is this natural synergy for a couple of businesses,” he said.
However, Specialty Products will also inherit DuPont’s legacy Kevlar aramid fibres, Rogers said. “It has nothing to do with the silicone business.”
The same goes for Tivek, a nonwoven material made of high-density polyethylene (HDPE), he said.
Such product lines and businesses could be more valuable either on their own or with another company, Rogers said.
Vertical Research also noted a lack of overlap. Outside of the legacy electronic-materials businesses of Dow and DuPont, there is almost no overlap among the businesses in Specialty Products.
Breaking up Specialty Products could take advantage of the high multiples for specialty-chemical businesses, Vertical said. These additional spin-offs will also make Specialty Products more focused, allowing it to avoid the label of being a diverse portfolio company. Such portfolio companies are not very popular among investors.
“We would not be surprised to see additional portfolio actions in the years to come,” McCarthy said.
Another option is for Specialty Products to grow by acquiring similar high-quality specialty businesses, Vertical said. It has the balance sheet to pursue such a strategy and the bolt-on acquisitions would provide the company with synergies.
Overall, DowDuPont’s move to shift the businesses to Specialty Products should benefit the company as a whole, Vertical said. There will be some lost synergies, but these are not large enough to alter the targets of DowDuPont.
Overall, Vertical maintained its earlier estimate that the shift will unlock $7bn-8bn in value for DowDuPont, or about 5% of the company’s market capitalisation.
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