Delving Into Dow Chemical's Strategy

The industrial giant's suit over its thwarted joint venture with a Kuwaiti company could be part of a strategy to soften the financial impact of a planned acquisition of Rohm & Haas.
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Dow Chemical

(DOW) - Get Report

gave investors a peek at its corporate strategy Tuesday, announcing that it will seek compensation from a Kuwaiti company for backing away from a petrochemical joint venture.


said in a press release

that state-owned Petrochemical Industries is in breach of contract for dissolving the JV. Kuwait could be liable for as much as $2.5 billion.

Dow had expected to reap more than $7 billion from the deal, some of which could have been used in its its pending $15.3 billion acquisition of chemical producer

Rohm & Haas



Dow's contract with Rohm stipulates that the deal close by this Saturday or the original purchase price will escalate at an annual rate of 8%.

The failure to mention Rohm & Haas in its press release suggests that Dow could still be negotiating a lower acquisition price. The original price of $78 a share already had a premium of more than $30 a share last July. An analyst at Credit Suisse reported last week that the fair value of Rohm & Haas is about $35 a share given the sour economic climate.

Many analysts have suggested that Dow should pay $50 a share for Rohm & Haas at most. Others have said that Dow Chemical should walk away from the deal.

However, the recent commodity bubble served to motive Dow Chemical to reduce its input costs and limit the amount of petroleum it must use as a feedstock. Dow's Kuwaiti joint venture would meet the first goal by constructing a chemical plant near an abundant and cheap source of hydrocarbons. Annexing Rohm & Haas meets the second goal by introducing new chemical products that aren't petroleum-based.

Credit Suisse analyst John McNulty said in a Dec. 29 research note that "the DOW/ROH merger agreement leaves little room for DOW to walk away from the deal." The contract mandates that Dow pay Rohm $750 million even if the merger is canceled by government regulators. Were Dow to walk for any other reason, it would face worse penalties and a Rohm & Haas lawsuit.

The awkward irony of being on both sides of a breach of contract lawsuit was surely understood by Dow Chemical's executives when they released Tuesday's statement. This suggests that the Rohm & Haas schedule will proceed.

Dow's threat to sue Kuwait could also be a strategic attempt to bring Kuwait back to the negotiating table so that the petrochemical plant gets built, according to a research note released Tuesday by Credit Suisse analyst Mark Connelly. "K-Dow remains a strong possibility," Connelly said, as do alternative JV deals.

If Dow does acquire Rohm for the original $78 a share, it will be saddled with a $13 billion, 12-month bridge loan, which it has lined up. Any reduction in the $78-a-share price Dow were to pry from Rohm would directly reduce its debt. Any monetary reward Dow receives by way of its Kuwait lawsuit would also help it pay down debt and boost its credit rating.

"Remaining investment grade is the top priortiy, even ahead of these deals," Connelly wrote. "If Dow's borrowing costs rise to much, no amount of trransformation will take Dow to its goals. So Dow is likely to pursue a range of options, including divestitures of other highly valuable assets from its broad porfolio."

Dow said it will continue to pay its regular quarterly cash dividend, which it has done without fail since 1912, and accelerate cost cuts in 2009.

Dow said last month it would lay off 11% of its work force, close 20 plants and divest a number of businesses.

Share of Dow closed Tuesday at $16.05, up $1, or 6.6%.