Everything Warren Buffett: WSJ: Could Warren Buffett Save Dow Chemical?

Saturday, January 10, 2009

WSJ: Could Warren Buffett Save Dow Chemical?

For Dow Chemical CEO Andrew Liveris, failure isn’t an option.

Liveris has a tough juggle ahead of him to complete his company’s $15.3 billion acquisition of Rohm & Haas. Ever since Liveris beat out rival BASF to win Rohm in a bidding war in July, he has touted Rohm’s ability to boost Dow’s profile and earnings. His reputation–and Dow’s strategy–rides on completing the Rohm deal. “He can’t walk away from the transformation message,” said one investor watching the deal. “It would be like Obama walking away from the ‘change’ message.”

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But as of Thursday, Dow’s market value was $14 billion, meaning investors believe the company is worth at least $1 billion less than the price it is paying for Rohm. Meantime, Liveris must find $7.5 billion to replace funds that had been promised in Dow’s now-collapsed joint venture with Kuwait. Regulatory approvals for the Rohm deal are expected to come through this week, which means Liveris will be required to close the deal by next week, whether he has arranged financing or not.

Liveris has said his priority is to preserve Dow’s investment-grade credit rating. And Standard & Poor’s and Moody’s Investors Service cut the company’s rating to within two notches of junk last week and have Dow on credit watch for further downgrades. That means Liveris probably can’t pay for Rohm by tapping all of a one-year, $13 billion bridge loan that 18 banks have promised, because taking on that much debt would hurt Dow’s credit rating.

So Deal Journal wanted to look at some ways that Dow could still save its deal. They are in order of how realistic the options may be.

1. Cut the dividend

Liveris has sworn to keep paying Dow’s dividend, a part of the company’s relationship with its stockholders since 1912. There is no pressing reason do so, except pride. Liveris needs $7.5 billion to pay for Rohm & Haas and preserve Dow’s capital structure in the process. Cutting the $1.5 billion yearly dividend won’t get him all the way there, but it would be a big step forward. And Dow’s dividend yield is already a whopping 11%.

2. Returning to the Buffett line

Liveris could try to persuade Warren Buffett’s Berkshire Hathaway to buy another $2 billion or so of Dow’s convertible preferred shares. Liveris told Bloomberg News that Buffett, who invested $3 billion in Dow last year to boost its chances of winning Rohm, stands by his investment even though his convertible preferred shares are underwater. Buffett’s shares, which hold an 8.5% dividend, have a strike price of $41.32. Dow shares recently were at $15.89. Perhaps Liveris could lure more Buffett investment by renegotiating Buffett’s holdings at a lower price, enabling Buffett to earn a better return if and when Dow’s shares bounce back.

3. Go begging to Kuwait

Liveris told Bloomberg he felt Kuwait’s decision to pull out of the $17.4 billion joint venture was “nothing personal,” a savvy thing to say as Dow has at least four other joint ventures with the oil-rich Middle Eastern nation. Still, Liveris said this week he would sue Kuwait to get a $2.5 billion breakup fee–or even more in potential damages. Kuwait said Thursday it believes it owes Dow nothing. In threatening such an important partner, perhaps Liveris was just giving himself negotiating room to offer to drop the threat of litigation if, say, Kuwait agrees to put more money into financing the Rohm & Haas deal.

4.Throw Dow on the mercy of the ratings providers

Liveris needs to impress S&P and Moody’s, whose primary concern is how Dow would refinance that huge $13 billion bridge loan in one year. Dow has just cut its production capacity 30%–meaning lower revenue to come and thus less money to pay down the loan. Still, Liveris may have made some headway in getting breathing room from S&P, which released a report Wednesday explaining its stance on the deal.

We maintained the CreditWatch status to indicate the potential for another downgrade if the company doesn’t announce meaningful steps toward that end soon. However, the CreditWatch status will provide a short amount of time for Dow to develop and disclose detailed plans to address our concerns, particularly related to the bridge loan refinancing. We believe that Dow remains highly committed to its investment-grade financial policies and expect that the company will announce plans to mitigate our credit concerns.

Liveris will have to back up any promises with action, as S&P expects Dow to come up with as much as $15 billion of cash:

To close the Rohm and Haas acquisition, we believe that Dow will need about $15 billion of external financing, including the $4 billion of cumulative convertible perpetual preferred stock that two large investors [Kuwait and Buffett] have committed. Based on the initial funding plan, we anticipated that Dow would initially draw about $4 billion of the bridge loan after receiving the K-Dow proceeds to close the transaction. Under the current scenario, without the K-Dow proceeds, the bridge loan drawdown is likely to be $11 billion or more. We view this as the most significant change related to the announcement last week. To preserve the existing ratings, Dow will have to demonstrate that it has the wherewithal, despite the difficult business and financial market conditions, to extend this debt so that the capital structure and debt maturity profile remain consistent with the investment-grade ratings. The company would have to provide sufficient details about the plan, and the plan would have to be highly certain for a rating committee to determine that investment-grade ratings remain appropriate.

5. Negotiate a longer-term bridge loan

Can Liveris turn a one-year bridge loan into a two-year loan? It probably would be a costly solution, if the 18 lenders would even agree to it. The banks would likely ask for a rich interest rate–perhaps as much as the benchmark London interbank offered rate plus 4.5 percentage points. Still, it might give him more breathing room with the ratings providers.

6. Find a new joint-venture partner

If Kuwait won’t help Liveris, perhaps another cash-rich country will. China is the customer for much of the petrochemicals produced in the Middle East, so perhaps Middle Kingdom could step into the Middle East country’s shoes. Liveris said this week that Dow has received calls from two potential partners to replace Kuwait, and he expects six more to jump into the fray within six months. Can he afford that kind of time? It took two years for Dow to negotiate with Kuwait, and that fell apart, while Dow’s financing agreements with Kuwait and Buffett expire in July. Still, a quickly signed, firmly negotiated joint-venture deal would show the ratings providers that Dow expects more money soon.

There are some solutions not explored here, such as trying to renegotiate the Rohm price below the $78-a-share offer. That is because he has no legal basis to do so: the Rohm & Haas agreement is firm, with no legal outs for Dow.

Liveris’s next move is anyone’s guess. But if he can juggle his myriad demands and appease the skeptics, he will regain the approbation received when he first signed the Rohm deal a year ago.

Update: It appears that there are signs of a rift between Dow and Rohm & Haas about the future of this deal. Rohm & Haas issued a press release just now confirming that it has received EU regulatory clearances. It is highly unusual for the target company to issue such a release (usually it would be Dow’s job as the acquirer). And the “do we have to do everything ourselves?” tone will not give investors much faith in Dow’s efforts: “The sole remaining regulatory clearance necessary for the transaction to close is that of the U.S. Federal Trade Commission. Rohm and Haas Company continues to work diligently towards completing the proposed transaction with Dow in early 2009.” Be assured that arbs will ask why Rohm “continues to work diligently” with no mention of its partner, Dow, doing the same.

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