Dow Chemical's Debt Rating At Issue

As Originally Posted at the Wall Street Journal

Dow Chemical Co. is set to buy rival Rohm & Haas Co. Wednesday, starting the clock on its efforts to pay for the $16.3 billion purchase.

But with the outlook for the chemicals industry glum, investors are waiting for Dow to provide more details on how it will repay the about $10 billion in debt required to complete the purchase.

"As of April first Dow will be a highly leveraged company in a very challenging economic environment," said David Begleiter, a chemicals analyst with Deutsche Bank Securities.

Weak demand for chemicals and plastics is battering even companies with relatively little debt. On Tuesday, debt-rating company Fitch Ratings changed its outlook on rival DuPont Co.'s credit rating to "negative" from "stable," saying the chemicals sector won't brighten in the next 12 to 18 months.

Midland, Mich.-based Dow must provide detailed plans for repaying its debt to keep its investment-grade credit rating. Moody's Investors Service said it could reach a decision on that rating by today, and Standard & Poor's has said it will decide "soon."

The chemical giant Tuesday said it continues to examine ways to raise cash and reduce the debt burden. Earlier this year it cut its annual dividend by 64%, saving about $1 billion a year. The company has said it plans to issue up to $5.4 billion in new securities and raise about $4 billion from asset sales, including Rohm & Haas' profitable Morton Salt unit.

Andrew Liveris, Dow's chief executive, has said the company has received more than six bids for Morton Salt and expects it to sell for more than $1.5 billion. The company Tuesday declined to comment on the status of the negotiations. It has said it plans to sell stakes in a Dutch oil-refining complex and a Southeast Asia petrochemicals business.

To conclude the purchase of the specialty chemicals maker, Dow will use up to $7 billion from investors and up to $10 billion from a loan that must be repaid in the next two years.

Dow intends to use assets sales to help pay back the short-term loan. The salt business is a rare bright spot in the otherwise gloomy chemical sector due to a string of bad winters that has dwindled supplies of the salt used to de-ice streets and sidewalks.

But selling other assets will probably be tougher due to tight credit conditions and the trough in the business of making commonplace chemicals and plastics.

The company's shares Tuesday were up 13 cents at $8.43 in 4 p.m. composite trading on the New York's Stock Exchange. The stock is about 74% below its level last July, when the Rohm & Haas deal was struck.

Dow was in a very different position then. The company was counting on $9 billion from selling a stake in some of its plants to a Kuwaiti company when it agreed to pay a 74% premium for Rohm & Haas.

But the Kuwaiti joint venture fell through in late December under pressure from the Kuwaiti government, and business in the chemical sector soured due to the economic recession.

Dow reneged on the merger, saying it would be financially disastrous for both companies, and Philadelphia-based Rohm & Haas sued. The two parties settled their dispute in March after Dow extended the terms for a portion of its short-term loan from one year to two years, and two major Rohm & Haas shareholders agreed to invest up to $3 billion in the combined company.

Dow Chemical / Rohm & Haas Still Have Problems

As Originally Posted to The Wall Street Journal

Dow Chemical and Rohm & Haas spent months fighting over their $15.3 billion deal, weeks engulfed in legal squabbles and the last frantic days negotiating a settlement that will enable Dow Chemical to go through with the acquisition of its chemicals rival.


A Hollywood ending? More like one of Shakespeare’s “problem plays,” in which justice is served but the audience leaves morally uneasy about the resolution. That is where Dow Chemical is, still struggling with high debt and oppressive interest payments while its revenue has fallen off and it has cut nearly one-third of its operations. And each victory of the settlement is shadowed by the prospect of a future defeat.

For instance, Dow Chemical won some attractive concessions from the syndicate of banks behind its $13 billion bridge loan: extending the bridge for one more year and giving Dow a total commitment of $20.5 billion–$12.5 billion in the first year and $8 billion in the second year. In the first year Dow will pay a modest interest rate of just Libor plus 1.25 percentage points. And all this after Dow Chemical has complained that its business wouldn’t be viable if it were forced to to through with its agreed-to acquisition of Rohm & Haas. (Dow Chemical also received money from the Rohm & Haas family trust, Berkshire Hathaway and the Kuwait Investment Authority, so it may need only around $10 billion of the bridge loan, according to Hilliard Lyons analyst Stephen O’Neil.)

Yet, the new debt agreement wasn’t enough for the folks at credit rater Moody’s, who still warned that Dow Chemical could be downgraded if it doesn’t right its financial house and reduce that debt. Debt also was spotlighted by Citigroup analyst P.J. Juvekar, who warned investors against buying Dow stock right now because:

Dow’s agreement to acquire Rohm puts it in a leveraged position going into the downturn. Dow ends up with gross debt of $25.2 billion (net debt of $22.1 billion) after drawing ~$10B on a bridge loan…High Operational Leverage AND Huge Financial Leverage – Dow’s “twin leverage” magnifies the EPS impact in a downturn, but on the flip side, this can work great in an upturn…Now to be sure, we don’t think there are any “insolvency” concerns on Dow despite the insolvency argument put forth during negotiations with ROH….We remain in a deepening recession that is global in nature, so we think investors should stay on the sidelines.

Adding to the debt issue is the $2.5 billion in perpetual preferred stock Dow Chemical sold to the Rohm & Haas family trust and Rohm’s other large shareholder, Paulson & Co. While the preferred stock sale prevents Dow Chemical from borrowing more money against the bridge loan, it also has a high price: a 7% cash dividend, in addition to an 8% payment-in-kind dividend.

Then there are the asset sales. Before the settlement, Rohm & Haas (and its investors) had pushed Dow Chemical to sell assets to raise cash to pay for the deal. But that prospect threatened the company with the loss of cash-flow generators. With the settlement, Dow Chemical no longer will try to sell its Agricultural Sciences business, one of the company’s top performers and a business valued at roughly $7.7 billion. Dow had been so intent on keeping the business that it didn’t loop in potential buyers like Syngenta, and instead discussed a stake in the business to private equity firms. But Citigroup’s Juvekar said Dow Chemical will have to sell assets anyway:

“Dow plans to pay down the outstanding $10 billion bridge loan by the end of year 1. That sounds aggressive to us since $3.8 billion of the repayment is predicated upon successfully divesting certain businesses, such as its 45% stake in a Dutch petrochemical refinery Total Raffinaderij Nederland, its equity stakes in olefins and derivatives businesses in Southeast Asia, and ROH’s Morton Salt business.”

He went on calculate that with the sales, the company would lose $760 million of earnings before interest, taxes, depreciation and amortization.

Rohm & Haas’s family trust, which threw roughly half its profits from the merger into more Dow stock, is making a vote of confidence in Dow Chemical. As in Shakespeare, we must wait for the next act to see if that confidence is justified.