Tuesday, January 27, 2009 0 comments ++[ CLICK TO COMMENT ]++

The ugly situation facing Dow Chemical due to their Rohm & Haas bid

We had one major M&A deal blow up in Canada--the BCE deal--but it looks like the proposed buyout of Rohm & Haas by Dow Chemical might be the next big one--this time in America. Similar to the BCE deal, this one was cut near the peak of the cycle (in this case, the commodities cycle back in July.) If you ever want to know why arbitrage hedge funds are doing terribly, it's because of situations like this.

It's a good case study for arbitrageurs. This is an example of a deal, that seemed somewhat certain at that time, completely disintegrate within two months.

I never pursued this as a risk arbitrage play because (i) I didn't have enough free money, (ii) I am bearish on cyclicals and don't want to be holding any of them if the deal fell apart, and (iii) the deal is not a simple cash-only deal and I'm not skilled enough to properly hedge these deals by shorting, in this case, Dow Chemical. Never the less, the deal "looked" somewhat safe to me because it was a strategic bid. Financial bids, such as those from private equity or management, are very risky in this environment. But strategic deals should be safer. It looked like Dow genuinely wanted Rohm & Haas and it likely would benefit from a merger even if the fundamentals deteriorated slightly.

The deal looked like it was falling apart in December but Dow re-affirmed their intention to buy Rohm & Haas. Dow was considering financing a portion of the deal from proceeds from a joint venture with some Kuwaiti government units. Unfortunately for Dow, the Kuwaiti government backed out of the joint venture, with accusations from the opposition, what little exists in the Kuwaiti government, of corruption and various other irregularities. The deal has been on the ropes ever since.

Now it looks like Dow is going to have to cut its dividend--a dividend that it has maintained or raised since 1912. Although rare, this does go to show how dividend investors relying on historical trends such as 'companies that paid dividends consecutively for 20+ years' can end up investing into a questionable situation (this was also the case with a lot of dividend investors who went into financials two years ago.) If you are a dividend investor that is not heavily diversified (say picks less than 20 dividend stocks,) it is perhaps best to do analyze companies on a case by case basis. I'm not a dividend investor but I see many dividend investors spend a lot of time looking at the historical dividend trend and projecting that far into the future; instead, they should be looking at the company in question. Admittedly, management can go and do something stupid and ruin the dividend, which is what Dow management seems to have done, but a deeper analysis would still bring up issues pertaining to the business environment--such as how cyclical earnings are.

The M&A deal seems airtight, especially after Dow re-negotiated with Rohm & Haas in December, if I remember correctly. Rohm & Haas has filed a suit against Dow. The New York Times' Deal Professor goes over the situation and thinks Dow has bought itself a few months at best. Dow supposedly will have to pay $100 million per month to Rohm & Haas (but this may be negotiated away if a deal is cut.) The suit by Rohm & Haas includes new allegations that the Dow CEO tried to get the FTC to delay approval--a claim denied by Dow. Break-fee is $750 million if Dow walks away but it seems that Dow may have a hard time even satisfying the break-fee (I don't know how this works.)

I don't think too many would be interested in taking risk arbitrage positions in this deal but, if you are contemplating it, be very cautious. If the deal collapses and Dow only has to pay $750 million, shares of Rohm & Haas can collapse anywhere from 30% to 60%! It can be hedged (say by buying put options) but the cost is likely to be too high.


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