The case presents an American company Dow, producer of commodity chemicals, who is in the final stages of acquiring another company Rohm and Haas. Dow’s CEO has been working for four years to transform Dow from a producer of low-value, highly cyclical commodity chemicals to a producer of high-value, specialty chemicals and advanced materials. Rohm is a perfect match for Dow in respect of the strategic and financial perspective. Dow is also pursuing another key deal with Kuwait’s Petrochemical Industries Company (PIC) that was supposed to generate $7 billion cash net of tax which could be used to finance acquisition of specialty chemical maker Rohm & Haas for $18.8 billion all cash deal.
However, by late 2008, a sever financial crisis gripped the US markets, causing a substantial decline in asset values. This financial crisis stretched across the entire globe, and the Kuwait based PIC terminated the joint venture with Dow in December 2008. To make matters worse, Dow reported a fourth quarter loss of $1.6 billion. Due to deteriorating market conditions and the credit market freezing up, Dow attempted to back out of its acquisition of Rohm & Haas. In response, Rohm & Haas approached the court to force Dow to complete the the terms of their deal. 2) Why does Dow want to acquire Rohm and Haas?
Rohm and Haas would be a strong operational and strategic fit for Dow. This acquisition would bring synergies as well as benefits in products and technologies, broad geographic reach, and strong industry channels. Andrew Liveris described the deal as a “jewel… that matched Dow‘s strategy perectly.” Rohm & Haas’ presence in the global market will provide Dow with an expanded network into emerging markets, producing important sources of revenues, while the synergies would create an outstanding business portfolio with diversified products and significant growth opportunities. Rohm & Haas is also backed by a strong and experienced leadership team with a culture of customer focus and innovation. In light of Dow trying to transform their production line beyond the low-value, highly cyclical commodity chemicals, Rohm & Haas’s portfolio of specialty chemicals and advanced materials made it a tempting acquisition.
3) Valuation using the Original Forecast:
Weighted Average Cost of Capital (WACC)
For the purpose of discounting cash flows to determine the present value of cash flows, we have calculated WACC. Using the long-term sustainable tax rates (35%) and debt level (D/V=28%), the WACC is 8.5% as shown in Exhibit 7b. Using short-term tax rates (26%) and debt level (D/V=49%), the WACC would be 7.44% as shown below. Weighted Average Cost of Capital (WACC)
We found that the equity value of Rohm & Haas to be $9,059 and dividing this value by the Rohm and Haas shares outstanding yields a value of $46.41 per Rohm and Haas share. This value is just slightly higher than what Rohm and Haas was trading at the day before the deal was announced. Perform a sensitivity analysis of the equity value per share based on the inputs to the TV (discount rate and growth rate). We explore the Equity Value’s sensitivity to the discount rate as well as to the projected growth rate. This sensitity is shown in Table . Using the baseline assumptions (WACC=8.5%, growth rate=2%), we arrive at a base equity level without synergies of $46.41 per share. However, this value is quite sensitive to both the WACC and growth rates. The overall spectrum of base values ranges from $27.75/share to $73.42/share, with the baseline assumptions falling squarely in the middle.
To be able to recognize the cost synergies, Dow had to incur a one time cost of $1.3 billion spread over two years. Dow also stated that it would take 2 years for them to fully recoginize the cost synergies. We found that $800 million of cost synergies would be worth and additional $32.18 per Rohm and Haas share. Value of the Growth Synergies
Growth Synergies are estimated to be between $2B and $2.6B based on expanded market porfolios, increased geographic reach and innovative technologies. We assume that these Growth Synergies would also take two years to completely recognize. The equity value per Rohm and Haas share is stated in the table below to view the difference between $2B and $2.6B:
Table 5: Per-Share Equity Value of Growth Synergies
Perform a sensitivity analysis of the equity value per share based on the variations in the annual cost savings ($500, $800 (pg. 3), $1,000) Using the equity value per share that we calculated for earlier of $46.41, we added the growth (used the low end of the $2.0b – $2.6B range) and cost synergies to this value to come up with a baseline value of $85.27. Adjusting the cost synergies we calculated an equity value per share of $71.37 to $94.26 per Rohm and Haas share.
Was the $78 per share bid reasonable?
Using the nominal assumptions of 2% growth rate, and 8.5% discount rate, the total equity value including $800M in projected cost savings, yields a value of $85.27 per share. Using a more conservative $500M in projected cost savings, yields a value of $71.37 per share. The $78 per share price falls squarely between the two values based on $500M and $800M annual cost savings. Thus, the $78 per share is a reasonbable bid based on the assumptions made by Dow. It is worthwhile to note that the cost synergies represent a very significant percentage of the overall valuation, and thus a more conservative ($500M/year) savings would be a far more prudent assumption, which yields about $71.37 share.
Dow’s offer of $78 per share is below the value of base case with synergy effects. It is to be noted that with synergies, all the sensitivity analyses are above $78, reflecting that this bid is reasonable Dow would acquire Rohm at a lower value considering the synergies effect. However, synergies are quite an important factor to the value of this deal. If there had been no synergies, none of the valuations (without synergy) cross the barrier of $78. Thus synergies are an important factor for this deal to be feasible for Dow.
4) Valuation using the Revised Forecast:
Value Rohm and Haas on a stand-alone basis using the Revised FCF forecast. Using the revised forecasts, the following are the projected cash flows:
Using the revised forcast we calculate an Enterpise Value of $8,879. Subtracting the Net Debt calculations from table 3, Rohm and Haas has an Equity Value of $5,568 or $28.53 per share. Perform a sensitivity analysis of the equity value per share based on the inputs to the TV (discount rate and growth rate). We explore the Equity Value’s sensitivity to the discount rate as well as to the projected growth rate. This sensitity is shown in Table . Using the baseline assumptions (WACC=8.5%, growth rate=2%), we arrive at a base equity level without synergies of $28.53 per share. However, this value is quite sensitive to both the WACC and growth rates. The overall spectrum of base values ranges from $15.65 per share to $47.31 per share, with the baseline assumptions falling squarely in the middle.
Based on the Revised Forecast, value Rohm and Haas based using the growth and cost synergies from question 2. Based on the Revised Forcast and using $2B growth synergies and $800M per year with a one time cost of $1.3B we calculate the value of Rohm and Haas to be $67.39.
Analysis of the Revised Valuation
To properly determine the correct valution under the new revised condtions, we need to revisit a number of assumptions: Risk-free rate (Rf): We believe that 3.5% represents a reasonable value for the Rf based on the 10-year treasury bills at that time. WACC: The lower Rf produces a WACC of 7.5% using the same long-term capital structure and tax rates. Revised (lower) FCF in the years 2009-2013 as shown in Table Growth synergies: revised down by 50%
Growth rates: the long term outght not be affected by the 2008 crises. However, at the time, many analsysts spoke of a “new normal” with lower growth rates. Thus, we look at using 1% as the growth rate. Cost synergies: The credit crunch of 2008 likely produces lower cost (certainly because of lower borrowing costs) which should result in better cost savings overall. However, we will continue to use the $800M/year as the baseline assumption. Using the above assumptions, we arrive at a value of $68.35/share vs. the original $87.67/share projected ealier and $78/share which is actual trasaction value. Supplamental DCF and Synergies
We figured that to properly calculate the value of the synergies, we would have to know the combined company WACC and growth rate. Because we were not provided this information and in the case, we decided to create a suplemental DCF and synergy model to try and estimate the combined company WAAC and to see the effects on the value of the synergies. We found a much lower combined company WACC (6.47%) due to the significant change in the capital structure (66% debt to 34% Equity).
However, for the revised combined company WACC we wanted to have a higher WACC due to the extreem risk that Dow was taking to go forward with the merger. We increased the debt premium because of the looming credit rating down grade that S&P was threatening to do, we increased the beta slightly, and we at a default risk premium due to the fact that they were financing a very large portion of their deal with a bridge loan. This lead us to a WACC of 11.76% and we lowered our growth rate to 1.5%. Results:
The lower WACC increased synergy values of the deal thus boosting the overall price per share value of Rohm and Haas, with a range of $80.96 to $113.38 per share.
5) Analyze the various provisions in Exhibit 4:
The following shows the risks associated with this deal, the provisions which prevent the aforementioned risks, the party favored by each provision, and the party holding the prime responsibility to address these risks.
1. Risk of delay or non-performance:
§1.2: The second business day after the satisfaction or waiver of all antitrust concerns and of all other conditions of the merger.
§2.1a: In the event the merger does not close by January 10, 2009, the per share consideration shall increase… using 8% simple interest per annum until the deal closes.
Enforcement and Jurisdiction
§8.5: The parties agree that irreparable damage would occur in the event that any of the provisions of this agreement were not performed in accordance with their specific terms or were otherwise breached… It is accordingly agreed that the parties shall be entitled to an injunction or injunctions to prevent breaches or threatened breaches of this agreement and to enforce specifically the terms and provisions of this Agreement exclusively in the Delaware Court of Chancery…(“Specific Performance”)
§7.2a & d: If Rohm terminates this agreement after accepting a superior merger proposal, then Rohm shall pay Dow $600 million in cash (termination fee). If this merger has not occurred by October 10, 2009, unless there has been an injunction prohibiting the consummation of the merger for antitrust reasons, then Dow shall pay Rohm $750 million (reverse termination fee).
The risk of delay is mitigated by stating explicitly the closing date in the agreement and specifying a ticking fee for any delay beyond the date specified. Non-performance is addressed by Specific Performance, with any potential breaches of agreement to be prevented with injunctions granted by the Delaware court.
These provisions primarily favor Rohm but allow for damages to be granted to both parties (termination fee and reverse termination fee) in the case of non-performance.
Responsibility is primarily allocated to Dow, but both parties are subject to financial penalties should the deal not occur.
2. Risk of governing body unfamiliarity:
§8.4: This agreement shall be governed by the laws of the state of Delaware.
This risk of governing body unfamiliarity addresses the risk of the case being discussed in a jurisdiction alien to one or both entities. Explicit statement of the applicable fiscal and legal policies affecting the deal allows both parties to predict and mitigate any potential material expenses or changes.
This provision is set to protect and allocate responsibility equally to both parties.
3. Risk of deal nullification on the basis of certain circumstances unforeseeable by Rohm:
Material Adverse Effect (MAE clause)
§3.1: A “Material Adverse Effect” means such state of facts, circumstances, event, or change that has had a material adverse effect on the business, operations or financial condition of Rohm, but shall not include: a) events or changes generally affecting the specialty chemical industry or generally affecting the economy or the financial, debt, credit or securities markets; b) any decline in Rohm’s stock price or any failure to meet internal or published projections. [Note: The MAE clause is also known as a “Material Adverse Change” or MAC clause.]
Certain macroeconomic or capital market forces, which are not under the control of Rohm, may negatively affect Rohm’s performance and cause Dow to terminate the deal. However, these factors are applicable to the general industry and may not be considered as grounds for termination of the agreement.
This provision favors Rohm and holds Dow responsible to act in accordance with the terms of the agreement.
4. Risk that the transaction may lack proper valuation and substance:
§3.17: Rohm’s Board of Directors has received the opinion of Goldman, Sachs & Co. to the effect that the consideration is fair to the Rohm shareholders from a financial point of view.
An incorrect valuation of Rohm’s financial position will negatively affect the interests of all stakeholders.
This provision protects Rohm, Dow, and stakeholders in both companies. The responsibility is attributed to Goldman, Sachs & Co. to consider the valuation’s fairness from a financial perspective.
5. Risk of competitive bidding, involving other buyers:
§5.3: Rohm… agrees… not to solicit, initiate, or knowingly encourage… any proposal or offer that constitutes… an alternative (merger) proposal. [Known as “no talk” or “no shop” clauses.]
This provision primarily protects Dow’s interests in the acquisition with Rohm and prevents additional parties from entering the bidding process while holding Rohm responsible in the event of any bid solicitation.
6. Risk of unintentional delay or non-performance:
Reasonable Best Efforts
§5.6: Each of the parties hereto shall use its reasonable best efforts to take all actions and to do or assist in doing all things necessary, proper, or advisable to consummate the merger.
“Hell or High Water” Provision
§5.6b & e: Dow shall take all such action as may be necessary to resolve objections, if any, from government authorities on antitrust grounds… so as to enable the closing to occur as soon as reasonably possible… including the sale, divestiture, or disposition of assets, businesses, products, or product lines… Nothing contained in this agreement requires Dow to take any divestiture action with respect to any of the assets if these assets represented in excess of $1.3 billion of revenue for the 12 months ending December 31, 2007.
This risk is mitigated by the specific provisions requiring best efforts in the attempt to complete the terms of the agreement.
§5.6 favors both parties as well as holds both responsible for taking all necessary actions in order to complete this deal under the specified terms and by the contractually specified closing date. §5.6b & e favors Rohm and holds Dow responsible with respect to any intentional delays in finalizing the acquisition.
7. Additional risks addressed in the conditions for closure:
§6.1, 6.2: Conditions to merger:
1) Approval by Rohm and Haas’s shareholders.
2) Expiration of the waiting period under the Hart-Scott-Rodino Antitrust Act. 3) European Commission declares that the merger is compatible with the common market. 4) Rohm and Haas has not experienced a “Material Adverse Effect” as of the Closing Date. 5) Consummation of the merger is not conditioned on the receipt of financing by Dow.
Condition 1 addresses the risk of non-approval by shareholders and holds both Dow and Rohm responsible while favoring shareholders’ interests.
Condition 2 addresses the risk of non-approval under antitrust law, holds both parties responsible for compliance with legal precedent, and therefore favors regulators.
Condition 3 addresses the risk of non-compatibility of the deal with the interests of European capital and money markets. This condition favors European markets and authorities while holding both parties responsible.
Condition 4 addresses the risk of a change in circumstances, specifically favors Dow’s interests and holds Rohm responsible for any changes within Rohm’s control that could materially affect completion of the deal.
Condition 5 addresses the risk of non-performance of Dow on the basis of financing. This provision favors Rohm and deems financing, or the lack thereof, as irrelevant to completing the acquisition.
In summary, it is the future Dow that would bear the risk, as the terms have functionally made this agreement irrevocable, even under adverse conditions. These provisions have been put in place to mitigate the effects of circumstances surrounding the transaction and protect the ultimate riskbearers, the shareholders of Dow and Rohm (excluding the family owners of Rohm). 6) As of early 2009:
What should Andrew Liveris (Dow’s CEO) ?
In the given scenario, the current economic situation has created a vacuum of liquidity in the financial markets. Simultaneously, the termination of the PIC deal also put Dow dow in a position of not having adicuate funding for this deal. There are three options presented within this case: 1) Deal is completed at $78 per share either through voluntary acceptance from Dow or Dow is forced to do so through litigation. 2) Terminate the deal through litigation, or
3) Renegotiate specific terms.
To close deal at $78, Dow needs to raise cash, but it has few options. Permanent financing is also difficult to obtain in the given scenario of limited liquidity in capital markets. Cutting dividend would end firm’s 97-year streak, which the CEO stated he would not do. And any asset sales would be at forced sale prices. Issuing equity through a secondary offering would significantly dilute DOW’s stock due to its recent selloff due to the announcement of this deal and overall market conditions. Dow’s stock had fallen to $11 per share, and Dow’s market capitalization had fallen below Rohm’s market capitalization ($10.7 billion vs. $10.8 billion). Though Dow may even go for generating some cash via dividend cut, asset sale and use of existing bridge loan (with one year repayment term), this would lead to a further downgrade of Dow’s credit rating, as warned by Moody’s, because there is a strong risk whether Dow could comply with the bridge loan’s covenants on cash flows and total leverage ratio.
As per the second option, terminating the deal through litigation would be a very difficult to a Judge to rule in its favor. The Material Advers Clause clearly states that changes in the overall marketplace are not covered by this clause: “events or changes generally affecting the specialty chemical industry or generally affecting the economy or the financial, debt, credit or securities markets.” Also, Dow is required to the Reasonable Best Efforts Clause, an it must do everything that it can do in its power to complete the deal. Since it is unwilling to suspend its dividend and/or issue a secondary offering to raise cash, the case could be made that Dow is not making a Reasonable Best Effort. Both Rohm and Dow have a final option to delay and renegotiate with each other.
Dow may negotiate with K-Dow (the Kuwaiti entities who terminated their agreement, as discussed in the introduction) and other lenders. Dow is planning to sue K-Dow to recover the break up fee from their failed deal. This breakup fee could be used to fund the deal, or Dow could use this breakup fee as leverage to renegotiate the deal with K-Dow and hopefully raise more cash. Delaying the deal, would also allow Dow to renegotiate its bridge loan. Dow may try to extend maturity of bridge loan, but the cost would likely rise and the banks would have to be willing to extend the loan. Finally, Dow may also look for other longer-term financing options or the credit markets may open up with more time. Therefore, the third option should be considered by Andrew Liveris, as this option would be prefferable and recommended from the perspective of Dow Chemicals. What should Raj Gupta (Rohm and Haas’ CEO) do?
Raj Gupta has a fudiciary duty to the Rohm shareholders and to do what is in their best interests. At this point, completing the deal at $78 per share is in the best interest of Rohm’s shareholders. If the deal were to fall through, Rohm’s stock price would plunge below it pre-announcement price of $44.83, because of the drastic change in market conditions. Therefore Gupta should force Dow to complete this deal through litigation. Because Rohm’s current shareholders would not receiving any Dow stock, Rohm’s CEO doesn’t have to take into account if Dow can afford the deal nor the value of Dow’s stock. He would be doing the right thing by suing Dow and bringing to light the fact that Dow has many avenues to raise additional capital and it is not making a Resonable Best Effort. For example, Dow could cut its dividend or do a secondary offering to raise more cash.
Even issuing long term debt is a possibility, given that other firms were able to raise a record of $167 billion of high-rated corprate bonds in January of 2009, despite the recession. Raj Gupta also has a compelling case to make, with seller baised and watertight merger agreement in his company’s favour. In the summer of 2008 the Deleware Court (the same court that would hear the Dow and Rohm and Haas case) heard the case of Huntsman Corporation vs. Hexion Specialty Chemicals.
The court ruled against the aquirer, Hexion, forcing it to complete the deal it agreed to. Though Hexion argued that Huntsman had experienced a meterial adverse effect, the court did not see it the same way and stated that Hexion did not use its resonable best effort to complete the merger agreement. With the shareholders best interest in mind and precedent that the Deleware Court would favor the target compnay in mind, eRaj Gupta should pursue the first option and have the deal completed at the agreed price of $78 per share.
7) Provide a Current Update.
The buyout of Rohm and Haas was officially completed on April 1, 2009 for $78 per share plus an additional $0.97 due to the ticking fee. The total value of the deal was $16.3 billion and to complete the deal “the company issued $7 billion in preferred stock and borrowed $9.23 billion from a short-term loan.” 1 This short-term loan was one of the keys to getting the deal done and Dow was able to negotiate extended terms though “the interest rate on the loan more than doubles in its second year.” 2 Also, “two major Rohm & Haas shareholders agreed to invest $3 billion in the combined company.” 3 That year, Dow announced that it “slashed its dividends by 64% to 15 cents a share” and “planned to lay off 3,500 workers, on top of 5,000 already announced by the company.”4 This was the first time the company had cut its dividends. To pay down some this debt Dow agreed to sell Rohm’s profitable unit Morton Salt to K&S AG for $1.576 billion, which was completed on October 1, 20095.
Rohm had purchased Morton Salt in 1999 for $4.6 billion6. Immediately S&P downgraded Dow’s credit rating to BBB-, to one step above junk, due to the increase of debt that had to be issued to complete the merger. 7 To gain regulatory approval from the US Federal Trade Commission (FTC), Dow was required to sell “certain acrylic monomer and specialty latex assets,” and these transactions were completed on January 25, 20108. On May 6th, 2009, Dow announced that it would issue a public offering of $2.25 billion in common stock of 130 million shares priced at $15 per share.9 Dow also annouced that “it would retire preffered shares used for its recent buyout of Rohm & Haas, a move that will save it millions in dividend payments” and offered $6 billion in debt securities for which Fitch gave a BBB rating.
10 Originally, Dow believed that the post-merger company would be able to “generate $2.0 to $2.6 billion in additional value” and “achieve at least $800 million of cost synergies.” 11 However, when Dow announced the deal on April 1, 2009, it believed that the merged companies would be able to “achieve $3.0 billion in additional value growth opportunities, as well as annual cost synergies of $1.3 billion.” 12 The integration of Rohm appears to be very successful and was completed in Quarter 1 of 2011.
According to Dow it “achieved its synergy targets related to the acquisition a full quarter ahead of schedule, with realized savings of $1.4 billion including increased purchasing power for raw materials; manufacturing and supply chain work process improvements; and the elimination of redundant corporate overhead for shared services and governance13.” Dow has been able to pay off the short-term loan that it required to complete the merger. In 2009 Dow had short-term debt of $2.12 billion and as of the end of 2012 it had paid this down to $396 million14. Dow’s long-term debt has remained around $19 billion since. Dow has been successful in increasing its Gross Margin from 12.76% in 2009 to 15.84% in 2012. Dow’s EBIT and EBITDA margins were improving until 2012 when the company had a pre-tax restructuring charge of $1.343 billion.