The acquisition of Rohm and Haas is a defining step in our transformational strategy to shape the “Dow of Tomorrow”—a high-value, diversified chemical and materials company creating the largest specialty chemicals company in the United States with a leading global position in performance products and advanced materials. Andrew Liveris, Dow Chemical CEO1 We strongly believe that by becoming part of Dow, we secure a brighter future and greater growth prospects for our employees . . . This was the right transaction, with the right company, and with a good friend, Andrew.
Raj Gupta, Rohm and Haas CEO2 The CEO of the Dow Chemical Company (Dow), Andrew Liveris, had been working for the past four years to transform Dow from a producer of low-value, highly cyclical commodity chemicals into a producer of high-value specialty chemicals and advanced materials. But as the U. S. subprime mortgage crisis evolved into a financial crisis and then into a global economic recession over the course of 2008, two key deals—the cornerstones of his transformation strategy—fell apart.
First, Kuwait’s Petrochemical Industries Company (PIC) terminated a proposed joint venture with Dow in December 2008, a deal that was supposed to generate $7 billion of cash. This cash, in turn, could have been used to finance Dow’s second deal, the pending acquisition of specialty chemical maker Rohm and Haas (Rohm) for $18. 8 billion. To make matters worse, Dow was about to report a fourth quarter loss of $1. 6 billion, further reducing its cash flow and its options. Given these events, Dow announced that it was refusing to close the Rohm acquisition on January 26, 2009.
Within hours, Rohm sued Dow to force it to complete the acquisition as required by the merger agreement. Liveris now had to decide what to do about the Rohm acquisition and the lawsuit as well as the PIC joint venture and the company’s growing operating losses. Professor Benjamin C. Esty and Global Research Group Senior Researcher David Lane prepared this case. This case was developed from published sources. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, so urces of primary data, or illustrations of effective or ineffective management.
We would like to thank Guhan Subramanian and Steven Davidoff for helpful conversations about the legal issues in this case, and Chris Allen and Kathleen Burke Ryan for assistance with collecting data and verifying sources. Copyright © 2010, 2013, 2014 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www. hbsp. harvard. edu/educators. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.
This document is authorized for use only by Yang Li in Valuation taught by Shyam Venkatesan, Tulane University from August 2015 to February 2016. For the exclusive use of Y. Li, 2015. Dow’s Bid for Rohm and Haas The Dow Chemical Company Dow was founded in 1897 by Herbert Dow as a manufacturer of commercial bleach. After merging with Midland Chemical in 1900, it branched out into agricultural and food products. A century later, Dow still maintained its headquarters in Midland, Michigan, and was the only Fortune 200 firm to have paid a dividend for 388 consecutive quarters (since 1912) without interruption or reduction.
By 2008, Dow had 46,000 employees and was the world’s largest producer of polyethylene and polystyrene resins (used, for example, to make plastic bags and Styrofoam, respectively). Over the years, Dow had developed a reputation for product innovation, having created popular consumer products such as Saran plastic wrap and Ziploc resealable plastic bags. In 1997, however, Dow sold many of its consumer products to S. C. Johnson as part of a corporate reorganization that shifted Dow from a regional to a business unit structure. Dow also had a history of restructuring its portfolio of businesses. From 1983 to 2007, Dow divested 166 businesses.
Over the same period, it made 95 acquisitions and took stakes in another 58 companies. 3 Dow’s largest acquisition in recent years was the purchase of Union Carbide in February 2001 for $11. 6 billion. When Dow announced the deal, its share price fell almost 5%. In response, an analyst at ING Barings commented, “If Dow was announcing they were going after a specialties company like Rohm and Haas, people would be standing up and applauding. Instead, they’re saying ‘What the hell is going on? ’”4 Australian native Andrew Liveris joined Dow in 1976, and worked for many years in the company’s Asian operations.
He became chairman and CEO in November 2004 and joined Citigroup’s board of directors the following year. Whereas his predecessor had focused on cutting costs, Liveris shifted the focus to growth and profitability. He announced the “Dow of Tomorrow” strategy at an investor conference in March 2006. This strategy consisted of two parts: pursuing an asset-light approach to its low-margin, but cash-rich, commodity businesses while at the same time building high-growth and high-value-added performance businesses. In essence, the objective was to generate higher growth, margins, and earnings, but with less cyclicality.
Dow earned $2. 9 billion on revenues of $53. 5 billion in 2007. It was rated A- by Standard & Poor’s with a debt-to-total capitalization ratio of 33%. (Exhibits 1 and 2 show Dow’s income statement and balance sheet; Exhibit 3 shows selected financial data for Dow over the past 14 years. ) Implementing Dow’s Strategic Transformation Over the next two years, Liveris worked to implement the new strategy. To achieve the first objective—becoming an asset-light producer of commodity chemicals—he signed a joint venture (JV) agreement with Petrochemical Industries Company, a subsidiary of Kuwait Petroleum Corporation (KPC).
KPC was the state-owned holding company that controlled all of Kuwait’s hydrocarbon interests. Dow had a long history of working with PIC, having signed three major JV agreements since the mid-1990s. 5 Continuing their long history of collaboration, Dow and PIC signed a memorandum of understanding (MOU) in December 2007, in which Dow agreed to sell a 50% stake in several basic chemicals plants for $9. 5 billion—a deal that would generate $7. 2 billion of cash after taxes.
6 The goal was to combine Dow’s technology and its production facilities with Kuwait’s lowcost feedstock (oil and gas were key inputs of petrochemical products) in a new joint venture known as K-Dow Chemicals. By selling its physical assets into the JV, Dow would cut its capital intensity. At the same time, Liveris worked toward the second objective—becoming a high-value-added producer of specialty chemicals and advanced materials—by agreeing to purchase Rohm and Haas. This document is authorized for use only by Yang Li in Valuation taught by Shyam Venkatesan, Tulane University from August 2015 to February 2016.
For the exclusive use of Y. Li, 2015. Dow’s Bid for Rohm and Haas Headquartered in Philadelphia, Pennsylvania, Rohm and Haas had $9 billion in sales, $10 billion in assets, and almost 16,000 employees as of year-end 2007 (Exhibits 1 and 2 show Rohm’s income statement and balance sheet). Raj Gupta, who had been CEO since 1999, was implementing a strategy that involved expanding sales in overseas markets such as China, developing new specialty chemicals,a and cutting costs in the maturing North American market.
Despite its strength in specialty chemicals and other advanced materials, Rohm had a diverse portfolio of businesses including Morton Salt, which it had acquired in 1999 for $4. 6 billion. The Haas family—45 people who collectively held 32% of Rohm’s shares—precipitated the company’s sale by telling Gupta in late 2007 that family members wanted to sell “substantially all” of their shares in the next 12 to 18 months. 7 Following the family’s instructions, Gupta began exploring options and started acquisition discussions with three companies in June 2008.
This process generated bids from both Dow and BASF, two of the world’s largest chemical companies. 8 In addition to submitting an offer price, both companies submitted draft merger agreements for review. After a brief auction, in which both price and certainty of closing were evaluated, Dow’s $78 per share offer prevailed over BASF’s $75 bid. 9 Dow not only bid more, but also included additional provisions such as a ticking fee and obligations related to regulatory approval that were designed to ensure the deal would close; BASF’s bid did not include a ticking fee.
Exhibit 4 provides a summary of key provisions in the Dow-Rohm merger agreement. Dow announced the deal on July 10, 2008, indicating it would pay $15. 3 billion in cash for Rohm’s outstanding shares and would assume $3. 5 billion of debt, for a total deal value of $18. 8 billion. The $78 offer represented a premium of 74%, 60%, and 27% over Rohm’s share price on the prior day, on its average price over the last month, and on its 12-month high. Moreover, it was approximately twice the average premium paid in recent years.
10 According to the plan, Rohm would become a Dow subsidiary, keep the Rohm and Haas name, retain its Philadelphia headquarters, and receive two board seats, but Gupta would retire. These post-closing commitments helped Dow’s bid prevail. Referring to Rohm as “beachfront property,” Liveris described the deal this way: “This [company] is a jewel . . . There aren’t many jewels out there, [but] this is one of them. The fact that it became available matched Dow’s strategy perfectly. ”11 Further elaborating, Liveris said: Rohm and Haas is a strong operational and strategic fit for Dow.
This combination brings together best-in-class products and technologies, broad geographic reach, and strong industry channels to create an outstanding business portfolio with significant growth opportunities . . . (Rohm) will provide Dow with an expanded network into emerging markets, which will be another important source of revenues for the future . . . [and] brings us a strong and experienced leadership team with a culture of customer focus and innovation from whom we can learn a great deal. 12
Turning from the strategic to the financial aspects of the deal, Dow’s CFO, Geoffrey Merszei, exclaimed, “Well, this is clearly a great day for Dow and its shareholders. This transaction is another example of Dow’s commitment to delivering long-term shareholder value by maintaining the highest standards in pursuing and selecting strategic growth opportunities. ” 13 The Rohm acquisition would change Dow’s earnings profile by increasing the growth rate and reducing the cyclicality, thereby recasting Dow as an “earnings growth company.
” In terms of value creation, growth synergies (expanded product portfolios, innovative technologies, increased geographic reach, and improved a The chemicals industry was generally divided in two broad categories: basic (or commodity) chemicals and specialty (or fine) chemicals. Whereas basic chemicals were critical inputs for industrial and consumer products, specialty chemicals were typically sold for specific applications such as adhesives, catalysts, and sealants. This document is authorized for use only by Yang Li in Valuation taught by Shyam Venkatesan, Tulane University from August 2015 to February 2016. For the exclusive use of Y.
Li, 2015. Dow’s Bid for Rohm and Haas market channels) were expected to generate $2. 0 to $2. 6 billion in additional present value. 14 According to Merszei, cost synergies would also generate significant value: We expect to achieve at least $800 million of (annual) cost synergies in key areas such as shared services and governance, purchasing synergies (including raw materials), manufacturing, supply chain, work process improvements, as well as corporate business development overlap. We expect the one-time cost of about $1. 3 billion to achieve these cost synergies, which will be completely phased in within two years.
We believe these are very realistic and achievable synergy estimates. 15 As evidence of Dow’s ability to achieve synergies, Merszei highlighted the company’s acquisition and integration track record. Dow had consistently achieved annual cost synergies ranging from 14% to 18%, measured as a percentage of target firm revenues, in its major acquisitions: Union Carbide (18%), Angus Chemicals (15%), EniChem Polyurethanes (14%), and Gurit-Essex (16%). 16 To finance the deal, Dow would issue $3 billion of 8. 5% convertible preferred equity to Berkshire Hathaway and an additional $1 billion to Kuwait’s sovereign wealth fund.
17 Liveris noted, “We are . . . thrilled with the investment by Berkshire Hathaway and the Kuwait Investment Authority, which we believe further underscores the merits of this transaction, our strategy and the great growth potential resulting from Dow’s transformation. ”18 In addition, Citigroup, Merrill Lynch, and Morgan Stanley were chosen to lead a 19-bank consortium that committed to provide a one-year, $13 billion bridge loan for the transaction. 19 Commenting on the financing, Liveris said: [W]e are not counting on [the K-Dow joint venture to close].
We can do this deal without the Kuwait money, and we will stay at investment grade . . . .We have been very thoughtful on our balance sheet here in retaining investment grade and doing all the things in our capital structure to create insurance in case there [are] any downturns out there . . . or bigger downturns than there are. 20 Before the deal could close, the firms needed several approvals. Because both boards of directors (Dow and Rohm) had already approved the deal and because the Haas family had signed an agreement to support it, attention turned to gaining approval from government anti-trust regulators in both the U.
S. and Europe, and from Rohm shareholders. In the proxy material sent to Rohm shareholders, Rohm management recommended they approve the deal, but warned: In considering the recommendation of the Rohm and Haas board of directors that you vote to approve and adopt the merger agreement, you should be aware that some of Rohm and Haas’s executive officers and directors have interests in the merger that are different from, or in addition to, those of Rohm and Haas’s stockholders generally.
21 One reason the interests between executive officers and shareholders could differ was compensation. Exhibit 5 describes the compensation Rohm insiders would receive as a result of the merger. According to papers filed by Dow, approximately 500 Rohm executives and managers would collectively receive $375 million for their stock and options. 22 Gupta alone would receive more than $100 million through a combination of stock, options, and other merger-related compensation. Rohm management also disclosed the fees it had agreed to pay the board’s financial advisor.
Goldman Sachs would receive $47 million for exploring options, advising the board, and providing a fairness opinion on the offer, with most of the fee contingent upon closing the deal. 23 As part of the valuation process, Goldman valued Rohm using historical trading analysis (bid premiums), multiples from comparable transactions, and discounted cash flow analysis. This document is authorized for use only by Yang Li in Valuation taught by Shyam Venkatesan, Tulane University from August 2015 to February 2016. For the exclusive use of Y. Li, 2015. Dow’s Bid for Rohm and Haas
On the day they announced the deal, Rohm’s stock jumped 64% (from $44. 83 to $73. 62), Dow’s stock price fell 4. 2% (from $33. 96 to $32. 52), and BASF’s American depository receipts (ADRs) were up 1. 2% compared to the S&P 500 which was up 0. 7% (see Exhibit 6). Equity analysts immediately questioned the magnitude of the acquisition premium. One analyst called it a “ridiculously pricey acquisition,”24 though another analyst at Credit Suisse was less critical: We think the Rohm and Haas acquisition is a credible step forward for Dow, but at a price and on terms that leaves us with mixed feelings .
. . Dow is getting a very good portfolio, but at a price that will make integration decisions absolutely critical to making the acquisition pay off. Cost synergies alone won’t make this deal work . . . Dow will need to graft Rohm and Haas’s innovation culture onto its own businesses . . . and to accelerate top-line growth. 25 The analysts also questioned the financing plan and the need to borrow heavily to pay for an allcash deal. “[If the high-leverage] scenario were to play out, we believe the dividend would likely be a goner, and so could Dow,” said one analyst.
26 Liveris, however, was undeterred: “I’ve said it before, but I will say it again. We will not break that [dividend] string. Not Dow. Not on my watch. ”27 Despite Liveris’ assertions, however, S&P quickly put Dow on its “watch” list: The CreditWatch with negative implications on Dow indicates that we could lower the ratings on Dow following completion of the transaction . . . Based on the preliminary information announced today, Dow’s financial profile will clearly move to an aggressive posture, but we expect it to be maintained at a level sufficient to support an investment grade rating.
Key to resolving the CreditWatch and the determination of the prospective ratings will be a review of the components of the financing . . . and Dow’s ability to successfully close the pending joint venture with PIC. 28 In addition to the comments from equity and credit analysts, the announcement generated scrutiny from the legal community. In reviewing the deal, Steven Davidoff, a law professor and legal commentator for mergers and acquisitions at the New York Times, said,b “[I]t is a plain-vanilla strategy deal that provides for specific performancec under Delaware law .
. . [but] it is a bit odd that Dow did not negotiate a more flexible structure in these days of uncertain financing. ”29 The Global Financial Crisis Hits Shortly after the deal was announced, the global financial crisis hit with a vengeance. What began as a downturn in the U. S. housing market in 2006 (the subprime mortgage crisis) rapidly spread into the U. S. capital markets in the fall of 2008. The most dramatic day was Monday, September 15, when Lehman Brothers declared bankruptcy and Bank of America bought Merrill Lynch in a forced sale. The next day, the U. S.
government injected $85 billion to save AIG. The S&P 500 index fell by almost 40% from the end of August through mid-November. As equity markets crashed and credit markets froze, financial institutions began to experience record losses and fail. The U. S. Treasury, the Federal Reserve Board, and the Federal Deposit Insurance Corporation had to inject $40 billion to keep Citigroup solvent. 30 Share prices for banks across the U. S. fell. In fact, the aggregate market b Steven M. Davidoff, the “Deal Professor,” was a legal commentator for DealBook, a financial news service produced by the
New York Times. He was an attorney at Shearman & Sterling before teaching at the University of Connecticut School of Law. c “Specific performance” is a legal remedy for breached contracts. It compels the defendant, the breaching party, to execute the contract (to perform) rather than to pay financial damages. This document is authorized for use only by Yang Li in Valuation taught by Shyam Venkatesan, Tulane University from August 2015 to February 2016. For the exclusive use of Y. Li, 2015. 211-020 Dow’s Bid for Rohm and Haas
capitalization of the 19 banks providing Dow’s bridge loan fell by more than 50% from July to December 2008. 31 The chemicals industry was especially hard hit as the recession caused demand to fall sharply. In response, firms cut production, shut plants, and fired workers. Unable to meet its debt obligations, LyondellBasell, the third-largest chemicals company in the U. S. , filed for Chapter 11 bankruptcy on January 6, 2009. Also in January, U. S. -based titanium dioxide producer Tronox filed for bankruptcy and foam products producer Foamex defaulted on an interest payment.
By early February, Standard & Poor’s had reduced the credit ratings to junk status for many chemical companies such as Chemtura (rated CCC), Ineos (rated CCC), and NOVA Chemicals (rated B+). 32 As the crisis unfolded, Dow’s share price plunged by more than 50% by year end (see Exhibit 6). Dow reported a fourth quarter loss of $1. 6 billion (total net income for the year was $579 million), a year-on-year quarterly sales decline of 23%, and a dramatic reduction in the firm’s operating rate (i. e. , capacity utilization) from 87% in 2007 to 44% in December 2008, the lowest level in 25 years.
33 In response to its deteriorating financial condition, Dow announced a restructuring plan in early 2009, including the elimination of 5,000 jobs (11% of its workforce), the closure of 20 facilities, and the divestiture of several non-core businesses. 34 Dow also planned to idle 180 of its plants. 35 Rohm’s performance was also declining as it eliminated 900 jobs and froze discretionary spending in early 2009. 36 Revised financial forecasts for Rohm showed a 20% decline in sales (see Exhibit 7a).
On November 28, 2008, approximately one month after Rohm shareholders approved the Dow acquisition, Dow and PIC signed the K-Dow joint venture agreement. 37 Before signing, however, they cut the total enterprise value from $19 billion to $17 billion. 38 Under the revised terms, Dow would receive $9 billion in pre-tax cash flow for its assets, $500 million less than originally planned. 39 Liveris acknowledged that the economic landscape had changed considerably: [W]hen we said we would close K-Dow by year end, no one anticipated the global meltdown that [occurred] in September and October.
This deal has closed in an economic environment that none of us have seen in our lifetime. Given this meltdown, it was natural . . . to revisit the economics of the deal, and extract a win-win. I believe we have done that, as do our partners. 40 Yet four weeks later, on December 28, 2008, PIC unilaterally terminated the contract, citing falling oil prices (from $147 to $41 per barrel) and turmoil in global financial markets. 41 According to the JV agreement, though there was room for different interpretations, PIC was liable for a break-up fee of up to $2. 5 billion if the deal did not close within six months of signing.
42 The next day, Dow and Rohm shares fell 21% and 16%, respectively, and Standard & Poor’s cut Dow’s rating to BBB, slightly above junk status, stating: Without the proceeds from the K-Dow transaction, debt leverage will be even more aggressive than anticipated, and Dow will remain more dependent on its commodity petrochemical businesses during the impending downturn . . . [We are concerned] that Dow will likely fund the Rohm and Haas acquisition, at least initially, with substantially greater utilization under a one-year $13 billion committed bridge loan, thereby increasing refinancing risk at a difficult time in the credit markets.
43 Given this sequence of events, Davidoff (the legal commentator at the New York Times) questioned whether the Rohm acquisition would proceed: This document is authorized for use only by Yang Li in Valuation taught by Shyam Venkatesan, Tulane University from August 2015 to February 2016. For the exclusive use of Y. Li, 2015. Dow’s Bid for Rohm and Haas As much as Dow might now regret the Rohm deal—especially in light of the collapse on Sunday of Dow’s joint venture in Kuwait—governing law and forum for [this case] is Delaware, and it is highly likely that the court there would enforce the provisions .
. . Dow has limited outs under its agreement with Rohm . . . [T]he only other out appears to be a material adverse change, or MAC, claim. Yet Rohm has negotiated a very tight MAC. The exclusions are not qualified by materiality, so any adverse effect to the specialty chemical industry or the economy or markets generally is excluded. Unless something really bad in particular happens to Rohm, and Rohm alone, Dow will have a hard time proving a MAC at this point. 44 Developments in Early 2009