Dissecting Dow And DuPont Deal, Part 2: Are The Synergy Expectations Reasonable?

One of the prime arguments in favour of the merger of Dow (NYSE: DOW) and DuPont (NYSE: DD) is the possibility of generating synergies by removing redundant operations and rationalizing costs. The companies expect to generate synergies of about $3 billion in annual cost savings. The three key businesses—Agriculture, Material Science and Speciality Products—are expected to generate about $1.3 billion, $1.5 billion and $300 million, respectively, in cost synergies. We note that, after taking these synergies into account, the EBITDA margins of the combined entity is likely to be close to the best in the industry. In our opinion this is reasonable, considering that significant operations overlap and the fact that the combined entity will have a leadership position. (Read: Dissecting Dow And Du Pont Deal: Does The Merger Makes Sense?)

Our price estimate for Dow stands at $52.53 | Our price estimate for DuPont stands at $58.14

Improved EBITDA margins for Agriculture Business

We have arrived at an EBITDA margin (combined entity’s agri-business) of about 25%, higher than both Dow’s and DuPont’s. In this category Monsanto has EBITDA margin of 30% approximately. We believe the synergy estimates are reasonable.

The companies have opportunity to optimize seed production cost and prune R&D and the supply-chain. Some of synergies may also be gained from a reduction in COGS through reduction in procurement cost and improved buying power.

Material Science Business in leadership position

Material Science would consist of Dow’s Performance Plastic, Performance Material, Infrastructure & Consumer Solutions and DuPont’s Performance Material Segment. The implied EBITDA margin that we arrive at is about 22%, placing the company in a leadership position.

The joint company would be able to leverage Dow’s low-cost feed-stock and, optimize marketing and R&D expenditure. It should be possible for this division to operate at 22% or higher EBITDA margin.

Healthy margins for Speciality Product Business

The business would comprise of DOW’s Electronic Materials and DuPont’s Electronic & Communication, Nutrition & Health, Industrial Biosciences and Safety & Protection segment. We have arrived at an implied EBITDA margin of 22%.

Speciality Products would cater to many diverse businesses and markets, implying lesser scope of cost synergies. There is overlap only in the electronics materials segment which can add some value.

To conclude, the indicated synergy benefits are plausible but, would depend on the integration of the processes, efficiency and speed of execution.

Notes on Calculation:

1. We have used the last 3 years average sales and EBITDA margin for the purpose of our calculation
2. Implied EBITDA margin has been calculated using last 3 yr. average sales, EBITDA and indicated cost synergy
3. Speciality Products would operate in a number of different segments with diverse competitors
4. We have considered only the respective segments of competitors for purpose of our comparison

Have more questions about Dow Chemical Company? See the links below:

• What’s Dow Chemical’s Revenue & EBITDA Breakdown In Terms Of Different Products?
• What’s Dow Chemical’s Fundamental Value Based On Expected 2016 Results?
• How Has Dow Chemical’s Revenue Composition Changed In The Last Five Years?

Have more questions about DuPont? See the links below:

• How Much Can Dupont’s Revenue Grow In The Next Five Years?
• What Is Dupont’s Revenue & EBITDA Breakdown?
• What is Dupont’s Fundamental Value Based On Expected 2016 Results?
• How Can Dupont’s Revenue Composition Change In The Next Five Years?
• How Has Dupont’s Revenue Composition Changed In The Last Four Years?

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