Case Dow

Doss bid for Room and Has Corporate Finance February 23, 201 5 Katherine Rotor Espanola 5908590 Stephanie De Ward 61 1 7309 Introduction In this case the acquiring of Room and Has will be discussed. DOD is an American multinational company who produces commodity chemicals. Their mission is to passionately create innovation for their stakeholders at the intersection of chemistry, biology and physics. As of 2009 it is the third-largest chemical company in the world.

Room and Has is a manufacturer of specialty chemicals for end use markets. The CEO of DOD, Andrew Liveries wanted to transform DOD from a producer of Lowell, highly cyclical Heimlich to a producer of high-value, specialty chemicals and advanced materials. His vision was to become the largest firm in the United States. In order to build his strategy and become an ‘asset light’ producing high value chemical he was pursuing two deals. First, he was planning to generate lot of cash from Kuwaiti Petrochemical Industries Company (PICK).

This could be used for the second deal, the acquisition of specialty chemical Room and Has- His idea was that the specialized resources of Room and Has could become even more valuable if it would be combined with the resources of DOD. His strategy was to exploit the different strengths of the three companies. On the one hand, PICK would lead to vertical integration. This would lead to synergy because the chain of production would become more complete. On the other hand, Room and Has would have a more functional integration. This could lead to increasing profit margins and sales, which in turn could lead to increasing market power of DOD. . 1 Why does DOD want to buy Room and Has? Was the SUDS a share a bid reasonable? As mentioned in the introduction, Room and Has would bring synergies and benefits in products, namely high-value specialty chemicals. It would create a diversified business portfolio. Which in turn reduces the risk for its investors and makes it more attractive investment. Also, DOD would expand its market share on the chemical market. Furthermore, there could be tax benefits. Taxes paid by two individual firms could be higher than taxes paid by one firm. Lastly, DOD could increase their debt capacity because they become less risky.

They could use that to invest in more value creating 1 projects or in Research & Development. 1. 2 Was the SUDS a share a bid reasonable? In exhibit b the discount rate from Room and Has Free Cash Flow valuation f Goldman Cash are shown. The following assumptions are provided: In order to calculate the firm value of Room and Has, the original forecast of the free cash flow in exhibit AAA is used. The method used is DC-model. Now the equity value is calculated: 2 Lastly, a sensitivity analysis is performed. The fair share price is $47,51, this is below $78 bid price.

As can be seen in the sensitivity analysis a share price of $78 is not reached after changing the assumptions of WAC and the growth rate. In our calculation, the premium per share would be 530. 49. This would reflect the synergies gains after the acquisition. So, the question now is, if this is reasonable. It is difficult to predict the true synergy gains for a company. First, it should be noted that DOD could have overvalued the bid price in order to win the auction. Furthermore, in order to value the synergy gains, you should look at the value of the cost synergies and the value of the growth synergies.

The cost synergies can be calculated by looking at how costs can be saved after the acquisition. Growth synergies can be identified by looking at the growth prospect of DOD after the acquisition. In the introduction both synergies are mentioned. The acquisition of Room and Has would have a functional integration, a reduction of costs. This could lead to increasing profit margins and sales, which in turn could lead to increasing market power of Dove. That would imply growth synergy. Also, the expanded market portfolio and the increased geographic reach could lead to more growth synergies.

In conclusion, the synergy gain of $30,49 seems reasonable after summing up the cost and growth synergies. 3 2. What are the major deal risks Inherent in this deal transaction? How and to whom does the manager agreement allocate these key risks? 1 . Merger incinerations In the merger considerations it is specified how much money each shareholder receives for his stock after the merger. It is also specified that all debt, duties and liabilities of Room will belong to DOD. The risk faced by DOD is that if the price per share declines after the merger, they still would have to pay the shareholders pre specified stock price.

Furthermore, the management of DOD faces the risk of taking over the debt, duties and liabilities of Room. It could be the case that they take on a lot of risk 2. Risk of delay A ticking fee is specified for any delay beyond January 10th. After this date, the price that DOD has to pay per share will increase with 8 percent per annum until the deal closes. As a consequence, DOD will have to pay more than their offering price for Room and Has. Furthermore, the financing risk will increase. Because of the higher price, they will have to raise more money in order to finance the acquisition. . Risk of non-performance If Room terminated the agreement after accepting a merger proposal, Room ass to pay a termination fee to DOD. If the merger didn’t occurred on the specified date, than DOD has to pay Room reversed termination fee. They OTOH carry the risk that when they suddenly don’t want to accept the deal, they will be subjected to financial penalties. 4. The ‘Material Adverse Feed clause In the MAE clause it is specified that DOD is not allowed to terminate the deal if certain macroeconomic forces cause negative effects on the business of Room and Has.

Under macroeconomic forces the following is included: generally changes 4 effecting the specialty chemical, generally effecting economy or financial, debt, credit or security market or any decline in Room’s stock price. As a consequence, a lot of the merger risk is transferred from Room and Has. DOD, since DOD carries the risk of the chemical industry, the economy and the security market. If in a later stage of the merger there would be a financial crisis, it would be better if DOD pulls back from the deal, but because of this clause this is not allowed. 5.

No solicitation With no solicitation Room will not involve other buyers into the bidding process. On the hand it project’s Doss interest, but because there is no bidding process they could miss a better deal 6. Reasonable best efforts In this paragraph it is specified that both parties will give their best effort in 7. The risk Of enforcement In this paragraph it is specified that if one of the parts pull back from the deal, irreparable damage would occur. The other party could go to court and stand up for it’s right. DOD and Room face the risk to be summoned to court, if they pull back from the deal. 8.

The fairness opinion In this paragraph it is specified that the valuation of Room’s financial position is done fair by Goldman, Cash and co. The board of directors of Room has received the opinion from Goldman, Cash and co. The risk that Room faces is that Goldman, Cash and co get paid from DOD and that they get most of the fee as the deal goes through. Goldman, Cash and co. Could have an incentive to deviate from a fair valuation. 5 9. Closing condition Here it is specified that there is a risk that the merger will not be approved by the shareholders of Room or by the antitrust laws and the European committee.

If this would be the case, there would be no consequences. As long as Room didn’t experience any MAE effects, the deal would go through anyway. The risk that DOD was facing, was the risk of getting its financing right on time. The merger would go through even if the DOD would face financing problems. In summary, the biggest risks for DOD were the financing sis and the ticking fee. First, the financing risk was not a problem in the pre- crisis period, because the financial and economic conditions were good. In the merger agreement DOD agreed to take the financing risk, even though the financing would become a problem.

If DOD would break this agreement, it would have to pay a fee to Room and Has. So, when the financial and economic conditions changed during the crisis, this agreement was a problem for DOD. Secondly, the ticking fee was a big risk for DOD. If there were problems in getting the financing done on time, DOD would have to pay a fee. This would cost DOD even more money. 3. Recommendation for Doss CEO Andrew Liveries Dove,/s current CEO, Liver is, has undertaken the task to deeply change the economic model of DOD Chemical Company on two major axes, one is becoming an asset light and two is adding more value to the company and be less cyclical.

The CEO is trying to implement strategic changes, which involve certain risk taking. DOD is suffering from the economic turmoil and its consequences. It faces decreasing expected revenues and severe financing conditions. Livery’s first goal to become an asset light company already failed with this R offer. Not only does funding this deal with debt seem as the only option, this also became harder due to the failed venture capital project with Pl. Because the value of 6 target R is also declining due the economic downturn, DOD is considering strategies that allow him to cut back on its offer.

To access funding for new investments, a firm can raise cash by cutting on dividend payments, by issuing new equity, renegotiate on terms of existing bridge loans, or by looking for new permanent financing option. In the early 2009 the financial markets were less liquid due to the supreme mortgage crisis of 2007. Applying for new loan agreements, or a new loan has become ore difficult. And as before mentioned due the less liquidity in the financial markets, and the recent failed PICK deal by Kuwaiti DOD this both deteriorates Doss lending position.

As of early 2009, financing the acquisition with new debt will be more costly. Exhibit 8 enlightens that DOD dedicates its cash to pay back interests. The rate BIT/loneliest expense fall from 7. 71 in 2008 to 5. 15 at the beginning of 2009 and is expected to decreasing further. Exhibit 9 illustrated Dhow’s debt on the market with CDC spread going up to 600 basis points in the early 2009. Showing that it is very risky for DOD to issue more bet. Exhibit b also extends on the former mentioned issue, here CDC spreads 1 0 times higher for some junk- rated chemicals companies compared to Doss CDC.

Equity funding is however also critical. The recent failed deal that was funded with equity issuance caused (1) that Dhow’s stock decreased to $11 per share, and (2) that owners will not agree on a secondary offering. Raising cash will not be possible by the former mentioned issue. The last option would be to cut dividend. Having already discontented shareholders with decreasing shareholders value, cutting dividend will not be an option for Liveries. It will sis his position as CEO and DOD has been paying dividend for 97 years, so he is not in a good position to change this.

Not only will issuance of new equity further downgrade DOD, also will asset sales and usage of bridge loan have this effect. The bridge loan will become due in one year, meaning that DOD will have to repay it loan after one year. Mood)/s warned DOD for lower credit rating as a result on bridge loan covenants on cash flows and total leverage ratio. Funding this acquisition is costly and it deteriorated the shareholders and Doss valuation, and with debt risk of lowering credit rating and decreasing future revenues. Financing this acquisition can even endanger Downs future existence when it is not able 7 to carry more debt.

DOD is planning to sue DOD Kuwaiti entities, to recover the break up fee from the failed deal. This fee can be used as funding, as leverage for renegotiation, and it raises more cash. However all the above-mentioned funding options have too many drawback. DOD can also end the joint venture (and the $7 billion of cash) however due to Doss decreased revenues this is impossible. The before mentioned ways of financing will be costly due to higher interest rates for new obligations, difficulties in raise capital, and can arm Doss image (e. G. Cause of cut in dividend) and encounters Doss future credit risks. Due to the recent economic, financial, debt, credit or securities markets recess, terminating the deal trough litigation has a small change to be successful. Both options in completing the deal at the share price of $78, either through (1) voluntary acceptance will not be a good idea due to the all before mentioned risks. AY alternative would be to terminate it through litigation. The outcome of this procedure is very uncertain. In case of success, this could solve the current dispute with Room and Has but would prevent

Liveries from achieving at least the second goal, that holds buying a more profitable company. The last solution would be to renegotiate the contract. This can be the more obvious solution. But this hits major points. First, DOD already signed a contract to purchase Room and Hawse against BASE. Secondly, as we will see in paragraph 4, Room and Has positions is much more certain and do face any risks. Renegotiating the contract could be very difficult and costly taking into account the cost of paying the arbitrage discount for DOD. So as a conclusion for Liveries, he should purchase Room and Hawse.

But in order to do so, DOD will need new ways to finance this operation, and so, time. So the best alternative for Liveries is to look at delaying renegotiating options. One solution could be to go to court against Room and Hawse. DOD has the financial means to do so, and also some strong arguments like the major risk of bankruptcy of DOD and Room and Hawse in 8 case of merger. This procedure could enable The DOD Company to gain time (at least few months) to find the funding. Moreover, just few months after the begging of 2009, the financial market situation will relax, making it easier to find the funding.

Once they found the funding, DOD could purchase Room and Hawse as previously signed in the contract. We have to take into account that this solution cannot solve all problems and that DOD could have to sell some non-strategic assets in order to finance the operation. A takeover bid made at the top of an economic cycle cannot be easily profitable. 4. Recommendations for the CEO Room and Has; Raja Guppy For Raja Guppy it is mandatory to act in the shareholders interest, maximizing takeover bid price and ensuring the takeover will take place.

The historical investors of R want to sell a substantial part of their shares and are testified by Dooms takeover bid. Due the economic recess Room and Has are also experiencing expected declining revenues that can further have a declining effect on the value of the firm, therefore the stock value. Room’s shareholders will not be receiving any shares of DOD, it is therefore mandatory for Guppy to close the deal as soon as possible, before the share price will fall below the pre- announcement price of $44. 83. Guppy faces increasing pressure since the market price of shares is constantly declining.

It is mandatory that this acquisition happened sooner than later. The CEO has several options. Option one is to litigate on the contract agreement signed by DOD. The expected outcome is uncertain and could lead to nullity of the contract. This will however only be the case if DOD succeeds in convincing the court that this acquisition could jeopardize DOSS existence and that could cause a large increase in the rate of unemployment. If Guppy however proves Doss funding possibilities, it could easily win this case.

The second option is to renegotiate terms, which can be a faster solution then going to court. This solution should only be used under the following two conditions. One, if the historical shareholders are flexible in agreeing in selling their shares at a lower share 9 price, or (2) if the economic situation would recover, so DOD can renegotiate on better debt funding terms. Overall we believe Guppy should force Ditto complete this deal through litigation. Recent jurisdiction also favored against the acquirer (e. G Huntsman Corporation vs.. Acquirer Hexing Specialty Chemicals), forcing the acquirer to complete the agreed deal. We believe Guppy has a very good case enlighten all the funding possibly for DOD. With this recent case, Guppy can force and win this case and it is recommended to do so. Overall we advise Guppy to Litigate DOD Chemicals to pay the agreed price Of $78 per share. 5. The honorable judge William. B. Chandler Ill in the Delaware Court of Chancery. In answering this question it is obliged to think of the following emphasis: Should a court rule based on laws or based on economics? The court is there in favor to the law.

We believe it should only look at what is stated in the contract and the agreed terms. A judge should not make judgments on whether the underlying case is smart, or should try to minimalism counterparts losses. When mainlining counterparts losses, companies would not go to the judge, they should go to a mediator. It is the judge his duty to only bring verdict based on whether the merger is liable or not by law. It should distinct the economic issues from the law. All sorts of clauses are included in contracts that allow both parties to legally back out if certain situations occur.

It is the judged duty to judge whether both counterparts detained these terms. The merging deal was created and started in 2008. This time unaware of what the starting crisis of 2007 will further hold and cause. DOD agreed on a contract that was risky. The contract contained a tight MAE clause and a full ash agreement. By accepting this deal and all the involved risks, DOD outbid BASS and won the highest bidder. If however the deal shows lullaby’s due to external economic effects one cannot back out that easily due the agreed terms. 0 There are several terms in the merger agreement that all both parties agree on that make DOD unable to back out. First there is the MAE clause. The clause clearly states that general effects on the economy and or finance markets will not be seen as a reason to cancel the agreement. Furthermore a failure to meet the projections by Room & Has is again not sufficient to back UT. The economic down turn of 2009 is clearly an general effect on the economy and therefore cannot be used as arguments to dissolve the merger agreement.

On second mention, all the closing conditions states in paragraph 6. 1 and 6. 2 were met. DOD argues that in the current state of the economy getting the correct finance could be devastating for the firm. In Paragraph 6. 2 clause 5 it is stated that getting financing by DOD is not a condition for closing the contract. In addition most of the finance for the merger is already in place. The $13 billion loan, together with other debt finance (e. G. There firms that were able to get financing in this economic state) makes the merger possible.

The extension of this loan, mentioned in (3), will however lead to extra cost and decreased credit rating. There is however no legal base to dissolve the agreement. The failing of the K-DOD joint venture is one of the reasons DOD wants to back out of the agreement. The main argument that DOD detained in court is that the continuation of the merger will have severe negative economic effects on both companies and its stakeholders. DOD states that it is therefore in both parties interest to cancel the merger.