Dow Chemical Credit Spreads Surge, Evoking DuPont Move Last Year

Jan 21 2014, 2:09pm CST | by

Dow Chemical Credit Spreads Surge, Evoking DuPont Move Last Year

Credit spreads referencing Dow Chemical were among the biggest movers wider in the credit markets today following news that activist investor Daniel Loeb’s Third Point hedge fund has taken a stake in the company.

Marking the first pronounced increase since last summer, the cost to purchase five-year protection on Dow debt on the CDS market swelled 18% today, rising 13 bps, to a three-month high in the 86-bps area, according to data provider Markit. Five-year CDS last month touched a post-recession low, under 70 bps.

Similarly, the company’s 3% notes due 2022 – which date to its last tap of the debt markets in November 2012 – changed hands today at spreads as wide as T+105, or 15-20 bps wider than trades reported in recent weeks, trade data show. The company borrows under a BBB/Baa2 investment-grade profile, including stable outlooks on the ratings at S&P and Moody’s.

Today’s credit-spread widening recalled a 38% jump in protection costs referencing rival DuPont last July, after activist Nelson Peltz’s Trian Fund Management took a big stake in the company, in what was considered a contributing factor in DuPont’s later decision to spin off its titanium dioxide unit to shareholders.

Even as Dow Chemical prepares to ramp up spending on investments in its petrochemicals business over the next two years, while continuing to divest its low-margin businesses, Third Point is reportedly advocating for a review of whether separating the petrochemicals business from Dow’s specialty chemicals operations would enhance returns. Dow is now the hedge fund’s largest single investment, according to reports.

Loeb’s outfit is apparently frustrated by a long horizon to achieve returns from shale gas-related spending, and is openly critical of a Dow strategy to place a greater focus on downstream operations. S&P last year said the realization of returns on shale-gas investments would likely be weighted to the second half of this decade.

Still, Dow has robust discretionary cash flow metrics. The company generated more than $7.1 billion of operating cash over the 12 months through September, the most in its history and 57% more than it generated over the year-earlier period, according to S&P Capital IQ. That level of cash flow was $2.7 billion more than it paid out in combined capital expenditures, share buybacks, and dividends over the period, filings show.

Third Point today characterized Dow’s acquisition of Rohm and Haas five years ago as “ill-timed,” and lamented weak operational trends across the company, despite a “powerful tailwind” from the shale-gas boom in North America, according to press reports. The hedge fund said today that Dow’s current balance-sheet flexibility would support a “meaningful” share buyback to offset M&A-related share issuance in 2009.

For reference, Dow issued more than $1.5 billion of new stock in 2009, according to S&P Capital IQ.

Dow recently reported modest share repurchases after the board last February authorized a $1.5 billion share-repurchase program. But the repurchases have primarily been intended to combat share dilution as a result of stock-related employee compensation plans.

Indeed, Dow has not posted significant buyback activity dating to 2008, when it repurchased roughly $900 million of its shares, before halting buybacks as the company worked to integrate Rohm and Haas following the massive $18.4 billion acquisition, and as the economy plunged into a deep recession. The company had previously bought back nearly $1.5 billion of its shares in 2007, or the most dating to 1997, filings show.

Dow today responded to events by arguing that its investments “have yielded sustainable value for our shareholders,” and said that it would continue an open dialogue on ways to further unlock value, according to a company statement obtained by press outlets.

Despite low share-buyback activity since the Rohm and Haas acquisition, the company has not stood pat on shareholder returns. Dow boosted its dividend payouts to nearly $1.9 billion over the 12 months through last September, from $1.6 billion over the year-earlier period and $1.1 billion two years earlier, reflecting the highest payout rate in the company’s history, according to S&P Capital IQ. – John Atkins

Source: Forbes Business

 
 

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