Dow Forms Yet Another Joint Venture; Will Reliant Deal Kill Private Equity Rumors?

In the next few days Dow Chemical (DOW) is expected to announce a Memorandum of Understanding to form a joint venture with India’s largest petrochemical producer, Reliant Industries Ltd. 

While Dow has become the master of the joint venture (they are up to nearly a half dozen), the arrangement with Reliant would become Dow’s largest by far, and possibly one of the largest joint ventures in history.  The goal is to transition production of Dow’s basic chemicals and basic plastics segments overseas to lower-cost manufacturing facilities in India; Reliant is flush with cash after divesting their oil exploration business, and has already announced plans to construct a new $3 billion petrochemical facility.  Reliant was also named in some of the many buyout rumors swirling about Dow for the past few weeks, having expressed interest in acquiring U.S. chemical assets either directly or through partnership.

The deal would likely be a 51/49 split with the slight nod going to core producer Reliant, while Dow would maintain the management of overall strategy and customer relationships.  Most importantly, it would allow Dow to improve their balance sheet by closing down underperforming plants in North America, improving operating cash flow and allowing for reduction of their $8 billion in LT debt. 

It will be interesting to see what a JV of this size will do to the appetites of private equity for Dow, as basic chemicals and plastics segments brought in over $17 billion in revenue during 2006.  We highlighted this strategy as a positive for the stock in our break-up analysis of Dow back on February 8^th:  We felt then, as now, that a move like this allows Dow to focus on their faster-growing performance chemicals & plastics businesses and promising Agricultural Sciences segment. 

At the time of our break-up report Dow was trading at just over $41, and continued rumors about a possible buyout have kept the stock treading positive gains since then, with the stock closing at $43.38 on Tuesday.  The stock currently trades for a modest 12x forward earnings, as the cyclical nature of their commodity chemicals keeps multiples compressed when earnings are running at relative peaks, such as what we saw from the company in 2006.

With Dow’s operating structure and cash flows becoming so spread out amongst various partnerships, private equity may decide that Dow is just too entrenched, and not worth the trouble.  If the partnership with Reliant is announced, look for a long time frame to be provided for total implementation, and investors should assume that there will be several sets of one-time charges to account for all the asset shifting and manufacturing transition that will need to occur. 

Ryan Barnes

March 15, 2007