By Swetha Gopinath
(Reuters) - Chemical titans DuPont and Dow Chemical Co agreed to combine in an all-stock merger valued at $130 billion (£85 billion) in a move that pleased activist investors, would generate tax savings and trigger more consolidation while drawing scrutiny from regulators.
The "deal of three centuries," as Wells Fargo (N:WFC) analyst Frank Mitsch dubbed it, will combine two of the biggest and oldest U.S. chemical producers in a prelude to a split into three publicly-traded businesses, focusing on agriculture, materials and speciality products.
Dow (N:DOW) and DuPont (N:DD) shares fell on Friday after spiking earlier in the week following reports of negotiations between the two companies.
The deal, announced on Friday, will face intense regulatory scrutiny, analysts said, especially over combining their agricultural businesses, which sell seeds and crop protection chemicals, including insecticides and pesticides.
Executives from both companies said the agrichemicals businesses have little overlap and any asset sales would likely be minor.
Potential tax savings were one reason for the complicated merger-before-breakup deal, analysts said. "They need to merge first in order for the subsequent spinoffs to qualify as tax-free transactions in the United States," said SunTrust Robinson Humphrey analyst James Sheehan.
Dow shareholders would own 52 percent of the new company after preferred shares are converted, while DuPont investors would own the remaining 48 percent, the companies said.
DuPont Chief Executive Ed Breen, who as Tyco International's (N:TYC) CEO engineered the breakup of the conglomerate, would be CEO of the new company, and Dow CEO Andrew Liveris would be executive chairman.
The merger, one of the biggest of the year, would allow Dow and DuPont to rejig assets based on the diverging fortunes of their businesses.
The companies have been struggling with falling demand for farm chemicals due to slumping crop prices and a strong dollar, even as their plastics businesses thrive thanks to low natural gas prices.
Activist investor Nelson Peltz of Trian Partners, who has pressed DuPont to separate its businesses, said he "fully supports" the transaction and sees the combination as "a great outcome for all shareholders."
DuPont said it expects 2016 sales growth to be "challenging," due to economic weakness in agriculture and emerging markets. It plans to slash about 10 percent of its work force and take a pretax charge of $780 million.
The two chemical majors felt compelled to combine because of few growth opportunities, said Key Private Bank analyst Rob Plaza.
"I think the big catalyst would have been Breen coming in, his track record of extracting value from companies, and the fight that DuPont had gone through with Nelson Peltz," Plaza said. "We may see more consolidation."
"GAME-CHANGER"
DuPont, which is 213 years old, makes products used in petrochemicals, pharmaceuticals, food and construction. Its brands include Kevlar and formerly Teflon, now part of Chemours Co (N:CC), which it had spun off.
The 118-year old Dow makes plastics, chemicals, hydrocarbons, and agrichemicals. It manufacturers Styrofoam insulation products and chlorine products, used in paper, pulp and soap. Dow also will assume full control of silicone products maker Dow Corning, its joint venture with Corning Inc (N:GLW).
The three-way split was likely to occur 18 to 24 months after the deal closes, which is expected in the second half of 2016, the companies said.
"This transaction is a game-changer for our industry," Liveris said in a statement.
The union would generate cost savings of about $3 billion in the first two years, with $1 billion in other savings possible, Dow and DuPont said.
The new board would have 16 members, with each company contributing eight directors, the companies said.
The biggest of the three new companies by revenue would be material sciences, catering to the packaging, transportation and infrastructure industries and competing against Germany's BASF (DE:BASFn), Honeywell (N:HON) and 3M (N:MMM). The new company's combined 2014 revenue was about $51 billion on an adjusted basis.
A speciality products company would sell materials to the electronics and communications industries as well as to the safety and protection sectors. The combined adjusted revenue was about $13 billion in 2014.
The third business, selling seed and crop protection chemicals, generated adjusted revenue of about $19 billion.
"VERY SUPPORTIVE"
The proposed merger puts pressure on rivals such as BASF and Bayer AG (DE:BAYGn) to consolidate as falling crop prices curb sales.
"The biggest impact will certainly be in the agriculture market, where the seeds and crop chemical industries are to undergo rapid consolidation," SunTrust's Sheehan said.
It could also prompt a renewed flurry of takeover bids for European rivals, with Syngenta AG (VX:SYNN) the most likely target.
Monsanto Co (N:MON) may take another shot at Syngenta, according to analysts. It abandoned a $45 billion offer for the Swiss company in August.
Monsanto said Friday it would not act rashly and likes its position in the marketplace.
Rivals such as Bayer, BASF, Solvay SA (BR:SOLB) and Eastman Chemical Co (N:EMN) might benefit in the near-term while Dow and DuPont integrate, said Nomura analyst Aleksey Yefremov. He noted the two companies' cultures differ, with DuPont more "research and growth-driven" and Dow focused on tight cost controls and reasonable innovation.
"There is a big execution risk," Yefremov said. "It's a very large transaction."
One DuPont shareholder described the deal as merely "OK."
"Our initial take is, given the commodity nature of Dow's business and the resulting low barriers to entry, the valuation is not obviously attractive," said Grayson Witcher, portfolio manager at Mawer Investment Management Ltd.
DuPont, part of the Dow Jones industrial average, fell 5.6 percent to $70.40 on Friday. Dow Chemical was off 2.4 percent at $53.61.
REGULATORY SCRUTINY
U.S. antitrust enforcers will not look at the deal as a simply a combination of two conglomerates but examine their many products to determine where competition will be lost. Regulators will be especially concerned about the agricultural sector, which could see big divestitures, antitrust experts said.
It's hard to know whether the fixes would work," said John Taladay of the law firm Baker Botts LLP.
The U.S. Department of Justice should block the merger, said Wenonah Hauter, executive director of Food & Water Watch, an environmental group.
"Any merger that consolidates this market into fewer hands will give farmers fewer choices and put them at even more economic disadvantage," she said.
"The (seed) market is already dominated by Monsanto. You're almost creating duopoly in the market, and that's a problem," said Diana Moss, president of the American Antitrust Institute.
The Senate Judiciary Committee, which has jurisdiction over antitrust policy, will listen to farmers' concerns, Chairman Chuck Grassley said in a statement.
"DuPont and Dow are two titans of American industry and the proposed merger demands serious scrutiny," he said.
Klein and Co, Lazard and Morgan Stanley (N:MS) are Dow's financial advisers. Evercore and Goldman Sachs (N:GS) are advising DuPont.
(This story corrects paragraph 17 to say Dow Chemical will assume full control of Dow Corning, not buy the remaining stake in the joint-venture; the error appeared in earlier updates)