DuPont: Is Some Sort of Breakup Now More Likely? We Would Own DD and DOW
With the exit of Chair and CEO, Ellen Kuhlman, and the interim replacement of Ed Breen, there will be lots of questions about; why so sudden, why Ed, why not Jim Gallogly and what comes next. One could take the negative position and be concerned that, given how long DuPont appears to have had its head in the sand, it may not know which way to turn now its eyes are open. We think this is unlikely, given that a number of alternate routes were discussed through the discussions with Trian over the last 12 months.
It is possible that there is a plan already and that the departing CEO did not like it, hence the change. If that is the case, we would guess that the plan goes back to Trian 1.0 and involves some sort of break-up. Recall that Trian’s initial position was that it might not be possible to achieve the cost cutting necessary at DuPont without breaking the company into smaller parts. Ed Breen, although labeled as “interim”, has quite a lot of experience in divestment strategies and this may be why he is now in the hot seat. If you look back at our recent work on DD and on the Ag space, you will see that we are big fans of the DOW/DD Ag deal and have been for years. The more we talked around the industry and with investors it is possible that the only people who did not like this idea (perhaps until now) was DuPont. We think that a further round of consolidation in Ag is inevitable and that the first deal will likely be the most value creative.
Whatever the revised strategy at DD, it has to address the following;
- The chronic underperformance of businesses that are labeled as “specialty” and differentiated
- DuPont can point fingers are currency, but others with similar exposure are doing better
- The terrible R&D productivity – as outlined in our recent thematic on R&D
- The very bloated cost base
- We stand by our estimate of 18 months ago that there is easily $3.0bn of costs that can be taken out of DD and that the company can drive significant EPS growth just through cost reduction
- As discussed above – what to do about Ag
DuPont is a complex business to analyze and is probably a very complex business to manage and so perhaps the break-up route is the more obvious. While we have talked about an Ag deal with DOW, there is probably a more ambitious and broader deal to be done with DOW, creating a large commodity company and a large specialty company and a large Ag company, but we may be stretching here!
DuPont’s stock is no longer expensive, although more expensive than it was a week ago. The negative revisions are concerning, but not unexpected and we would not change our “normalized” earnings view for the company – which is $3.63 today. It is a leap of faith to buy the stock today, but we still believe that Trian was right and that there is a $100 stock hiding in here somewhere! The path to $100 is difficult, but the change made yesterday would probably not have happened unless there was a fresh perspective and continued outside influence/advice.
The Chemours risk has not gone away. We do not think that the troubles in TiO2 are over, and we are very concerned that free cash flow at Chemours will drive a covenant breach and a debt downgrade – whether there are any large shareholders left, who took the stock at the spin and could therefore mount a fraudulent conveyance action, is unclear. If DD had to buy Chemours back – which is a worst case – it would not knock more than 10% of any possible target price.
We would own DD here, but we would probably also own DOW, now that the chlor-alkali piece is gone and with the Middle East project about to start-up. Both DOW and DD stocks would react well to a well-constructed Ag deal.