DuPont/Tronox – The Math Says Yes – The Rest Says No

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There is recent speculation that DuPont may explore a reverse Morris Trust (RMT) option as a means of divesting its performance chemicals, with Tronox as the “acquirer”/partner.  It is understandable why there would be such speculation – Tronox is the right size from a corporate perspective and has significant NOLs which the combined entity could utilize.

Financially, the deal looks very interesting.  The RMT would allow DuPont to exit a business with almost no tax basis in a very tax efficient way, effectively buying back stock or receiving cash or both as a consequence of the exit.  Separately, Tronox has around $1.5bn of potential NOL’s in the US.  Alone Tronox will not generate enough US EBIT to make use of these NOLs and they have been viewed as of more limited value (though not zero) to the company since its restructuring in 2011.  A combination with DuPont’s performance chemicals business would create a large enough stream of US EBIT to make full use of the NOLs, as DuPont’s business is profitable even at the bottom of the TiO2 cycle.  The business had global operating income of $2.1 billion at the peak of the TiO2 cycle in 2011 and almost $1.0bn in 2013 at what will likely be the trough (though it may be repeated in 2014).  This EBIT is biased towards the US where DuPont has the greatest cost advantage in TiO2.

So financially this is certainly worth looking at.  If you gave a $1b of the NOL’s to DD shareholders through the valuation of the deal it would add around 1.6% to DD value.

This assumes that DD is neutral to the RMT versus a spin or split (the current path).  Financially there are likely other benefits from the combination in terms of head office costs, SGA and R&D.  If we assume that all $200m of Tronox costs could be avoided this would likely sway DD in the direction of the RMT.  This does not include the intangibles of a consolidation move within TiO2, but this is where we start getting into the problems

Would the deal be allowed? 

Huntsman announced its proposed acquisition of Rockwood’s business in September of 2013, with an expected early 2014 close.  The deal is still being reviewed by the European Commission and clearly the argument that the real competition is now coming from Asia is not having much success.

If the HUN/ROC deal is approved in Europe this would make things more complicated for DD/TROX, as both have European assets and the European Commission would review the deal in the light of a now more consolidated market – i.e. HUN/ROC have first mover advantage.  If the only way this deal could get done would be through European divestments, and only after a long review period, DD would likely take the easier and more certain route of the spin/split.

DD’s CFO has been very clear that an alternative to the spin/split needs to generate a lot more value to make it worth the extra work and the extra risk.

Who would run the business?

In our view a DD/TROX deal would only work if TROX were willing to concede control and management of the combined entity to the legacy DD management.   DD is the 800 pound Gorilla in these businesses, with the best assets, the best technology and the best product line.  While TROX also operates chlorine based technology for TiO2, the economics of the process do not match those of DD and the opportunity would come from what DD know-how could do for the TROX assets.  In addition the rest of DD’s performance chemicals portfolio is substantial and unknown to TROX.

The PPG/Georgia Gulf deal worked because Georgia Gulf (now Axiall) management was always going to remain in control.    That is not the case here, and potentially a major impediment.

Conclusion

We expect DD to look at this opportunity, assuming that Tronox management is willing to entertain the discussion.  But DD are fast developing all the data needed to put a base case fair value of the business as a stand-alone, and it is unclear to us that a deal with Tronox would trump the base case when adjusted for the risk associated with getting the deal done.

Tronox may well find a partner/acquirer who would place more value on the NOLs without the complication of trying to combine two businesses in the same, already consolidated, markets.

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