DuPont – Now the Real Story Can Unfold
Last night DD took the logical, what we had referred to as default, route to separate the company in two. Shareholders will see a stock split sometime in the next 18 months and will hold shares in the new Performance Chemical company as well as the residual DuPont. This move allows DuPont to control the mechanics of the divestment and minimize any tax implications and the reality is that it would have been very difficult to get an accretive cash sale here.
As we have written in prior research, this move fully commits DD to its innovation and science driven strategy. The success (or failure) of DD from here will depend almost entirely on whether the company can deliver profitable growth from its “integrated science” approach to agriculture, nutrition and materials. The opportunity for the stock and for shareholders comes from the lowering of volatility and increased margins and returns on capital – resulting in higher earnings growth. The question now is whether DD can deliver. This divestment is a clear statement that company believes that it can.
Longer-term the actual growth rate will determine the value of the residual DD, it will either be great or it won’t. Shorter-term a lot will depend on a couple of releases of information from the company. The first will be the pro-forma financials for the residual DD and what the last few years have looked like on a fully broken apart basis (assuming we are given the history). We can estimate this from the accounts and earnings reports, but there will be some debt and other corporate cost allocations between the two entities which may make a difference. Given that we would expect Performance Chemicals to be reported as a discontinued business going forward, we should get that data soon.
The second release may or may not come, but we think it is needed and we have pushed the company for it. We would like to see DD produce more granular information on the returns they are seeing from their R&D initiatives. As we have written in prior research (and not only targeted at DD), we think that the “sales from products introduced in the last X years” metric is useless. It does not factor in how much of the new sales cannibalized old sales (product upgrades/line extension, etc) nor does it give any measure of what it cost to get those sales – in other words whether the R&D has created shareholder value. To be fair, it is not easy to come up with something which you are comfortable disclosing, which is meaningful, informative and repeatable, but we would encourage the company to try.
Our view is that the residual DD could trade at a meaningfully higher multiple and in the text below we repeat the analysis we published in July – the exhibit has been updated, as has the math given the higher normal value based on the higher multiples for the broader market.
Our initial suggestion of potential value is based on a very simplistic approach and assumes that there are no tax consequences of the separation. So please treat it in the illustrative manner for which it was intended:
- Our normalized value for DD today is around $67 per share
- Today the company is trading at the market multiple, though historically it has been higher (see Exhibit).
- The chemicals business is around 20% of the company and all things being equal would likely trade at a relative multiple of around 0.9x (worst case – it would be compared to commodity names but has much higher base earnings).
- The residual would likely trade at a worst case 1.15x relative multiple (PPG is at 1.25 today) – best case would be 1.50 initially; unless the EPS growth rate accelerates quickly (MON has a 10 year average relative multiple of 1.75).
- At the low end you would have a proportional multiple of around 1.1 – generating 10% upside from normal value – target price $74-75.
- At the high end you would get a proportional multiple of 1.38 – 38% upside from normal value $90-95 per share.