Dow Pbb

Dow Chemical By Kai Draaisma Laurens de Blij Diedrik Oost Eva Sloff Lesley Flohil 13-11-2012 Duisenberg School of Finance Executive summary 1. Summary of Facts. With an annual receipts of $20. 2 billion Dow held the leading commercialize position worldwide in ethylene and polyethylene (exhibit 1b). To consolidate all of Bahia Blancas polyethylene activity low Dows control a three-stage plan was developed. The first stage involved victorious control of PBB, the second stage involved acquiring Polisurs devil polyethylene rigs, and the third stage involved building a new ethylene cracker.To determine a proper dish out a chance premium Dow had to consider achievable country trys. Currency and government policy jeopardy may have had an impact because of possible future crises and changing government policies relevant to foreign investments. Furthermore, because of the conclusion of the convertibility law Dow in affixition had to consider a possible exchange-rate risk. Dow cr eated a holding corporation, Dow Investment Argentina, to invest in the project, then they had to decide whether they exit use usual corporate funds or raise debt for the PBB bid. 2. Statement of problem . 1General analysis Rational for Acquisition of PBB Dow Chemicals corporate strategy is to look for horizontal- and plumb integration, achieve technological leadership and gain inter content front end. Dow entrust benefit from a more integrated production process by lowering their apostrophize of production. PBB go away also create stable supplies of ethane for Dow allowing them to achieve operating rates near 100%. Cracking ethane in the region will result in lower operating risk for Dow meaning the supply/input risk for the production of Polyethylene.An add in the production output of Dow will allow them to benefit from economies of scale. Overall Dow will gain technology leadership and operational excellence from adding PBB to their company and enhance them with a costle ader position in the market required to compete with the government-subsidized chemical complexes. bump measurement In this section we provide a brief risk analysis. Table 1 is designed to institutionalise a compact overview of the different risks, possible mitigating actions and whether the risks be integrated in the cash flow or discount rate.Not every risk was applicable in the acquisition of PBB. The risk that influenced our cash flows the most is the currency risk caused by a possible liquidity crisis in Argentina. Argentina has experienced eight study currency crises (tijd/reference)and there is a risk of a new currency crisis in the future. When this happens, Dow will not be able to sell its output to the position country and will have to increase its export. Revenue de We have also shoot downn into account that the convertibility law that now provides stability could eventually stop. This will also have a substantive impact on inflation. run risk is the second risk wi th a large impact on projected cash flows. This is generally the risk of not collecting the full operating capacity. For the first 3 years we keep the operating rate of the plant at 65% and from 1995 we increase the operating rate by 5% each year. Other risks had less of an impact on our cash flows. Information risk was less of an issue because Dow was already present in Argentina and PBB was important to the government of Argentina. Corporate Governance risk in Argentina is not expected to have a signifi stomacht additional impact on cash flows.This risk is already included in the discount rate for similar projects in the US. Table 1 Risk overview Risk Mitigating actions Cash Flow (CF) or Discount rate (DR) putrescence risk 1. Have a large bank loan from a national bank. 2. Government stake of 49% here is a mitigating factor DR Expropriation risk Same actions as for corruption risk CF (tax wil increase 5%) run risk (only post/ completion risks ) n/a CF Sovereign risk Through t he convertibility law, the peso has been anchored to the USD to prevent hyperinflation. DR Currency/ Foreign exchange risk 1.Dow is a well diversified investor, therefore this should be mitigated. 2. Buy put options on the Arg peso. CF Corporate Governance risk Give shares to management to set incentives. DR Repatriation risk Current political climate is stable, not likely that Arg will impose limits on fund outflows. DR Information Risk Dow Chemical already has presence in Argentina, therefore are more likely to receive high quality selective information. n/a Adjusted discount rate All risks that are not used for adjusting cash flows are integrated in the adjusted discount rate.These risks include but are not limited to corruption risk, information risk, hyperinflation, sovereign risk, repatriation risk and other residual risks. These risks are partly mitigated, however all the different risks combined constitute a premium which we will add on to the the given discount rate for similar projects in the US of 8%-10%. A reasonable assumption for the combined premium will be . The auumed premium results in a discount rate of which we will use in our further valuation. 4. Recommendation Bidding decisionCompeting bidders strike to comply with certain covenants (exhibit 6). Competitors Perez Companc S. A. and Copesul do not comply with the requirements of having a statement of net worth of at least 5 billion. Even if the two companies would merge they do not meet the the requirements. This makes Dow the sole bidder for PBB. This has a profound impact on the internal valuation. Appendix 1 Risk Information risk. When you are doing a cross-border valuation you have to take into account that there may be information risk.This includes the risk of outside investors getting the wrong information because of poor disclosure in the monetary statements. provided since Dow entered Argentina in 1957 we assume they are familiar with the market and accounting rules, therefore information risk for this project is low as Dow chemical has already collected country experience in Argentina via Dow Quimica. Because this is difficult to quantify we have taken this into account in our discount rate. Corruptionrisk. The risk of corruption includes the vicious payments and favors outside the rule of law.Corruption exists to some extent in all countries, but there are large differences across countries. According to the Global Corruption king by Transparancy international, the level of corruption for Argentina in 1995 was given a 5. 24 out of a possible score of 10. This gave them a ranking of 24 out of 42 countries surveyed. All of which were assumed to be developed countries. However, Dow somehow secured itself thanks to PBBs importance and the Argentine governments intention to keeps 49% which is an advantage and not a disadvantage.The Argentine government will also appreciate the jobs being created in the later project stages, if successful, and a g ood kin with the government willlikely also be beneficial when discussing with YPF about long-term ethane supply. Mitigation Part of this risk seat be mitigated by taking a loan in Argentina to finance the project as the government will not want Dow to default on their debt resulting in an boilers suit bad outcome for Argentinas economic situation. Furthermore part of this risk is mitigated as the government has a stake in the company so it is also in their interest to keep the company strong.Currency risk As Argentina has experienced 8 major currency crises in the departed there is the risk of a new currency crisis occuring in the future. Even though the convertibility law took away some of the risk, Dow will still have to fall apart in mind that when a crises happen, they will not be able to sell their output to the home country and will have to increase its export. This risk is taken into account in the cashflows. Expropriation risk. Political instability or expropriation is small as they company has had a stable democratic government past 12 years.However, changes in the policy of the government will cause a risk for Dow and their foreign investments. At that moment there were no restrictions on borrowing abroad and there were no limits imposed on payments of foreign loan principal and interest. If something changes in this regulations it may have an effect on the acquisition of Dow. For this reason we will also include this risk in our discount rate. Furthermore the government has no limits on cash flows going out of their country but can eventually decide to do so.We consider the risk of the government taking over the company to be low as the production of polyethylene and filiation ethylene from hydrocarbon crackers is complex. This is a process for skilled people and not just anyone can therefore run the company properly. The risk of expropriation is therefore low. As the production of ethylene and derivatives such as polythylene is a highly com plicated process, requiring large captial investment and a high operating leverage, not many companies will be able and willing to take over the business.Furthermore as Polythylene is a commodity product that trades globally with a narrow price range. MitigationDow can decrease the risk mental picture by taking on a loan in Argentina to finance their project. This will decrease the risk exposure as Dow can only default on their debt when the government decides to raise taxes, which will not lead to a company default. Foreign Exchange arrange Risk. Foreign Exhange rate risk will be low because of Dow Chemicals international presence and the assumption that shareholders are sufficiently diversified. The convertibility law which ensured a fixed Argentine peso and U.S. dollar at exactly one already decrease the foreign exchange rate risk. However we need to take into account the risk that the convertibility law might come to an end. Mitigation The risk can be decreased by setting up b inding financial contracts with the governmetn to make sure the deal will happen. Furthermore Dow could decide to place a put option on the peso to protect themselves when the peso collapses. Operating risk Pre-completion as the project is already completed there is no risk concerning the technology risks or other completion risk.Post-completion we have included the post-completion risk in our cashflows as we run the risk of not meeting the full operating capacity. For the first 3 years we keep the operating rate of the plant at 65% and from 1995 we increase the operating rate by 5% each year. As the company provides their own input this risk does not need to be taken into account. Operating risk would likely matter but we handled that risk by adjsuting down our casfhlows in stage 1 so we do not take it into account for adjusting our cost of capitalSovereign risk Politcal events suchs as wars, labor strikes, terrorism and changes in laws can happen in any country you wager with and therefore needs to be taken into account. Since it is hard to quantify this risk we have handled it through the discount rate. Appendix 2 Source Erb, Harvey Viskanta, Poltical risk,Economic risk and fiscal risk, Fuqua School of Business Working Paper No. 9606, 1996. 1 . For broader news report of the different risks see Appendix 1 2 .According to the Global Corruption Index by Transparancy international the level of corruption for Argentina in 1995 was given a 5. 24 out of a possible score of 10. This gave them a ranking of 24 out of 42 countries surveyed. All of which were developed countries more or less. Source http//archive. transparency. org/policy_research/surveys_indices/cpi/previous_cpi 3 . See Appendix 1 for an explanation of the mitigating factors of the before mentioned risks 4 . This conclusion was reached byTaking the total assets as net worth on the financial statements of Perez on Copesul (exhibit 8a &8b).