Remaking Dow and DuPont for the Activist Shareholders

Deal Professor

By STEVEN DAVIDOFF SOLOMON    DEC. 15, 2015

The proposed combination of Dow Chemical and DuPont shows that in today’s markets, financial engineering prevails and that only activist shareholders matter. Whether that is good for the rest of us remains to be seen.

The merger is certainly an impressive feat of financial engineering. It will bring together two companies: DuPont, with 54,000 employees, and Dow Chemical, with 53,000 employees. The two behemoths will merge, and then in the space of two years spit out three newly formed companies, one in agriculture, another in material sciences and a third in specialty products used in such fields as nutrition and electronics.

This plan is one easily understood by a hedge fund activist or investment banker in a cubicle in Manhattan with an Excel spreadsheet. To them, it makes perfect sense to merge a company and then almost immediately split it in three. Doing so will meet the goal to define business lines with precision and, it is hoped, spur growth. Expenses can also be cut, on paper at least.

The companies that the combined entity will create can cut $3 billion in expenses, but the last time I checked, three companies each require a chief executive, general counsel and many other executives, so these savings may be eaten up by new overhead.

The problem, of course, is that putting together two companies and then splitting them almost immediately is no easy task. These are people and businesses being moved around and the logistics of integration alone may take years to work out.

Pushing babies out into the world almost immediately seems to be asking for trouble. There will also be significant costs for the employees, suppliers and customers of all the companies involved. Whether this will create value for shareholders is up in the air, let alone whether this will create value for everyone else.

DuPont’s last spinoff, Chemours, a performance chemicals unit, has been a disaster, losing three-quarters of its value in less than a year after its separation.

Nonetheless, it appears that the Dow Chemical chief executive, Andrew N. Liveris, initially proposed a split back into two companies, but Edward D. Breen, the chief executive of DuPont, countered with three. So it goes.

Given the risks involved, one wonders why the companies would commit to this. The reason is those activist shareholders.

Today, shareholder activist hedge funds roam our capital markets. They are willing to agitate vocally for change at almost any company. And in many cases the hedge funds are looking for a crystallizing event to capture more immediate value. A sale is the best option. But outside that, a spinoff has become the transaction du jour.

In either case, the funds and other shareholders are for the most part not looking to do the hard work of a turnaround, but instead perform some financial engineering. Whatever an analyst with an Excel spreadsheet can do is what companies seem to be plunging headlong to mimic, paying heed to their shareholder masters.

And the spinoff is the ultimate financial engineering exercise.

The idea behind a spinoff is that one plus one equals three. A spinoff allows the company to be more focused and deliver more immediate value. Rather than having a company sell two product lines, management can be more transparent and focus on the line they are better at. In addition, high-growth and low-growth businesses can be separated.

That’s the theory at least. In practice, studies have shown that spinoffs produce short-term gains but over the longer term may not be as successful. Moreover, spinoffs are often seen as a chance to take out the trash and jettison liabilities. Time Inc., for example, was spun off from Time Warner with substantial debt and has struggled significantly since its spinoff.

Still, these splits are all the rage and there were 60 last year, according to spinoff research. Even Hewlett-Packard, the granddaddy of Silicon Valley, has split into two companies: a low-growth HP Inc. and a high-growth Hewlett-Packard Enterprise Company. EBay and PayPal are now also separate. From General Electric to Yum Brands, corporate America is marching to the spinoff piper.

For those who study history, it feels a lot like the go-go years back in the 1960s. Only then, companies raced to become conglomerates, under the theory that diversification was the key and that managerial talent could be brought to bear anywhere. Now, it is the opposite, and companies are being atomized. Those go-go years, by the way, ended badly.

Despite the iffy empirical support and the bubbly atmosphere behind them, spinoffs persist because companies, frankly, are scared, and shareholders are much more powerful than they have ever been.

Today, institutional shareholders like BlackRock, T. Rowe Price, Vanguard and a handful of other companies often hold almost a majority of a public company. And many of these institutional investors pay heed to proxy advisory services like Institutional Shareholder Services, meaning that these shareholders often vote as a group. Increasingly, institutional investors are throwing their support behind the activists.

So far this year, hedge funds have won 59 percent of the proxy contests they waged, according to FactSet SharkRepellent. Now the mantra in corporate America is to settle with hedge funds before it gets to a fight over the control of a company.

And companies are running scared. Much was made of DuPont’s victory over Trian in a proxy contest. But now it is clear that it was a Pyrrhic victory. The chief executive of DuPont at the time, Ellen J. Kullman, is now gone.

DuPont did much of what Trian wanted anyway, and now Trian, which holds only 2.9 percent of DuPont, is a cheerleader for this merger.

Similarly, Dow Chemical had been a target of Daniel S. Loeb’s Third Point. While Mr. Loeb is supportive of the merger, he also sent a letter to the Dow Chemical board protesting the continued role of Mr. Liveris at the merged company. Mr. Liveris may have felt the need to do something to placate the activists by doing this deal, but in any event, it is now hard to see him surviving the wrath of Mr. Loeb.

When historians look back at this era, they will see this deal as a turning point when corporate leaders threw up their hands and surrendered to activist shareholders.

Is this a good thing?

The Dow-DuPont merger may create more value, but the risks are high. In the boardrooms and cubicles, these risks appear to be acceptable, because they are just items on a spreadsheet.

In real life, however, this series of complex transactions may end up harming not just shareholders but everyone else involved in the corporate enterprise.

To be sure there is valuable activism out there, but perhaps it is time to take a deep breath and do some thinking about whether the spinoff craze and indeed the relationship between companies and shareholders makes sense before it ends badly, like those go-go ’60s.

Steven Davidoff Solomon is a professor of law at the University of California, Berkeley. His columns can be found at nytimes.com/dealbook.

A version of this article appears in print on December 16, 2015, on page B5 of the New York edition with the headline: Does a Deal Have the Right Chemistry, or Is It Just Financial Engineering?

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