Loeb To Dow: You’re No LyondellBasell

In an investor letter, Daniel Loeb, who heads the hedge fund Third Point, a major Dow Chemical shareholder, gave his constructive critique of Dow's strategy. Dow, he says, should be earning $2.5 billion more than it currently does. The letter was by no means scathing. He praised Dow's share buyback program. He acknowledged that Dow has pledged more transparency, but he wants to see more. Specifically, he wants Dow to disclose its transfer pricing methodology between its petrochemical units and its downstream derivatives businesses. Without this, it is impossible to tell whether the Eeedstocks and Energy segment is subsidizing the Performance Plastics segment. In other words, where is the company really adding value? And overall, Loeb says, Dow isn't adding enough value. And whom does he compare Dow to? LyondellBasell: "Dow has ~30% more North American ethylene capacity, triple the Middle Eastern ethylene capacity, and more North American derivatives capacity than Lyondell, yet the two companies generate the same amount of EBITDA in their respective petrochemical businesses," Loeb wrote. (Both first have about $6 billion.) Loeb also analyzed Dow's capacity against industry average margins and probable feedstock slates to get at the $2.5 billion figure. (LyondellBasell was close to being right where it should be.) Loeb isn't a big fan of Dow's strategy of integrating its petrochemicals might with downstream derivatives. This means Dow needs more people, administrative expenses, R&D, facilities, etc. "Dow's headcount is ~2.5 times more than Lyondell's, which is not a reflection on poor efficiency, but rather that Dow is engaged in numerous downstream derivatives that Lyondell is not," he wrote. He wasn't finished. "Given Dow's decision to exit chlor-alkali, it appears that Dow believes that its Ag Chemicals and Ag Biology businesses do not derive value-add differentiation from chlorine integration. We take this one step further and question whether Dow's specialty segments need ethylene or propylene integration." Loeb makes some good arguments. The transfer pricing point to me is most intriguing. I wonder if the company squanders value by dipping into its presumed feedstock subsidies by underselling rivals. The ability to do that would strike me as a temptation that's hard to resist. I also wonder if a possible solution is for Dow to throw its U.S. crackers into an master limited partnership, like Westlake is doing. Problem solved.      

Author: Alex Tullo

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