Tuesday, February 27, 2007

Memo to DOW CEO Liveras: Please Do Not Sell Out

Having wrote twice in the past about Dow being undervalued, (read them here and here) it was no surprise Sunday when I read about the possible Dow buyout offer. It was only a matter of time before Dow came into savvy investors cross hairs. I have been trumpeting the fact that Dow's current share price ($44) is way too low and it would seem others are finally noticing.

Dow Chemical will be the latest and largest firm to get a leveraged buyout offer claims an unsourced report. In the next few weeks, Dow will get a takeover bid worth up to $54 billion from a consortium of private-equity firms, the report said. Over the weekend, there were several reports of an imminent private-equity bid for Texas utility TXU valued at around $44 billion.

It said the buyout team is "likely" to be composed of Kohlberg Kravis & Roberts, Blackstone Group and Carlyle Group. They intend to break up Dow Chemical into smaller companies, the report said. An offer is expected to come in at $60 a share, against Friday's close of $43.45, the report added. Unnamed "speculators" believe the break-up value could be up to $80 a share, it said. Dow Chemical, the top U.S. chemicals maker, is a component of the S&P 500. A message left with the company wasn't immediately returned.

I believe the $60 price is just a starting point for the fair value price for Dow. But, while the buyout, should it go through would provide a nice immediate return to the ValuePlays Portfolio and improve our already S&P beating returns, I for one hope it does not come to fruition. Why? I believe the true value of Dow long term is multiples of the $60 reported price tag. $60 is the floor where Dow should be trading at today just to reflect a fair valuation based on it's current results. At $60, Dow would trade at roughly 15 times earnings which is in line to the premium given other chemical companies like Dupont (DD). That makes $60 a level where as a value investor I would expect shares to find themselves soon enough as they realize their value, not a price I would expect a buyout offer. When I add in the almost 4% annual dividend, the price of Dow shares for any buyout in order for me not to be disappointed would be well over $70 each.That, I beleive would be a price that would be hard for management to turn down. As a consolation for losing my Dow shares in that scenario, at least I would be able to purchase more of current ValuePlays Portfolio pick Owens Corning (OC), which I feel is the most undervalued of our holdings (talk about a takeover target?). I find $70 unlikely though as is places the buyout at almost $70 billion.. too much.

For long term investors like me, we want to own Dow for the next few decades, not months. A transaction that takes it private only provides me a fraction of what I intend to earn holding this stock. These going private buyouts only really benefit the short term traders and management, not us long term folks. I am very excited about my Dow investment and more than comfortable in both the current situation and future direction CEO Andrew Liveras has position it for success. I would be very surprised and more than a little dissapointed should he consider any offer below $70 for Dow.

Then again, this could all be rumor and have no basis in fact. But, even if it is baseless, you seldom see buyout rumors for companies that are over or fairly valued. This gives more credence to our claim Dow is undervalued and in store for significant share price advances in the future. Once these rumors get out there people invariably begin taking a closer look at the company and other potential suitors will surface in the rumor mill. Once they do, my feeling is they will be pleased and so should us investors as their buying will boost our shares.

The ideal scenario would be the rumor is valid, the bidding begins driving the stock up to fair values and management does the right thing and does not sell out. Of course the stock price will recede from its highest levels but these things tend to settle in the end above their pre-rumor prices.

Either way, one thing is true, when you own undervalued shares in a buyout hungry market like we have today, it does make for a fun ride....

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