The Dow Chemical "White Paper"

You know, I have been so excited waiting for this thing. Is there something wrong with me? Anyway, Dow Chemical (DOW) released the paper Friday and it did not disappoint.

The paper details the Joint Venture Strategy (JV) Dow has embarked on. How important is it and why does it matter? In 2006, the JV's accounted for nearly 20% of Dow's EBIT (earnings before interest and taxes) of $4.9 billion. What is even more important here as the US economy slows it that 70% of the JV earnings are from outside N. America where growth is still surging. When you consider this segment is going to continue to grow, a careful reading of the paper then become very necessary. Fortunately for you, I have done it.

Why the JV's? Essentially, Dow has established a number of joint ventures with upstream partners focused specifically on developing highly competitive,world-scale production facilities with access to cost-advantaged feedstocks. Dow brings technology, operational know-how, global reach and product diversity. Its partners bring cost-advantaged feedstocks, upstream expertise, local market presence
and/or regional perspective. This combination delivers a significant competitive edge to each joint venture.

Is it a wise use of cash and resources? Yes, for the last three years Dow's return on investment in the ventures has been around 40%.

To date in 2007 announced JV's include:

• In April, the Company signed a Heads of Agreement with the National Oil Company of Libya to operate and expand the Ras Lanuf petrochemical complex. The venture is a strong example of Dow’s joint venture agenda for its Basics businesses lowering capital investment while capturing the benefits of a strategic location and cost advantaged feedstocks.

• Also in April, Dow announced the execution of a Memorandum of Understanding with Chevron Phillips Chemicals, for a polystyrene and styrene monomer joint venture in the Americas. The joint venture would unite Dow’s industry-leading polystyrene activities with Chevron Phillips Chemicals’ solid position in styrene monomers.

• In May, Dow announced the start of a detailed feasibility study with Shenhua Group for the construction of a world-scale coal-to-chemicals complex in the People’s Republic of China.

• The same week, the Company signed a Memorandum of Understanding with Saudi Aramco to move further forward with the Ras Tanura chemicals and plastics production complex in Saudi Arabia. KBR was subsequently appointed as the project management company for the feasibility study.

• And in July, Dow signed a Memorandum of Understanding with Crystalsev, one of Brazil’s largest ethanol producers, to form a joint venture to design and build a world-scale facility to manufacture polyethylene from sugar cane.

Who are they?

The top JV's that account for 90% of the "equity earnings" they contribute are:

• Compañía MEGA S.A.
• Dow Corning Corporation
• EQUATE Petrochemical Company K.S.C.
• Equipolymers
• MEGlobal
• OPTIMAL Group of Companies
• SCG-Dow Group
• Univation Technologies LLC

How do you know how well they are performing?

Dow’s equity investments are classified as “Investment in nonconsolidated affiliates” in the consolidated balance sheets. Under the equity method of accounting, Dow’s investment in a joint venture is increased by: the initial investment in the venture
(which could be in the form of cash or assets); subsequent capital injections (typically cash); and Dow’s share of joint venture earnings. Dow’s investment in a joint venture is reduced by: dividends paid to Dow by the joint venture; return of capital to Dow; and Dow’s share of joint venture losses.

Dow’s share of earnings (or losses) in its equity investments are classified as “Equity in earnings of nonconsolidated affiliates” in the consolidated statements of income. Dividends received from equity investments have no effect in the consolidated
statements of income; rather they reduce the carrying value of the investment.

Dow’s consolidated statements of cash flows include the cash flow effect of dividends and other cash distributions from the nonconsolidated affiliates. Since the consolidated statements of cash flows are based on Dow’s net income, the equity in
earnings/losses of affiliates (which are non-cash) must be eliminated and dividends included. The net impact of the elimination of the equity in earnings/losses of these joint ventures and addition of dividends is included as “Earnings of nonconsolidated
affiliates in excess of dividends received” in the consolidated statements of cash flows. Other cash distributions are included as “Distributions from nonconsolidated affiliates” in the consolidated statements of cash flow.

The entire paper (23 pages) can be viewed here (PDF.)