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The Dow-DuPont megamerger: A deal only Wall Street could love

A sign at the DuPont Chestnut Run Plaza facility near Wilmington, Delaware, in 2012. (REUTERS/Tim Shaffer)
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Two of the country’s oldest companies, Dow Chemical and DuPont, have long served as the backbone for American scientific ingenuity in the modern age. Their armies of chemical researchers are the reason soldiers wear Kevlar and homeowners buy Saran Wrap, Teflon-lined pans and Ziploc bags.

But the $60 billion titans’ latest feat of engineering is a financial one: a potentially historic megamerger focused less on long-term innovation and more on cost-cutting and short-term gain. The result, Wall Street watchers expect, will be mass layoffs, dramatic corporate changes and an abrupt belt-tightening of research budgets that would irrevocably change the face of two American greats.

The companies are reportedly far along in negotiating to combine their vast operations into what could be the world’s second-largest chemical giant, one of the biggest corporate mergers in a record-setting year for mega-deals. Once joined, the companies are expected to split again, into three conglomerates focused on agriculture, materials science and specialty products.

Spearheaded by activist investors, the combined deal would join together companies worth almost $120 billion and lead to billions of dollars in slashed expenses and “cost synergies.” Dow and DuPont together employ 113,000 workers worldwide, including at their expansive Michigan and Delaware headquarters, and the corporate marriage would allow the resulting company to lay off workers whose roles overlap.

The merger, which could be announced as early as Thursday, could still easily fall apart if the companies’ dealmakers back out or antitrust regulators crack down. DuPont declined to comment on the merger, and Dow did not return requests for comment.

Founded in the 19th century and named for their chemical pioneers, gunpowder maker E.I. du Pont and industrialist Herbert Henry Dow, the companies now produce, refine or research materials used in food, cars, film, pharmaceuticals, electrical and industrial machines.

Long before Silicon Valley was known as the capital of America’s fail-fast-fail-often inventiveness, Dow and DuPont were some of the leaders bringing new creations to the market. Dow’s research has revealed chemicals for everything from sunscreen to Scrubbing Bubbles. DuPont scientists — particularly those at Experimental Station, home to some of the most vital discoveries in modern chemistry — have rolled out chemicals used in Corian home countertops, Mylar balloons, Teflon nonstick pans and Neoprene synthetic rubber, used in knee braces, car fan belts and laptop sleeves.

The companies made more than $7 billion in net income, and $93 billion in revenue, last year on the vastness of their empire. Together, the companies would sell 17 percent of the world’s pesticides, 41 percent of America’s corn seeds and 38 percent of the country’s soybeans, Morgan Stanley analysts said.

Both firms have been dogged by activist investors who clashed with the companies’ chief executives, and the overturning has drawn comparisons to “Barbarians at the Gate,” the book on how corporate raiders took over RJR Nabisco conglomerate in the go-go Wall Street of the 1980s.

DuPont saw Nelson Peltz’s Trian Partners sparring with chief Ellen Kullman, a defender of the company’s research and development as its main engine for future growth. Peltz argued DuPont’s billions of dollars invested in research in recent years wasn’t producing enough in returns: DuPont’s cash flow this year is expected to drop by a half-billion dollars over last year. In October, under pressure, Kullman left the company, and the Dow-DuPont deal appears to fall in line with the push she had so long fought.

Dow chief Andrew Liveris battled with activist Dan Loeb’s Third Point, which pushed the company to spin off its petroleum chemical business. Dow spends billions on research and is expecting to pocket $400 million in cash from its operations this year, and the company’s stock rose 11 percent this year even before the merger news. But still, investors believed the company was missing out.

Investors were optimistic about the possibilities. Stock for both Dow and DuPont climbed Wednesday about 12 percent.

For traditional American companies, generating “organic” growth — innovating, making better products, expanding, repeat — can be slow, expensive and uncertain, particularly in a world economy as tottering as this one. Dow and DuPont have been slowed dramatically by a strong dollar and an international economic malaise.

Activist investors like those interested in Dow-DuPont are more interested in lowering risk and increasing reward, and that doesn’t always include research. DuPont’s agroscience business of seeds and pesticides eats half of the company’s research money but gives back only a third of its revenue. The companies have in recent years shifted focus from less-profitable oil-based materials, like the paint on your car or the epoxy on your sandwich bags, to specialty products with a greater upside.

But there are benefits to focusing investment on experimentation into smaller core companies, said Ben Gomes-Casseres, a professor at Brandeis International Business School and author of “Remix Strategy,” a book on business combinations.

“What do you get for the large traditional R&D approach? You get less and less,” he said. “In fact, we know that large corporate R&D functions have been on the decline, and the innovations are coming out of startups. … The underlying notion that we need large corporations, doing large R&D in aggregated centers of research, is under attack in every industry, from pharmaceuticals to chemicals to computers.”

Cheap debt and a slow-growing economy has helped fuel a record year for mergers and acquisitions. Deals across the globe have reached more than $4 trillion so far this year and $2.12 trillion in the U.S., according to data company Dealogic.

Antitrust cops will likely be all over the combined industrial conglomerate, largely because DuPont and Dow already operate in a highly consolidated market.

“Acquiring your way to market dominance … without the government enforcing the antitrust laws is a way to crush the market-based system,” said Diana Moss, president of the American Antitrust Institute. “You put another merger in the mix, farmers are going to pay the price for that.”

Regulators are already looking at several big deal across various markets. The Justice Department is already investigating whether the country’s biggest airlines have colluded to keep airfares high after mergers and bankruptcies cut the number of major U.S. airlines from nine to four over the past decade. The department also must rule on two major deals that could remake the health care industry — Anthem’s $48 billion deal to buy Cigna Corp. and Aetna Inc.’s $35 billion deal for Humana. Those mergers would shrink the number of large U.S. health insurers to three from five.

“Antitrust enforcement in health care should aim to prevent or remedy the acquisition and abuse of market power, just as it does in other industries,” Assistant Attorney General Bill Baer said last month at a health care conference. “Our job is to block mergers that threaten to reduce competition.”

The Justice Department has already helped scuttle several high-profile deals this year, including Comcast’s $45 billion acquisition of Time Warner. And earlier this week, General Electric abandoned a deal to sell its appliance business to Electrolux of Sweden after facing regulatory resistance.