With Wall Street still hesitant to make big bets on merger financing, corporate buyers are looking to wealthy investors such as Warren Buffett and international funds to bankroll their shopping sprees.
Dow Chemical Co, which is buying rival Rohm and Haas Co for $15.3 billion, followed the lead of candy maker Mars Inc in tapping outside investors for funding. The deal, the third-largest of 2008, includes an equity investment by billionaire Warren Buffett’s Berkshire Hathaway and the Kuwait Investment Authority in the form of convertible preferred securities for $3 billion and $1 billion, respectively. Dow has also secured $13 billion of debt financing from Citigroup, Merrill Lynch and Morgan Stanley. Dow aims to pay some of this debt immediately after receiving the proceeds from its planned joint venture with Kuwait Petroleum Corp.
The presence of outside help from Buffett echoed the agreement by M&M’s maker Mars in April to buy the No. 1 chewing gum manufacturer, Wm Wrigley Jr Co, for $23 billion. “I think that in a tough credit market you really have to be creative in finding sources to get your transactions done,” said Bob Filek, a partner with PwC Transaction Services. “It shows some of the creativity in financing. People looking at minority investors, at specialized institutions, at groups overseas, are more likely to be able to get deals closed,” he said.
The motivation to get creative with financing comes after a year of tight credit markets, several collapsed mergers, and massive writedowns by banks. Private equity firms have abandoned the $10 billion-plus transactions seen during the buyout boom, and blue chip corporations have brought in outside investors to spread the risk, even on smaller deals. With deal financing more difficult and costly to secure, US merger activity in the first half of the year dropped 29%, and private equity dealmaking dropped 85%, according to Thomson Reuters data. “You are seeing innovation here, driven by the retreat of leveraged buyout funds,” said Columbia University Law School professor John Coffee. “It is an unusual feature, rarely seen in horizontal mergers, but it is an example of a marketplace that has innovative investment bankers finding new sources of capital,” he said. “I think you will see more partial substitutes for a day a few years ago when all this could have been done by (private equity firm) Blackstone, for example.”
Although this marks Buffett’s second dose of funding help this year, some analysts see a limit to the number of times corporations can go to the same well. “The alternative sources of funding are not unlimited,” said Jefferies & Co special situations analyst Andy Baker. “There are some investors with deep pockets out there, of course, but these situations will be few and far between.” Dow has agreed to pay $78 cash per share for Rohm and Haas, a 74% premium over the stock’s closing price on Wednesday and a 24 premium over its all-time high set last year.
The deal values Rohm and Haas at 10.4 times EBITDA (earnings before interest, taxes, depreciation and amortization), well above the 6.7 multiple at which the chemical sector trades, Jefferies & Co analysts said. “If they weren’t paying such a high premium, they wouldn’t need secondary investors,” said one arbitrageur who declined to be named. “But they also may not have been able to get the Haas family investors to back the deal without paying up.”
Rohm and Haas previously had not been open to an acquisition, but it agreed to the deal after the trust for the Haas Family Group, which owns 30% of the company, decided to diversify its holdings, the company said in a conference call with investors. Dow could have afforded the acquisition on its own, but the cost of borrowing additional funds would have hurt its earnings more and changed its debt-to-cash flow ratio, Jefferies’ Baker said.
By bringing in Buffett, as well as the Kuwaiti fund, Dow lowered the overall amount it needed to borrow -- therefore reducing its borrowing costs -- and kept its debt-to-capital ratio at an investment-grade level, he said. Dow said it expects the deal to boost earnings in the second year following the closing of the transaction, and it aims to maintain its strong investment-grade credit rating. “Dow’s financial profile will clearly move to a more aggressive posture, but we expect it to be maintained at a level sufficient to support an investment-grade rating,” said debt rating agency Standard & Poor’s.
The use of funding from the Kuwaiti fund deepens Dow’s ties to that Middle Eastern country, adding to the planned joint venture. Although US politicians have raised concerns about investments by foreign funds, analysts say much of the noise is purely for show. “Largely, the concern expressed about foreign investment is political positioning,” Filek said. “There will continue to be regulatory concerns on foreign ownership of key strategic assets on the radar, but generally we live in a global financing world and that’s the reality.” (Reuters)