dove he HBS Case we will discuss takes us back to 1995; this is just a year after the devastating Mexican crisis that caused tribulations in other emerging

dove he HBS Case we will discuss takes us back to 1995; this is just a year after the devastating Mexican crisis that caused tribulations in other emerging markets. At the time Argentina was seen as a success story, as the government of Carlos Menem stabilized the Argentinean economy in the early 1990s; the country had low inflation and a fixed exchange rate against USD; while it was shaken by the Mexican crisis, it proved to be resilient. Like many other emerging market economies, Argentina is resourceful and promising; Dow executives thought they had a window of opportunity to invest in Argentina by acquiring PBB and possibly going further.  We will discuss various aspects of this acquisition in class tomorrow. Some questions we will consider are the following:

What is Dow Acquiring? Describe the target characteristics, the business, and its attractiveness to Dow.
What is the logic of acquisition from Dow’s perspective? What is the argument for the acquisition? Can the argument convince the Dow board?  Discuss the potential benefits and risks.
The cash flows for PBB Ethylene Cracker were provided in Exhibit 9a of the case.  Given these cash flows, provide a framework for valuation. What are the distinctive valuation issues in this case? For instance, is this investment riskier than Dow’s usual investments in developed economies such as UK or Germany?  What are risks that you can identify from Dow’s perspective?  How would you address them? How should these be incorporated into valuation?
How much should Dow bid for Ethylene Cracker? 
Discuss your conclusions and take away from your analysis.

 I would like you to discuss these questions in breakout groups during the class and then have the main room discussion sharing perspectives. Cross Border M&A
Dow Chemical’s Bid for PBB
Dr. Bulent Aybar
Professor of International Finance


Global M&A Transaction Volume

M&A Transaction Volume
(Billion USD)

M & A Volume (USD) 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2261.2526979781737 3363.3042840507164 3089.8987779795566 1678.6551268960079 1083.1221192684895 1239.1596671810955 2003.361250415343 2532.8616559085553 3712.362933175345 4169.304171464114 2443.3028988147926 1482.935125958898 2121.2300488145811 2121.1266542775261 1978.1006164393907 2244.3290740443445 3811.4114043169457 4943.5259155288795 4167.1246261922033 4612.2785395968067 4393.4757864952799 4517.5860407043701 3690.9601773194117 2286.8986904263143 # of Deals 15720 18029 23813 20286 17100 17335 19658 22127 25354 28855 23313 18305 20978 21218 20483 21038 25187 28741 29393 30725 32332 32600 30026 17794

Update View as of Q321

M&A Volume in 2021-A Strong Year
Worldwide M&A activity totaled US$4.4 trillion during the first nine months of 2021, an increase of 92% compared to year-ago levels and the strongest opening period for mergers & acquisitions since records began in 1980.
The first nine months of 2021 have already surpassed the full year M&A record set in 2015 (US$4.3 trillion).
The third quarter of 2021, which registered US$1.6 trillion in deals, marked the fifth consecutive quarter to surpass US$1 trillion, and ranks as the all-time largest quarter for worldwide M&A.
By number of worldwide deals, deal making increased 28% compared to year ago levels, an all time high.

© Dr. C. Bulent Aybar

Private Equity and SPAC Deals
Private Equity-backed buyouts accounted for 19% of M&A activity during the first nine months of 2021.
Overall value reached US$839.6 billion, more than doubling year ago levels, as more than 10,800 private equity backed deals were announced, an increase of 69% compared to last year.
Special Purpose Acquisition Companies (SPAC) announced 275 initial business combinations during first nine months of 2021, totaling US$545.8 billion, or 12% of value.

© Dr. C. Bulent Aybar

Large Deals Dominate the Market

The value of worldwide M&A between US$5 and US$10 billion totaled US$661.0 billion during the first nine months of 2021, an increase of 134% compared to a year ago and an all-time high.
Forty-three deals greater than US$10 billion totaled US$936.5 billion, an 50% increase compared to the first nine months of 2020 and the highest period for mega deals, by value, in two years.

Cross Border Deals reached to $1.6 tr

Cross-border M&A activity totaled US$1.6 trillion during the first nine months of 2021, a 99% increase compared to a year ago and the strongest opening period for cross-border M&A since records began.

Cross Border Deals reached to $1.6 tr
The Technology, Industrials and Financials sectors accounted for 43% of cross-border deals during the first nine months of 2021, up from 35% a year ago.

© Dr. C. Bulent Aybar

Top Global M&A Deals

Motives for International Expansion
Geographic and industrial diversification
Accelerating growth
Industry consolidation
Utilization of lower raw material and labor costs
Leveraging intangible assets
Minimizing tax liabilities
Avoiding entry barriers
Avoiding fluctuating exchange rates
Following customers

© Dr. C. Bulent Aybar


Impediments to Global M&A
Protectionist Sentiments
Global Implications of Regulation (e.g. MOFCOM, EU Economic and Financial Affairs Directorate; The Committee on Foreign Investment in the United States (CFIUS))
Tax Complexities
Cultural Factors
Equity Flow back in Stock payments

© Dr. C. Bulent Aybar


Equity Flowback
Flowback describes the sharp increase in selling pressure that investors place on a company’s cross-listed shares in the country of issuance due to an impending cross-border M&A.
In some situations, foreign investors have no choice but to sell their shares when the merger results in an investment that no longer meets their investment objectives. 
This occurs because the newly merged company will no longer be domiciled in one of the countries.
The investors in the country in which the company will no longer reside may sell their shares because the shares will soon represent a foreign investment, instead of a domestic one.
Fund managers may be forced to sell their shares because the merged foreign company may no longer meet the fund’s investment mandate and strategy.

© Dr. C. Bulent Aybar

For example, a US tech index fund only deals with tech stocks from US.
A leading US tech company, let say Oracle, decides to merge with Germany’s , SAP, and incorporates the new company, called OrSAP, in Germany.
The net effect of this action would force the US index fund to sell all its shares in Oracle because the company will no longer fit into the fund’s investment thesis of investing US tech companies.
If this occurred, Oracle shares would decline substantially and reduce the value of the combined company.
In such cases, companies should examine flowback that occurs as a result of corporate actions to prevent share prices from tumbling.

© Dr. C. Bulent Aybar

Cross Border M&A
On average, about one-third of global M&A activity involve cross-border transactions.
Most cross-border M&As involve private firms outside of the U.S.
Geography (proximity), accounting disclosure, and bilateral trade increase the likelihood of mergers between two countries.
Firms in countries with rising stock markets, appreciating currencies, and whose shares may be overvalued tend to be acquirers.
Firms in countries with declining stock markets, depreciating currencies and whose shares may be undervalued tend to be targets.

Source: Isil Erel, Rose C. Liao, and Michael S. Weisbach, Determinants of Cross-Border Mergers and Acquisitions, Journal of Finance, 2012. Results reflect 59,172 M&A transactions between 1990 and 2007.

© Dr. C. Bulent Aybar

Implementing Cross-Border Transactions in Developed Countries
Foreign acquirers of U.S. businesses
Acquisition vehicle: Often use C-corporations, limited liability companies, or partnerships
Form of payment: Most often cash (why?)
Form of acquisition: Share acquisitions generally the simplest
Post-merger organization: Centralized organization (division structure) used to rapidly realize synergies but decentralized operations (holding company) used where cultural differences significant
Tax strategies:
Share for share acquisitions may defer tax liability for target firm shareholders
Cash for share acquisitions may trigger tax liability for target firm shareholders

© Dr. C. Bulent Aybar


Implementing Cross-Border Transactions in Developed Countries Cont’d.
Acquisitions by U.S. and Non-U.S acquirers of foreign businesses
Acquisition vehicle: Corporate-like structures in common law countries (e.g., U.S.); share companies or limited liability countries in civil law nations (e.g., China)
Form of payment: Generally cash
Form of acquisition: Share acquisitions generally simplest
Post-closing organization: Holding company structure if target to be operated as independent unit or integrated with acquirer’s existing “in-country” operations
Tax strategies: Highly complex and vary with local tax and legal jurisdictions

© Dr. C. Bulent Aybar


Implementing Cross-Border Transactions in Emerging Countries
Poses challenges not common to developed countries such as political and economic risks including:
Excessive regulation;
Restrictions on cash remittances;
Currency volatility; convertibility
Expropriation of foreign assets;
Weak institutions
Civil war and local insurgencies

© Dr. C. Bulent Aybar


Do Mergers Destroy Value
In general combined returns in M&As are positive;
Most of the benefits go to the targets
The empirical studies generally report negative returns to the bidders
There are arguments suggesting that these results are related to methodological flaws or sample biases
Generalizations are based often on a limited number of studies

© Dr. C. Bulent Aybar

Moeller, Schlingemann and Stulz (JF, 2003) found that the adjusted returns to buyers measured in dollars (not percentage returns) over their study period were significantly negative (–$25.2 million), on average, consistent with the argument that “most mergers don’t work.”
But they also reported three other important details such as the average adjusted return to buyers was a significantly positive 1.1%.
Their research showed that the inconsistency between the dollar and percentage returns is due to the extreme unprofitability of a few large deals.

© Dr. C. Bulent Aybar


Acquirer and Target Performance


Dow Chemical’s Bid for Petroquímica Bahía Blanca (PBB)

Case Synopsis
In 1995, the Argentine government announced plans to privatize 51% of PBB, a company that produced ethylene and polyethylene.
The acquisition of PBB would make Dow the leading polyethylene producer in Latin America.

© Dr. C. Bulent Aybar

Dow Chemical
Multinational Company with 90+ plants in 30 countries
The company holds a leading market position in Ethylene and Polyethylene
They were looking to expand to Argentina since the 50’s

© Dr. C. Bulent Aybar

In late 70’s the government planned the development of the petrochemical industry and took the lead by creating the PBB
The industry grew quickly and expected grow in the foreseeable future
The forecasted demand for Polyethylene seemed to be strong and robust
As part of a larger economic reform program to strengthen competitiveness of Argentinean economy, government started the plans for privatization; large MNCs were interested in the Argentinean SOEs in the privatization block.

© Dr. C. Bulent Aybar

Polyethylene Production Process
Crude Oil Heavies
Natural Gals Lights
Various Cracker Models
Alpha Olefins
Ethylene Oxide, Ethylene Dichloride, Ethylbenzene

Drivers of Profitability
Ethylene is a global commodity with an international sales price in USD.
Ethylene production requires huge capital investments in crackers;
Fixed costs are high, and margins are low.
Profitability depends on scale, capacity utilization and efficient production processes. In particular, conversion ratios are critical for determining efficiency.
Since polyethylene production depends on the supply of ethylene, producers of ethylene and polyethylene are highly integrated.
Backward integration helps mitigate the risk of hold-up. Therefore, stage 2 and 3 acquisitions are critical from Dow’s perspective!
High transport costs and tariffs can provide opportunities in markets and determine profitability in this low-margin business.

© Dr. C. Bulent Aybar

Dow’s Strategic Motivation for the Acquisition
Local production facilities would lower Dow’s transport costs for polyethylene in the sizeable Latin American market.
Additionally, Dow’s production expertise could improve the efficiency of PBB’s plants, further lowering costs.
Moreover, it is a high-growth market with lots of potential for growth and Dow could capture this market.

© Dr. C. Bulent Aybar

Why PBB is Attractive to Dow?
Polyethylene industry was growing dramatically.
The demand for plastic packages increased globally.
The Bahia Blanca region was attractive due to its access to Argentine gas basins, maritime, rail, and road transport; proximity to Buenos Aires.
PBB had a cracker and a polyethylene plant.
PBB and Polisur controlled 70% of the Argentinian polyethylene market.
Their businesses included more than 100 local small and medium-sized plastic-processing firms.

© Dr. C. Bulent Aybar

Dow’s Feasibility Study Suggests Strong Cash Flows

Year (+) Net Income (+) Depreciation (-) ΔWCR (-) Cap Ex (=) CF to Ethylene

1995 43.5 4.2 8.3 – 113.4

1996 24.8 4.9 -1.6 7.5 23.8

1997 41.8 12.2 1.7 72.9 -20.6

1998 33.1 14.1 -1 18.5 29.7

1999 27.8 15.3 0 12 31.1

2000 30.3 16.3 1.1 9.9 35.6

2001 51.8 17 2.3 7.6 58.9

2002 76.1 17.8 2.6 7.9 83.4

2003 51.5 18.6 -2.2 8.1 64.2

2004 30.8 19.5 -1.8 8.4 43.7

2005 20.2 16.1 -1.1 8.7 28.7

2006 22.6 16.3 0.5 9 29.4

2007 36.7 9.9 1.2 9.2 36.2

2008 52.7 9 1.6 9.5 50.6

2009 68.2 8.8 1.6 9.8 65.6

2010 53.3 8.9 -1.4 10.2 53.4

Problems and Risks: Industry
A recession caused by increased oil or gas means costs would increase just as demand is likely to decrease.
This risk, however, is common to all polyethylene producers.
It would not only affect Dow or Argentina.

© Dr. C. Bulent Aybar

Dow also faces more specific risks and problems with the proposed acquisition of PBB, which includes:
The need to secure the supply of gas for ethylene production.
Backward integration is a key success factor in the business, so Dow has to ensure supply for the plant.
The need to secure the Polisur assets and expansion at the same time as the initial purchase of PBB. This is a three-stage project, which increases its complexity.
The impact of competition, especially from Brazilian producers who stand to benefit from the Mercosur trading bloc.

© Dr. C. Bulent Aybar

Potential government interference:

© Dr. C. Bulent Aybar

Summary of Project Specific Risks

Risk Description

Operational The Dow Chemicals’ plant may fail to operate at capacity or fail to produce sufficient ethylene and polyethylene to meet contractual obligations.

Counterparty Credit/ Performance The Dow Chemicals Company has offtake agreements that—like a future contract— require credit; the counterparty may either fail to post additional collateral as required or fail to pay.

Regulatory Contract settlement processes in Argentina may change after Dow has made investments in the Bahia Blanca stages. Regulatory agencies may choose to impose restrictions and taxes on production, imports of raw materials, labor,…

Construction The upgrading of PBB’s facilities (stage 1) and the construction of new plants (stage 3), once are completed, but the plants may not perform as they were supposed to (the heat rate is too high, the output too low, the availability too low, etc.)

Commodity Prices of raw materials (Crude Oils “Heavies, Natural Gas Liquid-NGL) and energy
/ utilities (fuel, electricity, water…) may spike.

Currency The Dow Chemicals Company may be unable to hedge the devaluation of the Argentine peso: Argentina had experienced no less than eight major currency crises between the early 1970s and 1991. The Convertibility Law, which tied the peso to the U.S. dollar (1:1), which had remained in force despite the Tequila crisis, showed growing signs of weaknesses.

Contract Enforcement/ Legal A local Dow Chemicals’ partner is in breach of contract and local government authorities may fail to enforce it. Alternatively, the Argentinean government may decide to expropriate or nationalize assets.

What is Dow Bidding for?
This is a complex three-stage project:
Stage-1 PBB acquisition: PBB has one ethylene facility and one polyethylene facility.
Stage-2 Polisur acquisition: Polisur has two polyethylene facilities.
Stage-3 Expansion of capacity: Construction of a new ethylene facility (or cracker) and a new polyethylene plant.
The acquisition of PBB is the first step, but Dow also plans to acquire Polisur’s polyethylene plants to expand its scale.
Then plans to build both a new ethylene cracker and a new polyethylene plant, both to expand capacity and to improve production efficiency.
The entire project underscores the importance of integration, scale and efficient production in this industry.

© Dr. C. Bulent Aybar

Evaluation Approach
Should Dow’s bid for PBB be based solely on the value of Stage-1 of the project?
Given the critical role of stage-2 and stage-3 investments, business logic suggests that we consider this as an integrated project.
Since Stage-2 and Stage-3 investments are not independent from Stage-1 investment, the interdependence further reinforces the integrated approach!
However, Dow may exercise some control over the subsequent stages in Polisur acquisition, and expansion project.
That brings up the possibility of a real options approach!

© Dr. C. Bulent Aybar

Valuation Framework
Start with Dow’s required rate of return on its US investments  8%
Consider making adjustments for PBB; account for additional risk:
Line of Business/Industry
Economic Environment
Business Environment
Project Specific Risks
Decide appropriate risk adjusted required rate of return
Estimate future PBB Cash Flows
Estimate Terminal Value
Estimate total value of PBB and design a bidding strategy
Should we consider value of Stage 2 and Stage 3 investments in deciding how much to bid for stage-1?

© Dr. C. Bulent Aybar

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