Risk arbitrage: Jan. 12, 2009

Rohm and Haas Co. | ROH
Dow Chemical Co. | DOW

Deal value $15.2 billion

Spread 01/05/09 $14.18, or 22%

Risk arbitrageurs are contemplating the potential ramifications of the seeming breakdown of Dow Chemical Co.'s joint venture with Kuwait Petroleum Corp. and the Kuwaiti government on the chemicals giant's $15.2 billion acquisition of Rohm and Haas Co.

The Dow plastics joint venture, K-Dow, has no legal relationship with the Rohm and Haas merger.

Under the joint venture agreement, which was negotiated over roughly a year and launched in late November for a contemplated Jan. 2 close, Dow would receive $9 billion in exchange for assets that it would place into K-Dow. The payment was in the form of $6 billion of equity from the Kuwait partner and $3 billion through a leveraged recapitalization of K-Dow at its outset.

Following the breakdown of credit markets and declines in commodity chemicals prices in the fall, the K-Dow valuation was reduced before its formalization Nov. 28.

A shakeup in the Kuwait government eroded support for the JV, and Dow announced Dec. 28 that it had been informed by Kuwait Petroleum's Petrochemicals Industries Co. that a decision of the Kuwait Supreme Petroleum Council, which controls the oil company, reversed the approval of the JV agreement. Official written notice was presented to Dow Dec. 31, with PIC claiming it would continue to make best efforts to close the JV before its May 28 drop-dead date. The Kuwait government decision is a material adverse violation of a condition to the close, the PIC says.

Dow says it will take legal action against PIC's alleged breach of the JV agreement. According to the agreement, disputes must be resolved under the Rules of Arbitration of the International Chamber of Commerce in London. In the JV agreement, damages are capped at $2.5 billion.

The K-Dow transaction is not a condition of the Rohm and Haas merger, which is also not legally conditioned on financing. However, the $9 billion Dow was to receive on Jan. 2 would be employed to fund the acquisition. Dow must now make up that difference in a tight credit environment.

In addition, Dow's equity partners in the Rohm and Haas transaction include the Kuwait Investment Authority which has committed $1 billion and Berkshire Hathaway Inc., which has a further $3 billion committed. The Kuwait commitment provides some economic linkage between the two transactions.

Dow Chemical in recent weeks has touted both the K-Dow and Rohm and Haas deals as part of its transformation to a higher-earnings growth company, a strategy Dow continues to insist it's committed to. Dow is also in talks with other potential JV partners for the plastics business. But the Rohm and Haas deal was struck in July, and Dow's comments following the breakdown of K-Dow now focus heavily on cost reduction, maintaining investment-grade ratings and shareholder returns.

Debt commitments of $13 billion for the Rohm and Haas deal lay with Citigroup Inc., Merrill Lynch & Co. and Morgan Stanley. The Rohm and Haas acquisition remains under antitrust review by the Federal Trade Commission, but a consent order for that approval is thought to be before the commissioners. Dow announced Sept. 10 that it intends to sell its acrylic acid and esters and its emulsions specialty latex plants to appease FTC concerns. If the resolution of the second request is in front of the commissioners, then any back-and-forth of information exchanges between the FTC and Dow are probably in the past.

That is of some concern as arbs await the outcome of the Rohm and Haas transaction, since Hexion Specialty Chemicals Inc. and Apollo Management LP are thought to have used the FTC review of the Huntsman Corp. buyout to delay the deal process while figuring out an exit strategy.