Laurens de Blij
Duisenberg School of Finance
1.Summary of Facts.
With an annual revenue of $20.2 billion Dow held the leading market position worldwide in ethylene and polyethylene (exhibit 1b). To consolidate all of Bahia Blanca’s polyethylene activity under Dow’s control a three-stage plan was developed. The first stage involved taking control of PBB, the second stage involved acquiring Polisur’s two polyethylene plants, and the third stage involved building a new ethylene cracker. To determine a proper risk premium Dow had to consider possible country risks. Currency and government policy risk may have had an impact because of possible future crises and changing government policies relevant to foreign investments. Furthermore, because of the ending of the convertibility law Dow also had to consider a possible exchange-rate risk. Dow created a holding company, Dow Investment Argentina, to invest in the project, then they had to decide whether they will use general corporate funds or raise debt for the PBB bid.
2.Statement of problem
Rational for Acquisition of PBB
Dow Chemical’s corporate strategy is to look for horizontal- and vertical integration, achieve technological leadership and gain international presence. Dow will benefit from a more integrated production process by lowering their cost of production. PBB will also create stable supplies of ethane for Dow allowing them to achieve operating rates near 100%. Cracking ethane in the region will result in lower operating risk for Dow meaning the supply/input risk for the production of Polyethylene. An increase in the production output of Dow will allow them to benefit from economies of scale. Overall Dow will gain technology leadership and operational excellence from adding PBB to their company and enhance them with a costleader position in the market required to compete with the government-subsidized chemical complexes.
In this section we provide a brief risk analysis. Table 1 is designed to give a compact overview of the different risks, possible mitigating actions and whether the risks are integrated in the cash flow or discount rate. Not every risk was applicable in the acquisition of PBB. The risk that influenced our cash flows the most is the currency risk caused by a possible liquidity crisis in Argentina. Argentina has experienced eight major currency crises (tijd/reference)and there is a risk of a new currency crisis in the future. When this happens, Dow will not be able to sell its output to the home country and will have to increase its export. Revenue de We have also taken into account that the convertibility law that now provides stability could eventually stop. This will also have a significant impact on inflation. Operating risk is the second risk with a large impact on projected cash flows. This is mostly the risk of not meeting the full operating capacity. For the first 3 years we keep the operating rate of the plant at 65% and from 1995 we increase the operating rate by 5% each year. Other risks had less of an impact on our cash flows. Information risk was less of an issue because Dow was already present in Argentina and PBB was important to the government of Argentina. Corporate Governance risk in Argentina is not expected to have a significant additional impact on cash flows. This risk is already included in the discount rate for similar projects in the US. Table 1: Risk overview|
Risk| Mitigating actions| Cash Flow (CF) or Discount rate (DR)| Corruption risk| 1. Have a large bank loan from a national bank.2. Government stake of 49% here is a mitigating factor | DR| Expropriation risk| Same actions as for corruption risk| CF (tax wil increase 5%)| Operating risk (only post/ completion risks )| n/a| CF|
Sovereign risk| Through the convertibility law,...