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Dow Chemical Gains from Natural Gas Liquids if DuPont Deal Fails

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If the proposed merger between Dow Chemical (DOW) and DuPont (DD) fails to close, it is possible that Action Alerts PLUS holding Dow could come out as the stronger of the two.

A report released by RBN Energy on Sunday said that prices for natural gas liquids such as ethane are heading up. Dow’s recent investments in ethane account for 14% of projected capacity of nearly 27,000 MMlbs/yr. Also helping Dow’s cause is its main project, an ethylene production plant in Freeport, Texas, which is expected to go on line in 2017, making it among the first in the space.

“Since Dow made the deal with DuPont we have seen Dow’s business get stronger but DuPont’s has gotten weaker,” Jim Cramer told Real Money. “I think short-term, Dow would be substantially higher without the merger. Long-term, I do like the combo but it has to happen this year or people will lose interest in Dow.”

In December, Dow and DuPont announced plans to combine in a “merger of equals,” which would put their combined market capitalization at $130 billion. Within two years after the completed merger, the company would split into three independent companies: one focusing on agriculture, one focusing on material science and one focusing on specialty products, such as consumer goods. The deal is expected to close in the second half of this year and is subject to shareholder and regulatory proposals.

The agricultural business is one area that is attracting the most regulatory attention as the two companies compete more directly with each other in that space. Of the $3 billion in cost synergies expected to be realized from the merger, nearly half — or, $1.3 billion — are expected to come from agriculture, even though the business is expected to account for nearly a quarter of the combined revenues of the three companies.

Should the deal somehow be halted on regulatory grounds or otherwise, Dow could have another leg to stand on. The company has said that it is focusing capital expenditures on projects that deliver high returns with robust cash flow generation, Cramer and Jack Mohr of Action Alerts PLUS said last week.

One of these projects could be Dow’s Texas-based ethylene production facility, which is expected to go on line in 2017. The project was announced in 2012 as production of U.S. shale gas was ramping up. Dow wanted to expand its existing ethylene production capacity and construction on the new facility began in 2014. The Texas facility will use ethane as a feedstock and is expected to increase Dow’s ethylene production capabilities by 20%. Ethlylene has a number of uses, including the production of plastics, antifreeze, and even as an agent for ripening fruit.

Being earlier than competitors in the ethane space is important and Dow’s Texas plant has reported no delays. Dow’s position in the front of the pack allows it to gain a foothold in the space while ethane prices are still low. Meanwhile, other players are still getting their projects off of the ground and could face headwinds and delays.

“I don’t expect a tidal wave of new capacity coming on,” Dow COO Jim Fitterling said during the company’s earnings call in February. “We’re well-positioned as a first mover in this. In fact, I think we’re going to be up before the rest.”


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