Dow Chemical’s Bid for the Privatization of Pbb in Argentina

Case 10: Dow Chemical’s Bid for the Privatization of PBB in Argentina

Dow Chemical’s always saw a benefit in expanding business in Argentina but never pursued it because the state controlled the oil supplies, gas and power. PBB, being in Argentina, and the expected growth in polyethylene demand made this acquisition very appealing. The decision to buy PBB would prove to be a complex one as it was one step in a larger plan for Dow. They not only had to consider what to bid for PBB in the privatization, but also develop an overall plan for the development of Dow’s polyethylene business in Argentina.

If will be difficult for Dow to impose its dominance in the Argentinean market if another company acquires PBB (although it seems they do not have a net worth of at least $5 billion as stated as a requirement in the tender). The three project stages represent a unique opportunity to rapidly build a large-scale operation. Nevertheless, there are certain uncertainties involved with the second and third stages. More importantly, the later stages cannot be undertaken independently; they depend on stage one - the acquisition of PBB. Therefore, the acquisition of PBB represents a vital step Dow’s plan to expand into Argentina.

Valuation

Dow’s corporate M&A department valuation methodology consisted in building a cash flow model and then running sensitivity analyses.

1-         Cash Flows

Cash flows were calculated for each stage:

1-         Stage 1: Two cash flows models developed, one for the PBB ethylene cracker (based in revenues, variable costs and fixed costs) and one for the PBB polyethylene plant (based in revenues, revenue destination and incidence of transport costs).

2-         Stage 2: Cash flows for the Polisur polyethylene plants. Same model as for the PBB polyethylene plant in Stage 1.

3-         Stage 3: Cash flows for the new ethylene cracker, using the same model as for the PBB cracker in Stage 1, and for the new polyethylene plant, using the same model as for the PBB plant in Stage 1.

2-         Terminal Values

In order to calculate the terminal value of each state of the project Vignart and Marcer estimated a terminal growth rate for the project. As demand and prices were subject to cyclical changes, they decided to average the last five years of cash flows of each stage.

3-         Financing Alternatives

Because Dow had a cost advantage in raising corporate debt, it might prefer to use internal funds rather than secure project loans. Dow would be faced with the same options for Stage 2. In Stage 3, project finance aimed at funding the construction of new facilities would have to be considered as a third alternative.

4-         DCF Valuation

Now, we are going to estimate a range of possible betas for the company as we know the required return without the country risk premium (8% and 10%). We will use the next CAPM formula:

Ra = Rf + β * (MRP + CRP)

Note: All calculations are shown in the excel spreadsheet (DCF).

Exhibit 12 shows us the risk-free rate in the US (5%). We have searched in information based in historical prices and we estimate a market risk premium of 5% (Fernandez and Baonza, 2010). Using this data, we have obtained a range of beta that goes from 0.6 (when US discount rate is 8%) to 1 (when US discount rate is 10%). Having calculated these variables, we only need to calculate the market risk premium to arrive at the appropriate discount rate for Argentine market.