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Why investors are souring on the Dow-DuPont deal

The harvest is coming early this year at DuPont Co. Crop research staff are losing their jobs at DuPont's Pioneer seed labs in Newark, Del., and Johnston, Iowa, in advance of DuPont's planned merger with Dow Chemical Co.

The harvest is coming early this year at DuPont Co.

Crop research staff are losing their jobs at DuPont's Pioneer seed labs in Newark, Del., and Johnston, Iowa, in advance of DuPont's planned merger with Dow Chemical Co.

At DuPont headquarters near Wilmington, senior managers are retiring early. CEO Ed Breen has combined science, technology and business units, canceled IT and lab projects, and elevated chosen lieutenants to take on combined responsibilities.

Engineers are bracing for "Decision Days" later this winter, when they accept retirement offers or take their chances that they can find an open post if their job ends. The company plans to cut more than 5,000 of the company's 54,000 workers before the Dow deal's scheduled closing next year, then keep cutting.

A recent memo to global managers demanded a "Leaner, Simpler and Faster mind-set." Breen sets the tone: By one count, seven senior executives now report directly to the former Tyco International boss, down from more than 20 under Ellen Kullman, his predecessor.

Kullman quit on the eve of a weak profit report two months ago. She was the last of a generation of DuPont CEOs who had trouble convincing investors that the company could still profit from costly research, production, management and sales efforts, which gave the world nylon, Teflon and Kevlar (just as Dow developed Styrofoam).

Those investors who hope for many more corporate firings at first cheered the unusual "merger of equals," carefully calibrated to avoid U.S. investment profits taxes. Both companies' share prices rose Dec. 11 when Dow boss Andy Liveris joined Breen to announce the deal, along with a planned 2017 spin-off into three companies: genetically modified seeds and pesticides; plastics and other commodity materials; and high-tech specialty products. Each of the three is to be stitched together from pieces of Dow and DuPont.

Both firms could end up cutting double the $3 billion in expenses they originally promised, suggested analyst Hassan I. Ahmed, citing other recent industrial mergers, in a report to clients of Alembic Global Advisors.

But in the last two weeks, share prices for Dow and DuPont have sagged toward pre-deal levels. Stock-watchers are weighing whether the complex deal's spending cuts, cheered by hedge fund investor Nelson Peltz, who targeted DuPont and Liveris critic Dan Loeb, will restore the companies' profits - or foreclose their future.

The post-merger breakup would strengthen the "materials" group as Dow's successor company; give DuPont shareholders a more valuable share of the combined firms than its size justifies; and leave DuPont in pieces that will likely be takeover targets, complains Jonas Oxgaard, senior chemicals analyst at Sanford C. Bernstein & Co. LLC, New York.

Oxgaard says more big cuts don't make sense. "DuPont had some fairly unrealistic expectations on cost-cutting even before the merger was announced," he told me. He said DuPont's activist critics have erred in comparing DuPont's potential cuts to the deep reductions imposed by investor Carlyle Group on Philadelphia-based Axalta, a pigments company spun off by DuPont two years ago.

"Axalta was a commodity business, in which you don't need all the R&D, you don't need all your sales guys, you don't need all the lawyers," said Oxgaard. "But the rest of DuPont is an innovation company. You cannot cut the scientists and researchers."

He agreed that consolidating Dow and DuPont farm sales groups in a slow market makes sense; they won't need the Dow agricultural sciences center in Indiana and DuPont centers in Iowa and Delaware.

But the two other proposed companies lack focus, Oxgaard added. "One division of DuPont, their best-performing Performance Materials segment, goes to Dow; one tiny division of Dow (electronics) goes to DuPont. How are you going to get another $2 billion of 'synergies' from that? Unless they have a different plan that they haven't communicated."

It's not too late, Oxgaard said, for Breen and Liveris to "restructure this deal into something that makes more sense. Let Dow do the commodities," mature and low-margin products.

"Take their speciality products and put those into DuPont (with its R&D), giving DuPont the chance to be the innovative company that we remember, but with more focus on things that customers want and are willing to pay for."

Which is tough, for science, Oxgaard conceded. "That is something companies often struggle with. It's easier to give scientists a random problem to solve than to get them to figure out what customers actually want."

As a rare merger-of-equals, the deal will likely prove hard to manage, said Dana Trexler Smith, a partner at the accounting firm EisnerAmper whose specialties include corporate valuations. A lot of attempted mergers-of-equals were major disappointments - AOL-TimeWarner, DaimlerChrysler - or aborted - Publicis Omnicom. "It's rare you find two companies positioned in such a situation where they are truly a merger of equals," Smith said.

So Wall Street is nervous. "Will the sell-off (of Dow and DuPont shares since the deal news) prove prescient or shortsighted? asked analyst Frank Mitsch in a report to clients at Wells Fargo Securities.

Mitsch thinks Dow and DuPont face many problems, even in their relatively coherent pesticides and seeds business. Pests, he noted, are growing immune to commercial pesticides. Things are looking up for the companies' materials businesses - today's cars use an average $3,500 worth of chemical products, new homes another $15,000 - and sales of both are up, he added.

One thing the deals aren't likely to face is government antitrust enforcement, because "they do not compete in most of their product lines," says Professor Michael Carrier, who studies competition at Rutgers Law School in Camden.

(215) 854-5194@PhillyJoeD