Did the Dow-DuPont merger have to happen?
Downstream from Friday's announced merger between DuPont and Dow Chemical, this much seems clear: DuPont’s Delaware operations will see a reduction in high paying jobs and the loss of many functions associated with a headquarters operation.
Many in the First State were caught off guard by the announcement and are slowly coming to terms with the possibility of a Delaware without DuPont for the first time since Thomas Jefferson was president.
But for those who have watched the worldwide agriculture market, the merger was anything but a surprise.
The companies will form DowDuPont, the world's second largest chemical business behind BASF. For now, it will maintain a headquarters in each company's hometown; just outside Wilmington for DuPont and Midland, Michigan, north of Detroit, for Dow.
DuPont, separately, reported it will eliminate 5,000 positions, or 10 percent of its global workforce. Some of those layoffs will be in Delaware, where it has about 7,000 workers. The move is part of the company's plan to slash $1.6 billion from its budget by 2017.
As corporate profits waned in the wake of a global agricultural market downturn, a mega-merger like the one between DuPont and Dow became inevitable.
The industry is producing its lowest returns in nearly a decade. Crop and soybean prices have dropped, while land and seed prices have increased, cutting into farmers' profits. Since 2012, individual farm profits averaged $33,000 per year, according to the Center for Farm Financial Management. That is more than 50 percent less than the $67,000 in average annual profits they enjoyed during agriculture's boom years between 2007 and 2012.
U.S. companies with agriculture stakes have paid the price. DuPont's agriculture unit generated an operating loss of $210 million in the third quarter, $154 million worse than the loss in the third quarter of 2014.
"Corn and soybeans in the U.S., two of the most important row crops there are, have seen their value cut in half or greater in the last two years," said Allan Gray, director of the Center for Food and Agricultural Business at Purdue University. "Farmers have certainly seen their revenue cut in half."
This is not a United States-only phenomenon, however. DuPont's heavy exposure in Brazil, which recently had its credit rating reduced to "junk" status by Standard and Poor's, is cited as the primary issue afflicting the Wilmington-based company's balance sheets.
Brazil's economy is plagued by an inflation rate that is approaching double digits. Demand for its two biggest exports, coffee beans and sugar, have fallen and the drop in commodity prices has undermined the nation's oil industry. Complicating matters is the sluggish economy of Brazil's largest trading partner, China.
The Brazilian recession has made it difficult for its farmers to afford the seed and crop protection products offered by U.S. agricultural companies like DuPont. With profits shrinking and credit difficult to obtain, Brazilian farmers are growing fewer crops and needing fewer supplies.
About 6.7 percent of DuPont's 2014 revenue came from Brazil, according to regulatory filings. When the company lowered its earnings outlook for 2015 in October, it placed the blame squarely on Brazil.
"The revised outlook primarily affects continued strengthening of the dollar versus currencies in emerging markets, particularly the Brazilian real, and a further weakening of agricultural markets, primarily in Brazil," the company said while reducing its outlook to $2.75 per share from its original estimate of $3.10 per share.
Despite the problems with Brazil, DuPont continues to invest in the country. DuPont's Pioneer unit, which produces hybrid seeds, maintains a heavy presence there. In October, DuPont announced plans to build a $22 million seed treatment laboratory in Brazil.
Matt Arnold, an analyst with Edward Jones in St. Louis, said Brazil had been a strong market for DuPont and could again be a growth region for the newly consolidated company.
"I think those Brazilian challenges will be prove to be short-lived," he said.
Why merge?
Exposure to Brazil has also impacted DuPont’s rivals. Syngenta AG, which is also very active in Brazil, saw its revenue drop 12 percent in the third quarter to $2.6 billion, due mainly to reduced commodity prices in that country.
Dow Chemicals' Latin America exposure was one of the reasons its AgroSciences business lost $2 million in sales between the 2014 and 2015 third quarters. The units' operating earnings before taxes was a loss of $39 million because of Latin America. Monsanto Co. is less active in those markets, but still has been impacted by the industry downturn. The St. Louis-based company will eliminate 2,600 jobs to save $300 million annually by 2019.
A weak agricultural market across the U.S. and abroad has left industry players with little choice but to pursue consolidation. Smaller returns have left companies with little to invest in research and development, making a combination of efforts attractive.
Mark Gulley, an industry analyst and principal at Gulley & Associates, a chemicals consulting firm in New York, said the merger of Dow and DuPont's agriculture business allows them to combine resources to compete with industry leaders Syngenta and Monsanto.
Gulley said that DuPont has "never really scored" in its efforts to develop new genetically modified seed traits – herbicide-resistant seeds, for example – and would benefit by adding Dow AgroSciences technology.
The $130 billion merger of Dow and DuPont may have surprised some, but industry watchers had been expecting a major consolidation announcement for some time. Monsanto in August withdrew its $46 billion bid to acquire Syngenta, the world's largest pesticide maker after the Swiss company refused to negotiate. Syngenta said the offer didn't fully reflect its prospects and created antitrust risks.
The China National Chemical Corp., or ChemChina, a state-owned Chinese company is said to be pursuing Syngenta. ChemChina is not a major agricultural player yet, but the company has been investing in pesticides.
Monsanto CEO Hugh Grant said earlier this year he was still searching for deals, calling industry consolidation “inevitable.”
"I think some kind of merger among the big six was inevitable," said GianCarlo Moschini, an economics professor and chair of the Science and Technology Policy unit at Iowa State University. "I am little surprised it is these two because, for a while, it seemed like it was going to involve Monsanto and Syngenta. I wouldn't be surprised if there was more to come."
One of the reasons Dow and DuPont came together is because their agricultural units are compatible. DowDuPont would control roughly 40 percent of the American corn-seed and soybean market and 17 percent of global pesticide sales.
Currently, Monsanto is the largest player in the seed market with nearly $5 billion in sales, accounting for 23 percent of the market.
The increased market share of DowDuPont will likely pass antitrust scrutiny because it doesn't give the newly merged company an overwhelming edge in any one sector.
"What each one is good at is somewhat different," Moschini said. "They both have chemicals but I don't think there's much overlap for them to compete head-to-head."
Arnold said the reduced possibility of regulatory hurdles is one of the reasons why a Dow and DuPont merger worked rather than either company pursuing another rival.
"I don't think Monsanto and DuPont or DuPont and Syngenta would have pared well," he said. "They would have created an antitrust behemoth in the seed market."
Kullman vs. Breen
Formed as a gunpowder manufacturer in 1802, as DuPont grew so did Delaware.
Three DuPont cousins assumed control of the company nearly a hundred years later and based it in Wilmington instead of New York or Philadelphia. The cousins revolutionized downtown Wilmington through the construction of the DuPont Building, which opened in 1907. More than a corporate headquarters, the DuPont Building expanded to include an upscale hotel, and a Broadway-style theater.
The DuPont name is everywhere in the state. It adorns hospitals, schools, country clubs, and highways. Towns were transformed as Wilmington became the "The Manufacturing Capital of the World" and Seaford was known as "The Nylon Capital of the World." During World War I, the company built suburban developments throughout New Castle County.
At its peak in the mid-1980s, DuPont employed roughly 26,000 in the state.
Now, Delaware must adjust to the once unthinkable – the likely end of DuPont in Delaware.
Had the Dow deal not materialized, DuPont would have likely survived the downturn following the path laid out by Ellen Kullman, the company's former CEO. Kullman, who was forced out by the board in October, was replaced by Ed Breen a man with a reputation for mergers and acquisitions forged during his time at the helm of Tyco International Ltd.
Kullman had implemented cost-cutting measures to ride out the cyclical agricultural market, but had not pushed for any significant changes. It was this plan that helped Kullman defeat activist investor Nelson Peltz's efforts to gain four seats on DuPont's board.
In contrast, Breen discussed an agricultural acquisition or divestiture in his first earnings call with Wall Street analysts, mere weeks after being appointed CEO. Some thought DuPont would likely pursue a joint venture, rather than a massive merger.
If DuPont remained a stand-alone company, it would likely be a little leaner by selling of some business units. However, the company would have remained largely intact until the market rebounded.
"This isn't a deal that had to happen," Arnold said. "They were already on a path to ride out the down cycle."
Strategic mergers during an economic downtown typically position the combined company as a stronger entity poised to take advantage of improved market conditions. By merging during this period, Dow and DuPont no longer have to settle for just surviving the downturn, but can boast they emerged as a stronger entity.
It also creates opportunity to lower the companies' cost structures so the new business is better prepared when the market returns.
"I think this merger is going to reduce costs and allow DuPont and Dow to combine their best and brightest, which ultimately will result in better products at a faster pace," Gray said.
Reporters Scott Goss and Jonathan Starkey contributed to this article.
Contact Jeff Mordock at (302) 324-2786, on Twitter @JeffMordockTNJ or jmordock@delawareonline.com.