Tag: dow

Disclosure (“none” means no position):Long DOW

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Busy day today. Was on Fox Business this morning discussing the results, will try to post video later …

Earnings:
The Company reported a loss of $1.68 per share; excluding certain items, the loss was $0.62 per share. Earnings in the fourth quarter of 2007 were $0.49 per share; excluding certain items, earnings in the fourth quarter of 2007 were $0.84 per share. (See Supplemental Information at the end of the release for a description of these items.) In addition, earnings for the quarter were reduced by a much higher effective tax rate, which was unfavorably impacted by several items totaling $295 million, equivalent to $0.32 per share.

The Company delivered on its fourth quarter commitments related to generating cash and controlling costs as outlined in October 2008. Management interventions contributed to cash provided by operating activities of $2.2 billion and free cash flow(1) of $1.2 billion in the quarter.

Sales for the fourth quarter were down 23 percent from the same period last year to $10.9 billion. Volume declined 17 percent, and was down in all operating segments and in all geographic areas, reflecting the global economic downturn as well as the de-stocking that occurred through most value chains.

The Company reduced production to match market conditions. This resulted in historically low operating rates, particularly in December which was 44 percent. For the quarter, the operating rate was 64 percent, a rate not seen in more than 25 years.

Price was down 6 percent in the quarter, as a 4 percent increase in the Performance segments was more than offset by a 15 percent decline in the Basics segments. The decline in Basics was principally due to a 23 percent drop in feedstock and energy costs versus the same quarter last year.
(1) Free cash flow is defined as “Cash provided by operating activities” of $2,249 million less “Capital expenditures” of $692 million less “Dividends paid to stockholders” of $389 million.

2008 Full-Year Highlights

Cash provided by operating activities was $4.7 billion in 2008, an improvement of more than $200 million versus 2007, against deteriorating economic conditions.

Despite the sales decline in the fourth quarter, 2008 sales increased 7 percent compared with 2007, setting another record for the Company of $57.5 billion. Price increased 12 percent, while volume was down 5 percent.

Dow AgroSciences reported full-year sales and EBIT(2) records. Sales grew 20 percent to $4.5 billion, reflecting an 8 percent increase in volume and a 12 percent increase in price, and delivering EBIT of $761 million.

Equity earnings declined to $787 million from $1.1 billion in 2007, reflecting the global demand destruction that took place in the fourth quarter of 2008.

Dow reported full-year earnings of $0.62 per share; excluding certain items, earnings for the year were $1.82 per share. Earnings for 2007 were $2.99 per share; excluding certain items, earnings for 2007 were $3.76 per share. (See Supplemental Information at the end of the release for a description of these items.)
Comment

Andrew N. Liveris, Dow’s chairman and chief executive officer, stated:
“With a global economic crisis unfolding during the quarter, we responded with speed and urgency to get ahead of the demand destruction that continued to accelerate as we approached the end of the year. We immediately put in place a full array of aggressive cash generation and cost and capital control measures that delivered results. We remain intensely focused on those actions that we can control and will continue to do so throughout 2009.”

Here is Dow’s (DOW) Answer to Rohm and Haas (ROH)
Dow Chemical Answers Rohn & Haas

Was asked this morning if I am selling Dow. No. Would I buy more now? I would wait until more clarity in litigation. I doubt the Judge will force a merger now. That being said, one cannot take anything for granted in court.

By waiting you may pass up considerable upside to shares as a favorable court ruling will cause shares to rally, but, a negative ruling will be far worse. That being said, if it is new money, one should wait or keep position small to limit risk.

With the economic outlook for the globe, low equity prices will be here for a while, no need to rush in and buy right now.

Disclosure (“none” means no position):Long Do, none

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Just got off the phone with “sources close to the situation”.

Some note:

– Dow (DOW) will answer the suit by Rohm & Hass (ROH) tomorrow
– They will be looking for the chancellor to issue a “business resolution”.
– Dow is still committed to the transaction
– Are in “active” conversations with several bidders for the previously named “K-Dow” JV with Kuwait. “Several other parties have come to the table” in bidding for the businesses.
– Dividend. Company credit rating is taking priority.

I got the impression that should a “business solution” to the litigation be required, the dividend may be safe but, it an immediate deal consummation is ordered, it is not. Now it should be noted that while Delaware Chancery Court Judge William B. Chandler III set the first day for March 9th and scheduled a trial of about five days, he said in the letter that “I strongly encourage the parties to focus on a business solution to this dispute.”

“The court will promptly rule at the trial’s conclusion,” Chandler added.

On page 24 Chandler said:

One thing that sort of strikes me — not knowing as much about this case as either of you or your colleagues — it strikes me that, A, there is a fundamental business problem here, and it is always my view that business problems are better resolved by business people; and that to the extent that the Court is called upon to resolve a legal issue, the Court will do that, of course, and will do it as promptly as possible. This Court obviously tries to accommodate parties who come and ask for expedited proceedings or accelerated proceedings because of the business necessities that a particular legal question implicates.

So, with that said, and with the hope that even after we resolve this immediate problem of how to go forward and in what manner to go forward, with the hope and trust that you will carry back — and I am sure you will — that the view of the Court is that it would be even better if the parties continue to try to figure out a way to resolve this business problem amongst the business people.

Full Filing:
Chancery Transcript

Anyone else take that to mean neither is going to get all of what they want? I have said it before, Rohm has the most to lose here, should this fail, they’ll not see $78 a share this decade, best they work with Dow.

Now, earnings are released tomorrow am and expect the news to be bad, just like the rest of the manufacturing world. Liveris & Co .will be pelted with questions on the merger, sale, dividend etc. Don’t expect concrete answers, just assurances which, in the current environment will not go very far to assuage investors.

This is one you’ll just have to wait out a few months

Disclosure (“none” means no position):Long DOW, none

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No other words to describe it other than “totally unacceptable”.

First watch the video of Dow Chemical (DOW) CEO Andrew Liveris:

So, what to think.

First:
Mr. Liveris, the market is not telling you the dividend is too high, the market is telling you we are in a very mean global recession. You make the building blocks for almost anything sold in the global economy. Because of that, the market is saying they expect your earnings to suffer, greatly. The market is telling you that the reason to invest in your stock now is the dividend of which you have said “this CEO will not cut the dividend”. Remember Dow’s 96 years of uninterrupted and uncut dividends? If I do the math that takes us back to the 1929-1935 years which were far worse than anything we face today. This why the news of the action has had no effect on the stock today.

Second:
Rohm & Haas (ROH). Yes we all expect it to get done also, the only people who want it done more than you are the Rohm & Haas shareholders. Without your bid, their $78 offer becomes a $30 stock. Trust me, they want this….bad. Tell them “go sit down and wait your turn”, they will.

Third:
Things will get better, take a breath. Walk away for a few days, go to an island and clear your head. You have not slept much obviously from the video and need a fresh outlook. Oil (USO) prices will rise significantly in the second half this year and currently tentative Arab nations will have renewed and stronger desires to diversify their revenue streams, and will have the cash to do so. You offer them that opportunity.

Fourth (here is the solution part):
You cannot cut the dividend and ever have the trust of shareholders ever again. You can’t. You swore up and down all fall it would not happen, so it can’t. I understand economic conditions have changed but using that excuse simply means you and your management team were not prepared, still bad. How can you do it and still save face? Put it in arrears for current shareholders.

This would take Board approval (you are the Chairman) but it could be done. Simply put, for shareholders of “x” date, the current dividend level is maintained but 50% of it will be paid in arrears 1 year from now. The current rate for new shareholders after “x” date is 50% lower. This will stabilize the shareholder base as current shareholder are not likely to sell and forgo the 50% in arrears. If it means anything, I wouldn’t.

No you can’t just cut it now say you will raise it next year, if you cut it now, we will not believe you and we already now dividend increases come much slower than reductions do.

I know the details are more complicated than that but it could be done. This gives you the financial flexibility you need now and while not destroying shareholder trust in you.

Disclosure (“none” means no position): Long DOW, Long OIL

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Some thoughts on today’s Dow Chemical (DOW) and Rohm & Haas (ROH) news.

The Release:

The Dow Chemical Company (NYSE:DOW) confirms it has informed Rohm and Haas that Dow will not close the proposed acquisition on or before January 27, 2009.

Dow has determined that recent material developments have created unacceptable uncertainties on the funding and economics of the combined enterprise. This assessment is based on several macro-economic factors such as the continued crisis in global financial and credit markets combined with the dramatic and stunning failure of Petrochemicals Industries Company of Kuwait (PIC) to fulfill its obligation to complete the formation of the K-Dow joint venture in late December 2008.

“Our long term strategy remains unchanged and the proposed acquisition of Rohm and Haas is consistent with this strategy,” said Andrew N. Liveris, Chairman and CEO. Since Dow learned in late December of PIC’s failure to close the K-Dow transaction, Dow has been aggressively engaged on multiple paths seeking ways to enable the Rohm and Haas transaction. Dow remains interested in discussions to find a solution to complete the acquisition of Rohm and Haas, but recent events have made closing untenable at this time.

“Dow Chemical has a long history of resiliency in responding to changing market conditions, and that resiliency continues,” said Liveris, “but the world has changed significantly and we still do not see the bottom of this unprecedented demand destruction which only accelerated through the fourth quarter and brought December operating rates to historic lows. The Company’s commitment to remain financially strong is part of the DNA of this 112-year old company.”

Dow previously announced a series of wide-ranging actions to address global economic conditions and is accelerating those actions based on continued deteriorating demand. “We are well-prepared to take the appropriate steps to ensure we retain our options and financial flexibility to see our way through what we anticipate will be an extremely challenging year,”
said Liveris.

Rohm & Haas Replied:

Rohm and Haas Company (NYSE: ROH) announced today that it has been advised by The Dow Chemical Company that Dow does not intend to close the pending acquisition of Rohm and Haas on or before Tuesday, January 27, 2009. Rohm and Haas and Dow have received all required approvals for the closing and the merger agreement requires that Dow close by such date.

Rohm and Haas stated that it intends to pursue all available alternatives to protect its shareholders’ interests.

What does it all mean in the end? Nothing really. The deal will still get done, just not now. The deal in in Dow’s best interest and even a 10% price reduction is more money than Rohm shareholders are going to see for the rest of this decade so they will want it done. If the Haas family really wants to protect shareholders (being the largest, lets assume they do), they will work to get the deal done. It just comes down to financing.

By delaying the deal, Dow is also setting up a damages claim against Kuwait for their upcoming litigation.

Now that oil (USO) prices are creeping back to $50 a barrel from $30, Kuwait may be rethinking its decision to pull out, simultaneously ruining its international reputation and come crawling back. Dow will have other bidders for some or all of the commodity business’s it wants to sell, again, just a matter of time.

Liveris promised to keep the balance sheet at Dow in tact and this move is doing just that. Now if you are trading the deal this news may be awful, but id you are a long term Dow shareholder enjoying a 10% dividend, this is good news.

Yes I know the merger agreement is rather “iron clad” as folks like to say for dramatic effect but lets be honest, by the time anything winds its way through court, this will all be settled anyway. Both side are simply posturing, and both side need the deal to get done…

It will, eventually and it will be done in a way that does not pout the company in a perilous position.

Disclosure (“none” means no position):Long Dow, Long Oil (DXO, not USO), none
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Like I said repeatedly, I don’t think Kuwait thought their decision to cancel the Dow Chemical (DOW) deal all the way through and are only now beginning to recognize the damage they have done to themselves.

From the Arab Times

MP Jamaan Al-Harbash on Tuesday asked his colleagues to conduct a thorough investigation on the Dow Chemical project, especially after the company announced its plan to take legal action against the state-owned Kuwaiti company which, sources say, might be asked to pay a fine of $2.5 billion for pulling out of the deal. Al-Harbash also urged the MPs to look into allegations that some people have earned commissions amounting to $750 million from the deal, conflict of interests, and unfair penalty clause. He also stressed the importance of determining the actual reason behind the decision of the Supreme Petroleum Council (SPC) to sign the deal only to withdraw from it later.

Proposing the formation of an investigative committee to look into the alleged violations, Al-Harbash stated “we have to find the truth to take the right decision on the issue. We must identify the people behind the violations and hold them liable for their acts as Kuwait has now become the laughing stock of the whole world due to this deal.”

No kidding…..

As for proof Kuwait still does not get it, Reuter reported yesterday,

“The state of Kuwait has undertaken all necessary measures to counter the case Dow Chemical is pursuing against KPC for not concluding a deal by Petrochemicals Industries Co with Dow,” al-Watan quoted Commerce & Industry Minister Ahmad Baqer as saying.

Baqer did not elaborate.

Several Kuwaiti officials have told Reuters that under the agreement Dow would need a court ruling proving that Kuwait had violated the deal to qualify for a break fee.

Dow is not suing for a “breakup fee” but for damages due to breach of contract as CEO Andrew Liveris stated several times over the last two days. The two are very different things. Dow only needs to prove monetary damages due to the Kuwait action (will be easy enough) to be awarded a settlement. Although I think the real reason for the suit is to force the deal.

Disclosure (“none” means no position):Long DOW
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First, I’m a fan of Mr. Matthews but too be honest he really over reached on this one and what gets me the most is it is a bit dishonest..

First here is his post…

Headline of the Day: “We’re Firing 5,000 Workers So We Can Make a Stupid Acquisition”

Tuesday, January 6, 2008: Dow Chemical admitted today that roughly 5,000 workers are being laid off in order to help pay the cost of acquiring Rohm & Haas at a price that makes no economic sense…

Actually, we made that up. Dow Chemical admits no such thing.

The company, which in July agreed to buy specialty chemical maker Rohm & Haas at a pre-Credit Crisis valuation of $15.4 billion—more than Dow’s current $14 billion market value—recently received a shock when Kuwait exercised economic prudence by backing out of a $9 billion joint venture that no longer made sense, thus depriving Dow of money to pay for Rohm & Haas.

So today, Dow released a whopper of a rationalization for not excercising its own economic prudence, in the form of a press release that begins as follows:

The Dow Chemical Company (NYSE:DOW) today announced a wide range of legal, operational and financial actions that will keep the Company on track to fulfill the transformational corporate strategy Dow has pursued since 2005.

Dow’s strategy will continue to involve aggressive steps to establish Dow as a high-performance, earnings growth company organized around a strong portfolio of joint ventures and market-facing performance business divisions. Central to Dow’s strategy is its commitment to retain a strong investment grade rating and to maximize shareholder return.

If that last sentence is suppposed to bear any semblance to reality, how is it possible that Dow continues to pursue the acquisition of a chemical company at a pre-Credit Crisis price which even Wall Street’s Finest consider to be as much as, oh, a third too rich?

Well, one way is layoffs, as today’s press release trumpets:

Since the onset of the global financial crisis in September 2008, Dow has taken aggressive actions to reduce capital spending, working capital and operating expenses. With further weakening in the global economy, Dow announced a restructuring in December which will reduce the Company’s workforce by approximately 11 percent, close facilities in high-cost locations and divest several non-strategic businesses. “We undertake actions like these with a very clear outcome in mind — to preserve our financial flexibility and improve our financial performance.

In the final paragraph of the release, labeled “About Dow,” the company claims 46,000 employees worldwide.

So the real headline should be more like, “We’re Firing 5,000 Workers So We Can Make a Stupid Acquisition.”

Why can’t they just say it?

Well, maybe because it is not true in any aspect? I’ll not go into the arguments for or against the Rohm & Hass (ROH) deal but just deal with the erroneous claims above..

Here is the December 5th press release Mathews references. Note the date? December 5th. Kuwait pulled out of the JV on December 27th (that comes after the 5th) meaning the decision to lay off workers at money losing locations and sell other businesses has nothing to do with the Kuwait decision.

Further, Dow said in the release “The Company also expects to complete several divestitures within the next 2 years, which will result in a reduction of approximately 2,000 positions. As a result of the restructuring plan, the global workforce reduction and the divestitures, approximately 5,000 jobs will be eliminated across several functions, geographies and businesses.”

So 2,000 of the 5,000 are not even losing their jobs, as the businesses are for sale. They may even still end up working for a new JV Dow will be involved in, who knows? In short, they’ll be on someone else’s payroll, just not Dow’s.

Why the closings? Again, from the 8-k
– Due to the recent, severe economic downturn, a decision was made to shut down a number of facilities, including the following:
* Chlor-alkali manufacturing facility in Oyster Creek, Texas
* Styrene and styrene derivative manufacturing facilities in Freeport, Texas; Pittsburg, California; Terneuzen, The Netherlands; and Varennes, Quebec, Canada
* Facilities that manufacture NORDELTM hydrocarbon rubber in Seadrift, Texas, and TYRINTM chlorinated polyethylene in Plaquemine, Louisiana

With manufacturing firms the world over cutting back production, it would have been irresponsible for Dow to keep these facilities open as prices and demand plummet for the products they make and they become unprofitable.

“Why is Dow going forward with the deal” Matthews asks? Because ROH actually accepted a lower price from DOW in the auction for itself in return for a purchase agreement that gives Dow virtually no ability to cancel the sale save for regulatory objections. It is called a binding contract.

As for the “paying for the acquisition” claim. A cursory glance at the 8-K says “the Company will record a charge of $300 million to $400 million in the fourth quarter of 2008 for severance costs associated with the restructuring plan and the workforce reduction, and curtailment costs associated with Dow’s defined benefit plans.”……followed by this “Once fully implemented, these actions are expected to result in $700 million in annual operating cost savings by 2010.”

So, can anyone do the math for me? How does a charge of $400 million now, followed by saving maybe $700 million by the end of next year finance a $15.4 billion deal by the end of this week?

Anyone?

Bueller? Bueller?

Disclosure (“none” means no position):Long DOW, Sold ROH Jan. $50 puts this morning
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I hope people are not surprised by this. The question here is not about the court case, but of how much damage Kuwait wants done to its reputation in the international community as a potential business partner.

The News:

On December 31, 2008, Dow Chemical (DOW) received official written notice from Petrochemical Industries Company (PIC) of Kuwait that the closing must be postponed because the Kuwaiti Supreme Petroleum Council withdrew its earlier approval of the transaction. As a result, Dow has said it will seek to enforce its rights under the terms of the various agreements and the JVFA executed by Dow and PIC since the joint venture partnership was first announced in December 2007.

“We were shocked by this news, and this was completely unexpected given the approvals already received and the behavior, actions and words from our partners. We have over 1,500 documents prepared for closing for what we believed to be Day 1 of K-Dow Petrochemicals on January 2,” said Liveris. “Pursuing legal options is not a decision we take lightly, especially because of the longstanding partnerships we have established in Kuwait over the past decade, but PIC is in breach of contract, and we must take action to protect the interests of our company and our shareholders.”

Beyond K-Dow: New Partnerships, New Opportunities

Although Dow is prepared to close K-Dow immediately if PIC does indeed cure the breach of contract, the Company has already been approached by other interested parties about joint venturing with Dow for the basic plastics businesses. As a result, Dow has also announced it will establish a formal process to secure a joint venture partner to accomplish the goals of its asset light strategy. The core businesses involved in the K-Dow joint venture include strong Dow franchise businesses, among them the largest and strongest producer of polyethylene in the world. Polyethylene is the world’s largest thermoplastic and for the last several decades has grown well above global GDP.

“Prior to signing the definitive agreement with our Kuwaiti partners about the K-Dow joint venture, we had other options and partners to consider,” Liveris said. “Some of these discussions were active as recently as November, and we have already been contacted by other interested parties and have begun discussions. This can be done on an accelerated timeline due to the considerable groundwork that has already been established in anticipation of the K-Dow joint venture.”

Dow believes that the identification of an alternative joint venture partner for Dow’s basic plastics business combined with the acceleration of planned divestitures and several additional divestments that are consistent with the Company’s strategy will yield proceeds greater than the funds Dow expected to receive in connection with the K-Dow joint venture.

Now it was just three weeks ago Dow and Kuwait finalized the JV and set up shop in Michigan. It was a done deal and Dow’s action are about that.

When the Kuwait action was first announced I said: “Kuwait needs to look past today. This was the first mega scale JV in the country and based on current actions, may be the last for a while. Let’s not forget Dow currently has JV’s in Saudi Arabia, Russia, South America and China proceeding without delay or problems. The Saudi deal at Ras Tanura is nearing first stage completion. Does anyone really think Dow CEO Andrew Liveris has not picked up the phone and called them or even Dubia to inquire about another partnership?”

Today’s statement confirm’s Dow is talking to other potential partners. Who called who first is irrelevant. Dow has options.

Prediction? What Dow’s wants is the $2.5b breakup fee from Kuwait. It will then created a JV with another partner at a lower price than the $7.5b Kuwait was going to pay Dow. The new parnter gets a great deal, Dow gets its money and at the same time sticks its finger in the eye of the Kuwaities.

OR

Kuwait realizes they are doing more damage to themselves than any present deal could do, wants to avoid the discovery process in court (or Dow making public the 1500 pages of communications it has with them) that would lay bare their deception to the world and capitulates on the deal, perhaps restructuring it not for a lower prices but delaying some payments to the JV.

This is a game of chicken now and unfortunately for Kuwait, Dow has an out in another partner. Can Kuwait really afford to let the chance to get these assets go? They can’t.

Disclosure (“none” means no position):Long DOW
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SPR, Ford, Dow, NetFlix

– Fill It

– Good Quote

– 4 Reason to own it

– This is really cool

Disclosure (“none” means no position):
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I have a call schedule later today with Dow folks and will hopefully have more. The question Kuwait has to ask itself now is, “Who in their right mind will commit to a deal with us now?”……Do they think they are the only country with oil fields?

Here is the news:

Now Dow’s dividend is being called into question:

The possible effect on the Rohm & Hass (ROH) deal

Kuwait needs to look past today. This was the first mega scale JV in the country and based on current actions, may be the last for a while. Let’s not forget Dow currently has JV’s in Saudi Arabia, Russia, South America and China proceeding without delay or problems. The Saudi deal at Ras Tanura is nearing first stage completion. Does anyone really think Dow CEO Andrew Liveris has not picked up the phone and called them or even Dubia to inquire about another partnership?

Let’s move outside of Dow. If you were GE (GE) or another oil or chemical major, how eager are you now to call Kuwait to form any type of partnership? Kuwait does not seem to understand they do not have all the oil, they do not have the technical expertise they would have received from Dow.

The dividend…………it is Liveris’s words now. It cannot be cut. He has staked his reputation and word on its safety.

Rohm & Hass (ROH). Liveris has spent the last few years fixing Dow’s balance sheet. I’m not convinced to advantages of buying Rohm at these prices justifies the damage that would be done to it now without the Kuwait money. Let’s be honest, nobody in their right mind is going to buy Rohm at these prices anytime soon (2 years) anyway. That is a tactic that can be used to lower the price. If Dow walks away and pays the $750 million breakup fee, that comes to 5% of the deal price. If Rohm goes back on the market, they will be lucky to get the 40% discount the shares are currently trading at to the deal price.

If Dow walks, Rohm shareholders suffer far more that Dow’s do. I think it is safe to say the current depressed Dow share price reflects the pessimism over the deal today, getting rid of the deal ought to boost share price.

As bad as it does seem, Dow does have some leverage. Rohm needs the deal currently more than Dow does. Dow could also do considerable damage to Kuwait’s reputation in the business community should it choose to fight for the $2.5 billion breakup fee as in a court hearing, all internal communications will become public and the meaningless assurances from Kuwait will be known to all. I’m not sure Kuwait really understands how much trust is involved in business and without it, how difficult it will become to do future deals.

The best thing for all parties is for both deals to get done in some form…

Disclosure (“none” means no position):
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Lecture Number Seven
MR. GRAHAM: Good evening. You have all had a month’s rest since the last lecture. I hope you had a pleasant vacation during that period and you are now ready to absorb some more punishment.

If you recall as far back as the last lecture, we dealt there mainly with the prospective earning power of the Dow-Jones list considered as a unit, and with its prospective central market value.

You might now ask the question: What about the earnings of the individual components of the Dow-Jones list? How would one go about evaluating them, and what results would you get?

As it happens, that job was done — at least from the standpoint of expected earnings power — in an article that appeared in the Analyst Journal in July 1945. It is called “Estimating Earnings of an Active Post-War Year,” and it is by Charles J. Collins. There he gives his estimate of the post-war earnings of all the companies in the Dow-Jones unit, together with the sum of these earnings.

His total figure varies from $15.96 to $17.58 per unit. You may recall that my rather rough calculation gave a figure of $13.60, and it may thus appear that my figure is rather definitely lower than Collins’. Actually that may not be true, because Collins identifies his earnings as those of an active post-war year, whereas the earnings that I had used in the last lecture are supposed to represent the average future earning power of the Dow-Jones unit — which would include some allowance for poor years as well as good ones.

It is interesting to note that Collins’ estimates for individual companies show considerable variation from their pre-war earnings, say their 1940 figures. I might read off a few to you to show how different are his expectations for different companies. Here are four that show large expected increases, taking 1940 as against the future years: American Smelting, from $4.21 to $9.50; Chrysler, from $8.69 to $17.75; Johns Manville, from $6.34 to $14.75; Goodyear, from $3.44 to $8.60.

Here are four others that show very small increases, if any: ( I am using here, the average of his range of figures) American Tel and Tel, from $10.80 to $10.50; American Tobacco from $5.59 to $5.90; National Distillers, from $3.28 to $3.35; and Woolworth, from $2.48, in 1940, to $2.62 in the postwar year.

Collins does not give his method of calculation in detail, but he does give you a description which you can follow through fairly well.

He starts from industry sales projections which have been made by the Committee for Economic Development of the Department of Commerce, and he adjusts them to an expected national income of $112-billion. That happens to be quite a conservative figure, because the national income for the year 1946 was about $165-billion.

He does not apply the exact percentage increase in each industry to the particular company; but he allows for its better or poorer trend than that of the industry as a whole over the period from 1929 to 1940. He assumes, in other words, that a company which did better than its industry from 1929 to 1940 will do proportionately better in the increase that is to be seen from pre-war; and correspondingly for those that may have done worse.

From the estimated sales he then calculates net before taxes based on pre-war ratios; he takes taxes of 40 per cent; and that gives him his figure, with a small range that he allows for possible adjustments.

You will recall that the profit margin that we used was distinctly lower than the pre-war; but on the other hand we took a considerably higher national income, and we also took a lower expected tax.

These variations in method suggest that there is no single way of dealing with a projection of future earnings and that individual judgment will have to play a considerable part. But the variations in this technique are not likely to be as great as the variations in the market’s response to what it thinks are the possibilities of different companies.

I would not criticize the Collins’ method, except in one respect which I think it is rather significant to consider. He assumes that the trends shown from 1929 to 1940 will continue in the future, and that seems a natural assumption to make. But I would like to warn you against placing too much reliance on that supposition.

Some years ago we made a rather intensive study on the subject of whether earnings trends did or did not continue. We tried to find out what happened to companies showing an improvement in their earnings from 1926 to 1930, comparing them further with 1936???; and also those that had failed to show improvement in the period. We found that there were at least as many cases of companies failing to maintain their trend as there were of those that did continue their trends. And that is a very vital consideration in all future projections.

As a matter of fact, Collins himself says that, when he accepts the trends, in some cases he finds he gets such large earnings that he felt constrained to reduce them in the interests of conservatism; and I imagine he was probably right.

*** Now I would like to return for a moment to the analyst’s view of Wall Street as a whole — that is, the scope of his own activities in the securities markets and his approach to his function of analyzing securities and drawing conclusions from his analysis.

I suggest that there are two fundamentally different approaches that the analyst may take to securities as a whole.

The first I call the conventional one, and that is based primarily on quality and on prospects.

The second I call, in complimentary fashion, the penetrating one, and that is based upon value.

Let us first attempt a brief description of these different approaches as they relate themselves to actual activities of the analyst.

The conventional approach can be divided into three separate ways of dealing with securities. The first is the identification of “good stocks” — that is “strong stocks,” “strong companies,” “well-entrenched companies,” or “high quality companies.” Those companies presumably can be bought with safety at reasonable prices. That seems like a simple enough activity.

The second is the selection of companies which have better than average long-term prospects of growth in earnings. They are generally called “growth stocks.”

The third is an intermediate activity, which involves the selection of companies which are expected to do better business in the near term than the average company. All three of those activities I call conventional.

The second approach divides itself into two sub-classes of action, namely, first, the purchase of securities generally whenever the market is at a low level, as the market level may be judged by analysts. The second is the purchase of special or individual securities at almost any time when their price appears to be well below the appraised or analyzed value.

Let me try to do a little appraising of the appraisers or the analysts themselves, and embark on a brief evaluation of these five lines of action which I have briefly described to you. Of course, I am expressing, basically, a personal opinion, which is derived from experience and observation and a great deal of thought; but it should not be taken as in any sense representing the standard view of the work of the security analyst.

The first division, you recall, was the simple identification of good companies and good stock; and one is inclined to be rather patronizing about a job as easy and elementary as that. My experience leads me to another conclusion. I think that it is the most useful of the three conventional approaches; provided only that a conscientious effort is made to be sure that the “good stock” is not selling above the range of conservative value.

Investors do not make mistakes, or bad mistakes, in buying good stocks at fair prices. They make their serious mistakes by buying poor stocks, particularly the ones that are pushed for various reasons. And sometimes — in fact, very frequently — they make mistakes by buying good stocks in the upper reaches of bull markets.

Therefore, the very simple kind of advice which keeps the investor in the paths of righteousness, or rather of rightness, I would say is very worthwhile advice — saying merely “These are good companies, and their prices are on the whole reasonable.” I think also that is the key to the policy of the well-established investment-counsel firms; and it accounts for their ability to survive, in spite of the fact that they are not in a very easy kind of business.

When you move from that simple and yet valuable occupation, namely, telling an investor that General Motors and General Electric are safer things to buy than Barker Brothers at 25 3/4, for example — when you move from that into the next activity, you are getting into much more difficult ground, although it seems to be much more interesting. And that is the selection of growth stocks, which for a long while was the most popular or rather the best-regarded type of activity by analysts.

The successful purchase of growth stocks requires two rather obvious conditions: First, that their prospect of growth be realized; and, second, that the market has not already pretty well discounted these growth prospects.

These conditions do obtain with regard to some growth stocks, as they are identified by analysts; and highly satisfactory profits are made from that work. But the results vary a great deal with the skill of the selector, and perhaps with “the luck of the draw.” It is quite questionable to my mind whether you can establish a technique of a communicable sort — that a good instructor can pass on to his pupil — by which you will be enabled to identify those stocks not only which have good prospects of growth but which have not already discounted pretty much those prospects in the market.

Let us put it in this way: I think at bottom success in the identification of growth stocks comes from being smart or shrewd, but I do not consider it a standard quality of good security analysis to be smart or shrewd. Not that I have any objection to that, but it just doesn’t seem to me to fit into the general pattern or canon of security analysis to require those rather rare qualities.

I might say rather that a security analyst should be required to be wise, in the sense that he is technically competent, that he is experienced, and that he is prudent. And I don’t know that wisdom of that sort is particularly well adapted to the successful selection of growth stocks in a market that is so full of surprises and disappointments in that field as in many others. I have in mind many examples. If you take the chemical companies, which have been the standard example of growth stocks for as long back as I can remember, you will find that for a long period of years their market behavior was quite unsatisfactory as compared with other companies, merely because they had previously had a great deal of popularity at a time when other companies were not so popular. If you take the air transport stocks, the selection of those securities for investment, based upon the idea of growth, seems to me to have been an exceedingly speculative type of thing; and I don’t know how it could have been properly handled under the techniques of well-established security analysis. As you know, there are many, many hazards which exist in that kind of industry, and in many others that have been regarded as having unusual growth prospects.

Now let me pass on to the third activity of the conventional sort, which I think is done most constantly in day-by-day Wall Street organizations — the trade investigation, which leads one to believe that this industry or this company is going to have unusually good results in the next 12 months, and therefore the stock should be bought.

Permit me to say that I am most skeptical of this Wall Street activity, probably because it is the most popular form of passing the time of the security analyst. I regard it as naive in the extreme. The thought that the security analyst, by determining that a certain business is going to do well next year has thereby found something really useful, judged by any serious standard of utility, and that he can translate his discovery into an unconditional suggestion that the stock be bought, seems to me to be only a parody of true security analysis.

Take a typical case. What reason is there to think that because U.S. Plywood, for example, is going to do better in 1947 than it did in 1946, and National Department Stores will probably do worse in 1947 than it did in 1946 — what reason is there to believe that U.S. Plywood should be purchased at 34 rather than National Department Stores at 17? There is scarcely any serious relationship between these concepts of next year’s operations and the purchase and sale of the securities at the going market price; because the price of 34 for U.S. Plywood might have discounted very good earnings for three years, and the price of National Department Stores might theoretically have discounted poor earnings for three years. And in many cases that is not only theoretically so, but is actually so.

I would suggest, and this is a practical suggestion — what I said before has been perhaps only a theoretical analysis in your eyes — that if you want to carry on the conventional lines of activity as analysts, that you impose some fairly obvious but nonetheless rigorous conditions on your own thinking, and perhaps on your own writing and recommending. In that way you can make sure that you are discharging your responsibilities as analysts. If you want to select good stocks — good, strong, respectable stocks — for your clients, that’s fine, I’m all for it. But determine and specify that the price is within the range of fair value when you make such a recommendation. And when you select growth stocks for yourself and your clients, determine and specify the round amount which the buyer at the current price is already paying for the growth factor, as compared with its reasonable price if the growth prospect were only average. And then determine and state whether, in the analyst’s judgment, the growth prospects are such as to warrant the payment of the current price by a prudent investor.

I would like to see statements of that kind made in the security analyses and in circulars. It seems to me that you would then be getting some kind of defensible approach to this process of handing out recommendations.

And finally, in recommending a stock because of good near-term prospects, you should determine and state whether or not, in the analyst’s judgment, the market price and its fairly recent market action has already reflected the expectations of the analyst. After you have determined that it hasn’t, and that the thing has possibilities that have not been shown in the market action, then it would be at least a reasonable action on your part to recommend the stock because of its near-term prospects.

Have you any questions about this evaluation, perhaps somewhat biased, of the conventional activities of the security analyst?

QUESTION: Do you confine your near-term valuation, your Point Three, to just one year?

MR. GRAHAM: I am thinking more or less of between one and two years. Most people seem satisfied to talk about the next twelve months in this particular field. Let us spend the next five minutes on the unconventional or penetrating type of security analysis, which emphasizes value.

The first division represents buying into the market as a whole at low levels; and that, of course, is a copybook procedure. Everybody knows that is theoretically the right thing to do. It requires no explanation or defense; though there must be some catch to it, because so few people seem to do it continuously and successfully.

The first question you ask is, of course: “How do you know that the market price is low?” That can be answered pretty well, I think. The analyst identifies low market levels in relation to the past pattern of the market and by simple valuation methods such as those that we have been discussing. And bear in mind that the good analyst doesn’t change his concept of what the earnings of the next five years are going to be just because the market happens to be pessimistic at one time, or optimistic at another. His views of average future earnings would change only because he is convinced that there has been some change of a very significant sort in the underlying factors.

Now he can also follow a mechanical system of operating in the market, if he wishes, like the Yale University method that many of you are familiar with. In this you sell a certain percentage of your stocks as they go up, or you convert a certain percentage of your bonds into stocks as they go down, from some median or average level.

I am sure that those policies are good policies, and they stand up in the light of experience. Of course, there is one very serious objection to them and that is that “it is a long time between drinks” in many cases. You have to wait too long for recurrent opportunities. You get tired and restless — especially if you are an analyst on a payroll, for it is pretty hard to justify drawing your salary just by waiting for recurrent low markets to come around. And so obviously you want to do something else besides that.

The thing that you would naturally be led into, if you are value-minded, would be the purchase of individual securities that are undervalued at all stages of the security market. That can be done successfully, and should be done — with one proviso, which is that it is not wise to buy undervalued securities when the general market seems very high. That is a particularly difficult point to get across: For superficially it would seem that a high market is just the time to buy the undervalued securities, because their undervaluation seems most apparent then. If you could buy Mandel at 13, let us say, with a working capital so much larger when the general market is very high, it seems a better buy than when the general market is average or low. Peculiarly enough, experience shows that is not true. If the general market is very high and is going to have a serious decline, then your purchase of Mandel at 13 is not going to make you very happy or prosperous for the time being. In all probability the stock will also decline sharply in price in a break. Don’t forget that if Mandel or some similar company sells at less than your idea of value, it sells so because it is not popular; and it is not going to get more popular during periods when the market as a whole is declining considerably. Its popularity tends to decrease along with the popularity of stocks generally.

QUESTION: Mr. Graham, isn’t there what you might call a negative kind of popularity, such as the variations of Atchison? I mean, in a falling market, while it is perfectly true that an undervalued security will go down, would it go down as fast as some of the blue chips?

MR. GRAHAM: In terms of percentage I would say yes, on the whole. It will go down about as fast, because the undervalued security tends to be a lower-priced security; and the lower-priced securities tend to lose more percentagewise in any important recessions than the higher ones. Thus you have several technical reasons why it does not become really profitable to buy undervalued securities at statistically high levels of the securities market.

If you are pretty sure that the market is too high, it is a better policy to keep your money in cash or Government bonds than it is to put it in bargain stocks. However, at other times — and that is most of the time, of course — the field of undervalued securities is profitable and suitable for analysts’ activities. We are going to talk about that at our next lecture.

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Lecture Number Four
I find one of the students presents me with a question which I shall be glad to answer for his benefit and for the benefit of the class. He quotes a statement made in “Security Analysis,” page 691, which ways, “Judging from observations made over a number of years, it would seem that investment in apparently undervalued common stocks can be carried on with a fair degree of over-all success, provided average alertness and good judgment are used in passing on the future prospect question, and provided also that commitments are avoided at the times when the general market is statistically too high.”

That is our statement, and his question is: “That, after reading the article in the Financial Chronicle which we distributed, one reaches the conclusion that you consider 185 for the Dow-Jones Average statistically very high. In general, above what Dow-Jones Average price would you consider it high and between what ranges would you consider it normal?”

That certainly is a very direct and leading question, but I would like to start with a correction. If I recall the article of October, 1945, in the Financial Chronicle, in which we discussed the then level of stock prices, it was not our conclusion that the level of one-eight-five was statistically very high. The conclusion, was that it was historically very high. That is quite a difference. We pointed out that in the past the market had not been able to go beyond that level without getting into dangerous territory.

As far as the statistical discussion was concerned, I think we found that 185 or thereabouts would appear to be a normal valuation for the Dow-Jones Average as of last year, and that on a statistical basis there was no particular reason to be afraid of the stock market there. Our point was, though, that historically there was reason to be afraid of it, and we were inclined to advise caution for that reason. As near as we are able to determine a central value for the Dow-Jones industrials, we are inclined to believe that somewhere around the present level or a little bit higher perhaps might be a central level in the future. The figure we gave provisionally in that article was 178 as so-called “appraisal value.” For that reason there would be no special cautionary factor in the current general level, working against the purchase of under-valued securities. The only caution we would want to add to that is this: If by any chance you are still going through the usual alternations of bull markets and bear markets, — which is by no means unlikely — then there is no particular reason to believe that when the market has receded to about its average value it would necessarily have stopped going down. Experience in former markets indicates that just as they are too high in bull markets, they get too low in bear markets. If we are going through a similar experience now, the historical analogies would point to lower prices, simply because in bear markets securities sell for less than they are worth, just as they sell for more than they are worth in bull markets. Whether that means that a person should avoid a bargain security because he thinks the general market is going down still further is quite another question; and I think that is largely a personal matter. Our opinion is that for the investor it is better to have his money invested than it is to feel around for the bottom of the securities market. And if you can invest your money under fair conditions, in fact under attractive specific conditions, I think one certainly should do so even if the market should go down further and even if the securities you buy may also go down after you buy them. That is rather a long answer to this question, but it is an interesting one.

I might add another introductory statement: By a coincidence last week I noticed a news item with regard to the Taylorcraft Corporation, which was a company of which we gave a brief and unfavorable analysis at our first meeting. That company, you know, sold some stock on terms which we regarded as rather outrageous last summer. I find now they are in financial difficulties, and that trustees have been appointed. That is a rather extreme example of the value of security analysis. (Laughter.)

Our purpose tonight is to start our discussion of the factor of future earnings in the analysis of securities. In the past two lectures we spoke more or less exclusively about the analysis of the past earnings. Of course, volumes can be written on that question now before us. It is not our purpose to cover it in a comprehensive way, starting from scratch, but rather to assume that you are familiar with the general treatment of the future earnings component which we gave in “Security Analysis”, and to subject it to a further scrutiny, particularly with respect to what may have happened in the last few years in that sector.

I would like to start with something that would appeal to at least two members of this class, and that is with a definition of the term “earning power.” That term has been used so loosely that I am ready to start a movement for its official abolition in Wall Street. When somebody asserts that a stock has an earning power of so much, I am sure that the person who hears him doesn’t know what he means, and there is a good chance that the man who uses it doesn’t know what it means.

My suggestion is that we use two phrases: One is “past earning power,” and the other is “future earning power.” Past earning power is certainly definite enough and it should mean the average earnings over a stated period which would ordinarily be identified in the discussion. But if not so identified it would be some representative period such as five or seven or perhaps ten years in the past. That would be the meaning of “past earning power.”

When you are talking about future earning power, you should mean the average expectable earnings over some period in the future. I think most of us ought to think pretty much alike as to the period that we would talk about. My suggestion is that it would be a five-year period, and that when we speak of future earning power of a company, we should have in mind ordinarily the average earnings over the next five years. I say “ordinarily” because you have situations in which a company may be subject to abnormal conditions affecting earning power for some years to come; and there it may be desirable to make a further distinction. We shall talk later about the analysis of a building company stock, in which you might very well make some distinction between the earning power for a boom period, which is ahead perhaps for several years to come, and the earning power for a normal period, if there is such a thing in the building company industry. But apart from some special type of situation such as that, (and a war period such as we have gone through,) I think the use of “future earning power” to mean earnings expected for the next five years would be useful as a general expression.

As far as the use of earning power or earning prospects in Wall Street is concerned, let me point out that in most of the current thinking earning power is not considered along the lines of an average over a period of time of medium duration. It is either considered as the earnings that are being realized just now, or those right around the corner, such as the next twelve months; or else the earnings are considered in terms of the long and almost endless future. A company with good prospects, for example, is supposed to be a company which will go on and on, more or less indefinitely increasing its earnings; and therefore it is not necessary to be too precise about what earnings you are talking about when you are considering the company’s future. Actually that idea of the long-term future of companies with good prospects shows itself, not in the use of any particular earnings, but in the use of the multiplier which is applied to the recent earnings or to the average earnings of the past.

I am reminded of an analysis that we used in this course in 1939, in their very first lecture, which I believe illustrates that pretty well. We put on the board three companies: A, B, and C. Two of them, which we did not name, showed earnings of practically identical amounts for the last five years — $3.50 a share in each case. The earnings year by year were closely similar. The only difference was that one stock was selling at 14 and the other was selling at 140. The stock that was selling at 140 was Dow Chemical; the one that was selling at 14 was distillers Seagrams.

Obviously, the difference between 14 and 140 meant that the market believed that the prospects for Dow Chemical were very good and those for Distillers Seagrams were indifferent or worse than that. This judgment showed itself in the use of a multiplier of four in one case and a multiplier of 40 in the other.

I think that represents a very dangerous kind of thinking in Wall Street, and one which the security analyst should get as far away from as he can. For if you are going to project Dow’s earnings practically to the year 2000 and determine values that way, then of course you can justify any price that you wish to. In fact, what actually happens is that you take the price first, which happens to be not only the present market but some higher price if you are bullish on the stock, and then you determine a multiplier which will justify that price. That procedure is the exact opposite of what a good security analyst should do.

I think if a person had tried to project the earnings of Dow Chemical for a five-year period and the earnings of Distillers Seagrams for a five-year period, and compared them, he could not have gotten values which would have justified the price differential as great as ten to one in the two companies. It is always an advantage to give examples of this sort that have such a brilliant sequel; because I notice that this year Distillers Seagrams sold as high as 150 as compared with its earlier price of 14, and Dow Chemical sold as high as about 190, against 140 — which is quite a difference in relative behavior.

We have been trying to point out that this concept of an indefinitely favorable future is dangerous, even if it is true; because even if it is true you can easily overvalue the security, since you make it worth anything you want it to be worth. Beyond this, it is particularly dangerous too, because sometimes your ideas of the future turn out to be wrong. Then you have paid an awful lot for a future that isn’t there. Your position then is pretty bad. There will be other examples of that sort which we may take up as we go along.

Let me now get back a little more closely to the work of the security analyst, and ask the question, “What is the relationship of this concept of future earning power to the day-to-day, careful work of the security analyst, and his attitude toward security values?” That relationship has developed gradually over a period of years, and at a somewhat more significant rate in the last few years.

It is interesting to go back in one’s thinking to the elements from which we started our ideas of the value of securities, — say, a generation ago or more than that. When I came down to the Street, the thing everybody started with in valuations was par value. That did not mean, of course, that a stock was worth its par value. It might be worth more or less. But it was considered as being worth a percentage of its par value. So much was this true — I don’t know how many of you are aware of this — that prior to about 1916 stocks were regularly quoted on the stock value. Westinghouse and Pennsylvania would sell, say, at 150, which meant they were selling at $75 a share — because their par value was 50. I suppose we have gotten so far away from par values now that the only people who are interested in them are those who calculate transfer taxes on securities. Because of that tax reason, one-cent par values are regarded as a very smart procedure in Wall Street today.

I can imagine the attitude of the old-fashioned investor were he to buy a stock for $50 and looked at the certificate and found its par value was one cent. He would probably have fallen in a faint. Well, through many stages in a long period of development from that rather naive attitude toward the central point of value, you have come now to what might seem to be the ultimate stage where the central point of value is the future earnings power, — something which you cannot read on any certificate. In fact, you cannot read it anywhere.

There is often a question in my mind whether we have really made so much progress in moving on from the physical to the almost metaphysical in this way; but be that as it may, we have. And now it is the law of the land that the values of securities, if they must be determined for the purpose of judging fairness of any kind of transaction, will be based primarily on the capitalization of expected future earnings. That is the burden of the famous Consolidated Rock Products case that you see referred to all the time in SEC proceedings, and in other cases of similar character. When the Supreme Court says it is a fact that the value depends upon future earning power, that does not mean that the test of the value that the Supreme Court has laid down as the law on this subject has therefore become the proper test for us security analysts. I think rather that we have laid down the law to the Supreme Court. That is to say, the Supreme Court has said that the values are now to be determined primarily in relation to future earning power, because it has observed that values have actually been determined by buyers and sellers of securities more and more in relation to such expected earnings.

The Supreme Courts had lagged behind the times for quite a while in that matter, and it just caught up. I think perhaps that it is still lagging behind the times in some other respects.

The concept that investment value is dependent upon expected future earnings is undoubtedly a more persuasive and a more logical one than thinking of value in relation to past earnings only, or in relation to the par value printed on the certificate, or any other stage in between. But I must emphasize to you that this concept does not make the job of the security analyst easier. On the contrary, it makes it a great deal harder, and it places him in a serious dilemma, for now the past earnings, with which he can become very closely familiar and which he can study with a great deal of skill and ingenuity, — those past earnings unfortunately are not determinative of value. And the element which is determinative of value, the future earnings, is just the thing which he cannot analyze with any real feeling of assurance as to the correctness of his conclusions.

That would be a very sad dilemma indeed for us security analysts if it were not for that principle of continuity that I tried to emphasize in the first lecture. While it is true that it is the expected future earnings and not the past that determines value, it is also true that there tends to be a rough relationship or continuing connection between past earnings and future earnings. In the typical case, therefore, it is worthwhile for the analyst to pay a great deal of attention to the past earnings, as the beginning of his work, and to go on from those past earnings to such adjustments for the future as are indicated by his further study.

You all know, of course, that the dependability of past earnings as a guide to the future is sufficient to make it possible to rely almost exclusively on them in the selection of a high grade investment ??? bond or preferred stock. We have said, in fact, that you cannot properly buy such an investment security on the basis of expected earnings, where these are very different from past earnings — and where you are relying on new developments, as it were, to make the security sound, when it would not have been sound on the basis of the past.

But you may say, conversely, that if you buy it on the basis of the past and the new developments turn out to be disappointing, you are running the risk of having made an unwise investment. We find from experience, though, that where the past margin of safety that you demand for your security is high enough, in practically every such case the future will measure one. This type of investment will not require any great gifts of prophesy, any great shrewdness with regard to anticipating the future. In fact, it would be a very unfortunate thing if you could not get two and three-quarters per cent on your money without having to be something of a soothsayer as far as the future earnings of corporations is concerned.

When I make that statement, of course I do not mean to lay down the inflexible rule that any company that gives you a sufficiently great margin in its past earnings can be regarded as having sound securities for investment. If the investor has occasion to be fearful of the future of such a company, it is perfectly logical for him to obey his fears and pass on from that enterprise to some other security about which he is not so fearful. But the point I am making — and I hope you can understand it, — is that in the selection of high-grade securities you start with a demand for an adequate coverage in past earnings; and in the typical case that is sufficient to justify the selection of the bond. I think I might pause there to see whether any questions have arisen in your mind on that point, before I go on from that rather simple application to its more complicated application to the valuation of common stocks.

In the case of common stocks the technique of security analysis has made rather important progress from the rather hit-and-miss method of taking past earnings as a guide and then saying, “Well, I think the future is pretty good here, so I’ll multiply the earnings by a higher than average multiplier.” Or in the converse case: “I think the future is not so good, so I’ll multiply these past earnings by a lower amount.”

It is now becoming approved practice in any really good analysis to work out the future earning power along somewhat independent lines, — by considering afresh the most important factors on which the earning power will depend. These factors in the ordinary case are not very numerous. They consist, first, of the physical output or volume of business that you expect from the company. Secondly, the price, or unit price, that it will get. Thirdly, its unit cost; and then, fourth, the tax rate. We now have a standard technique by which you go through these various motions and set up these successive figures, — all of which are estimates, of course. By this operation you arrive at a conclusion as to future earning power. That is regarded, and should be regarded, as a better technique than the simple one of merely taking the past earnings over a period of time.

Consequently, when you undertake a full-scale analysis of a security and want to determine whether it should be bought or not — I should say, frankly, whether it should be bought or sold — your proper technique should consist of estimating the future earning power along the lines that I have mentioned, and then applying a multiplier to it which is influenced in part by your subjective ideas as to the security, but which has to be kept within a reasonable range of variation.

It is not, I assure you, admissible security-analysis technique to say, “I don’t like this company, so I will multiply the future earnings by four; but I do like the other company so I will multiply the future earnings by 40.” You will not get a passing grade on a security-analysis test if you do anything of that kind. But naturally there is room for some variation in your multiplier as applied to these earnings. When you use that multiplier, you arrive at a valuation which can be a guide to you in your attitude toward the stock.

I was going to go on with some other examples of that method, but I find that I have left out a little note that I put on one of my pages headed “The Digression.” This was intended to contribute somewhat to your amusement and edification.

You may recall that I have been emphasizing the difficulty of peering into the future and coming through with some good ideas as to what will happen. Let me now indicate to you the position of somebody who really could have looked in the crystal ball and derived a good deal of dependable information about the future. Let us see how well he would have fared. I am assuming that each of you was one of these fortunate investors who really had a crystal ball, and could foretell in 1939 that different groups of stock would expand their business in the percentages that we show on the blackboard here.

Now, we say, suppose you were also told that in September 1946 the general level of industrial prices (as shown by the SEC calculations) would be 29 per cent higher than they were in January 1939. That happens to be true. Consequently the stocks in these groups would vary around a center of a 29 per cent advance. Suppose, then, you were asked back in 1939, “What would be the change in the prices of these securities by 1946?” Here, for example, is Aircraft Manufacturing, which is expanding 31 times in volume, from 1939 to 1944. Here is Aviation Transport, which is expanding two and a half times. I could, for our amusement, ask you to make what you would regard as a reasonable estimate of the change in market prices from January 1939 to September 1946; but instead of going through that rigmarole I shall merely give you the results.

At September 16, 1946, the Aviation Transport securities were up 274 per cent from January 1939 — which was pretty good, I should say, compared with 240 per cent increase in business. But the aircraft manufacturing companies were down 74 per cent. I do not think you would have expected that if you had known the relative change in sales. Amusement stocks and Tobacco products both benefited just about the same in gross from the war conditions. But the difference was that the Amusement stocks advanced 242 per cent and the Tobacco stocks declined 10 1/2 per cent, — which is quite a difference.

The Tire and Rubber companies did not do as well as Electric Manufacturing in sales, but in price they went up 85 per cent while the electric machinery equipment went up only two per cent.

Metal and Metal Mining did not do quite as well as paper in sales expansion. But the difference here is also rather surprising, because the Paper and Allied Products stocks increased 107 per cent in value, and the Metal Mining stocks declined six per cent during that period.

You see that the discrepancies in market movement are so great that they should add an extra note of caution in our attitudes toward our future calculations. For even if we knew what was going to happen to a company, in terms of its business and its earning power, we might not be able to make too good a prediction as to what was going to happen to it in the market price, which interests us a good deal. That is just an added reason for being either as cautious as possible in regard to our own decisions on security purchases, or else protecting ourselves as much as we can in our own thinking and in our statements by qualifying comments, whenever we begin to make predictions as to the future.

Now I should like to go on and give you a detailed example of the kind of analysis which is now being made, that centers around an estimate of future earnings and works on from there to a valuation. I have two examples here. One of them relates to the Childs Company. That happens to be rather convenient because here we have our good friend, the Securities and Exchange Commission, sweating through a valuation of the Childs Company which is based primarily upon their estimate of future earnings. They do this because they have to. They are required to find out the comparative values of the preferred and common stocks in their report to the court on the fairness of the proposed reorganization plans. The only way they know of determining the comparative value is by getting the total value of the enterprise and then comparing that with the claim of the preferred stock. And so they go through an elaborate technique in order to value the Childs Preferred and Common shares.

It might be worthwhile to take a little time and see just how they have done it. Perhaps I should make the matter a little clearer to you. The Childs Company, most of you know, has been in trusteeship. The company is now evidently solvent, and can easily take care of its debts. So the problem of reorganization actually turns upon giving the proper amounts of new securities to the old preferred and common stock.

The SEC, in its wisdom, decided that the capitalization of the preferred and common stock should be changed from what it was before. It is thus necessary to determine what proportion of a new common-stock issue, if that is to be the only stock, should go to the preferred and what to the common. The problem before the SEC, then, was to determine what the whole enterprise was worth. If the preferred stock claim was 75 per cent of such value, for example, they would then allot 75 per cent of the stock to the preferred and the balance to the common.

What they did was to start with a projection of the sales of Childs, which they took at $18-million, somewhat less than the figures for 1945, — they assuming that business would not be as good in the long-term future as it was under war conditions. They then took a percentage of profit of six per cent before taxes. That was based upon a study of profit margins both for this company and for other restaurant companies; and I do not believe that analysts would be likely to differ very much with them. So they got a net before taxes of $1,100,000.

Then they subtracted the expected average tax rates. Here the SEC decided to cut down the current rate of 38 per cent to 35, — a very valiant gesture of guessing. The main question, in estimating the tax rate, was whether it was likely that the great pressure to eliminate double taxation on corporations would be effective in the future in such a way, perhaps, as to relieve corporations of either all or most of the tax. Their guess, and mine too, was that such was not likely to happen, desirable as it might be.

So the net after tax was estimated at $715,000. That is the future earning power, and you can see that is a relatively simple calculation. It represents smaller earnings than Childs had during the war period before taxes, but considerably more than in the pre-war period.

***

QUESTION: How do they estimate the future sales?

MR. GRAHAM: Well, here is sort of a summary of a rather long discussion about the effect of retaining some restaurants, closing others and opening up others. They say, “Considering the record of the 53 units” — which includes some which would be closed — “and giving weight to the various factors that affect future sales to the chain, we believe that the management forecast of $20-million restaurant sales for the average future years is excessive. For such a figure to be achieved, the chain would have to average in good years and bad years sales which would be ten per cent higher than those achieved by the 53 restaurants in 1945, which in turn were higher than in any previous recent year for more than a decade. It is true that in 1946, with the first six months’ results known, the management estimated that the sales will exceed $21,400,000. However, it must be recognized that the company is experiencing extraordinarily high retail sales and Childs’ current high sales level cannot be considered to correspond to the level which may reasonably be forecast for a normal year in the future.” “We believe however, even giving consideration to normal retail business, that the chain can reasonably be anticipated to average sales of $18-million, which was the amount realized in 1945 by the 53 restaurants –” The conclusion is a rather interesting point of technique. Rather than take a figure completely out of the air, you go back to the earnings of a past year which you think will correspond to a typical future year and arrive at the figures that way.

QUESTION: Wouldn’t the common stock holders have a basis of argument about the sales and therefore throw out the whole business?

MR. GRAHAM: You mean can they argue against that?

QUESTION: Yes. Well, they can say it is higher; it should be 21 million, or whatever it was in 1946.

MR. GRAHAM: Well, your point is perfectly right. The common stock holders can say that, and so could the SEC have said it — but they didn’t. And when you get down to the judicial question on which this matter turns, here is what the courts say on a matter of that kind: They would say that the SEC is competent and impartial; that their guess is probably a better guess than one advanced by an interested party such as a common-stock holder. But if the common stock people could adduce very convincing evidence, — not merely an insistent argument — which would show that the estimate is out of line with normal expectancy, then the SEC’s figures could be reflected by the court. QUESTION: Did the trustee represent the common stockholder’s viewpoint here?

MR. GRAHAM: No, a trustee wouldn’t normally represent just the common stock. The SEC assumed Child’s Trustee’s views were too liberal. In other cases, the Commission has considered the Trustee’s estimate as not liberal enough.

QUESTION: Didn’t the SEC introduce the price level in their computations somewhere?

MR. GRAHAM: Not in any explicit calculation.

QUESTION: By using the 1945 level they might discount what they consider to be a bulge in food prices right now.

MR. GRAHAM: Perhaps they do refer to the fact, in their analysis of merchandise costs; that there has been a scarcity of supplies, and that the opportunities to purchase food and liquor at bargain prices have disappeared during war years.

QUESTION: Let me ask another question, then: From your observation isn’t retail merchandising, whether it is a restaurant chain or anything else, strictly a matter of percentages? In other words, give them a price level, they work both their costs and selling prices up and down accordingly.

MR. GRAHAM: It generally works out that way. This six per cent figure which they give for net before taxes is based pretty much upon average experience in the past. I presume that is the percentage you are referring to. We know, for example, that food in the typical restaurant represents anywhere between one third and 40 per cent of the total sales check. Once a stable price level has been established, that percentage tends to be established again, even if it was set aside for a while because of sudden changes in price level. For Child’s merchandise costs have risen from 34.7 per cent in 1938 to 38.5 per cent in 1945.

QUESTION: No question that the prevailing prices that this chain has to deal with in ’46 would be higher than in ’45? No question in your mind, is there?

MR. GRAHAM: No.

QUESTION: And that automatically would govern in actual volume of sales, wouldn’t it?

MR. GRAHAM: It would unless for some reason the customers were driven away from restaurants, which so far I don’t think the figures show. But ’46, of course, is not regarded necessarily as a typical postwar year by the SEC, and probably correctly so.

These questions are really good questions, not so much as criticisms of what the SEC does, as they are indications of the necessary degree of uncertainty involved in any such procedure. The only thing you can say in favor of it is that something of this kind must be done. The SEC must do it as intelligently as they can; and you as security analysts must also do it intelligently. But don’t ever think that because you go through some very careful operations and work things out to two or three decimal places, as I sometimes see it done, that you have got an accurate and precise idea as to what will happen in the future. You just don’t have any such thing. It isn’t there.

*** QUESTION: I would like to raise the question of working with post-tax margins rather than pre-tax margins to avoid the dilemma of estimating what the tax rate will be, on the theory that competition will drive the post-tax margin down to about what it was.

MR. GRAHAM: There has been a great deal of discussion in academic circles on the incidence of the corporation tax, — as to whether it is really paid by the consumer or whether it is paid by the prosperous corporation as compared with a non-profitable corporation that couldn’t have to pay any tax. That matter is still very controversial, and apparently the SEC prefers to follow the assumption that the margin should be calculated before tax. In practice, it didn’t make much difference, since they use practically the current tax.

*** We are really going on further in the Childs’ matter, than the mere matter of estimating future earnings; because I think we ought to follow it through to its conclusion by the SEC, and perhaps by ourselves as sitting in judgment on the SEC.

They next came to the multiplier and they said that their multiplier should be 12 1/2. That is to say, a capitalization rate of eight per cent, which gave them a value of about $9-million for the company on an earnings basis. I don’t think much was said that would illuminate the question of why they selected a multiplier of 12 1/2. They reject the Trustees’ multiplier of ten. That is the first thing they do. Then they add one of those precious clauses that you find in the Tax Court almost always, and in the SEC frequently. They say, “Giving consideration to all the factors, including rates of capitalization which have prevailed for other restaurant chains, it is our conclusion that estimated net earnings of $1,100,000 before income taxes and $715,000 after income taxes can fairly be capitalized at rates approximately 12 per cent and eight per cent respectively, resulting in a capitalized earnings figure of about $9-million.

That means that using their best judgment they will multiply the earnings after taxes by 12 1/2. I assure you that the alternative capitalization of earnings before taxes was figured out at a rate to correspond with their capitalization of the earnings after taxes. I think it was put in there, because in the McKesson and Robbins case they were led by the Trustees’ calculations there to do some valuation of earnings before taxes — something that had never been done before, as far as I know. Their capitalization rate, of course, is pretty much an arbitrary matter, and yet I assume that most analysts would not get very far away from their multiplier.

QUESTION: They use a lower times multiplier that the trustees. Is that the effect of that? MR. GRAHAM: No, a higher multiplier. They cut down his earnings somewhat, and they increase his multiplier so I think they end up pretty near the same evaluation.

QUESTION: You said eight times, didn’t you?

MR. GRAHAM: No, an eight per cent figure. That eight per cent is 12 1/2 times. The trustee had used a multiplier of ten.

QUESTION: And they were giving arguments against the use of the ten per cent by the trustee?

MR. GRAHAM: Yes, but the matter is too complicated to take up here. The Trustee had used what he called a “segmental method”, in which he considered that part of it was equivalent to bonds, another part to preferred stock, another part to common stock, and the SEC argues about it. Incidentally, you should know that the SEC goes at these things very seriously. I mean, their valuation isn’t so much of a rule of thumb way as you may think from my description, — though I have a little mental reservation on that, and believe that you might get pretty much the same results by rule of thumb method. But they certainly don’t do it that way. When they start with analysis of estimates of earnings, they have a discussion of about three pages on the management factor. Then they have three pages on the sales, half a page on merchandise cost, half a page on labor costs, then paragraphs on other costs, on building operating profits, on depreciation and rentals, on overhead. Then, after all those discussions, they reach this calculation of six per cent of the sales of $18-million. Evidently, a great deal of work of the staff went into this. Thus they got a valuation of $9-million, based upon earning power. Then they went through some motions after that, on some of which I part company very definitely with the SEC. First they figure out some tax savings due to carrybacks and things of that sort, and they say they will get $1,200,000 from that. Then they say they have to spend $1,800,000 for rehabilitation of the restaurants, so they subtract that. And therefore they reduce their $9-million by $600,000 net and get $8,400,000. That is their net value by the earnings method.

Then they add excess working capital and unneeded real estate to that figure. From their calculations these amount to $5,100,000, and so they get a final total of $13,500,000. They have to deduct from this $13,500,000, the funded debt of $3,200,000. So they get a net value for stock of $10,300,000. They value the preferred stocks’ claim at par and back dividends, amounting to $7,649,000. Thus the balance left for common would be $2,656,000.

Consequently they reach the conclusion that, if one class of stock is to be issued, then somewhere between 70 and 75 per cent of the total should be given to the preferred stock and somewhere between twenty-five and thirty per cent should be given to the common. That happens to be an unusually modest type of conclusion for the SEC. In the past they have generally come out with an elaborate calculation and said: “We believe that 72.45 per cent of this company should go to the preferred and the balance of 27.55 per cent to the common.” But I think they are getting a little mellow and are realizing that their calculations are pretty much estimates and should be turned into round amounts.

As a practical matter it turned out that the reorganization is now being carried through on close to the SEC’s basis, although the original plans which were proposed by the Trustee and by a number of other people for the most part departed very substantially from these proportions. I won’t take the time to tell you what the different plans were; but the Trustee now allocates 76 2/3 per cent of the new stock to the preferred.

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Andrew Liveris, Chairman and CEO of The Dow Chemical Company (NYSE:DOW), issued the following statement today on the current discussion and debate over the Company’s joint venture agreement with Kuwait’s Petrochemical Industries Company (PIC)

“Among the accomplishments I am most proud of since becoming Dow’s Chairman and Chief Executive Officer since 2005, has been the strong and growing economic relationship between our company and our business partners in Kuwait,” Liveris said.

“Since the early 1990s we have worked together to establish four joint ventures, each of which has created economic development and prosperity and established the State of Kuwait as one of the leading petrochemical producers in the world.”

“In recent weeks there has been much discussion and debate about whether a fifth partnership to establish a new joint Kuwaiti-American company — K-Dow Petrochemicals — is in the long-term interest of the people of Kuwait,” Liveris continued.

“As the person who often sat at the table while the details of this joint venture were being settled, I know from personal experience that our Kuwaiti partners negotiated with tenacity and resolve to assure the company we were building together would be one that would be worthy of the immense talent and energy Kuwaiti men and women who would become its foundation.”

Dow has also issued the following responses to issues related to the joint venture recently reported in the media:

1. The deal is solid and was thoroughly and fairly negotiated

• Negotiations between the two parties began over two years ago.

• This transaction was originally announced in December 2007 and has proceeded through many regulatory requirements in Kuwait AND in the European Union and the United States and culminated in the signing of a definitive agreement which was signed by both parties on December 1, 2008. The process and progress has also been covered widely in the news media over the entire timeline.

• PIC and KPC have followed all required approvals and disclosures within Kuwait as required by law, including reviews with the Oil Ministry, Supreme Petroleum Council, KPC Board of Directors and PIC Board of Directors.

• PIC/KPC enlisted the services of two world-class advisors on the deal, which helped ensure a fair agreement for both parties could be reached. J.P. Morgan and PriceWaterhouseCoopers are well-known and world-class in assessing valuations and ensuring fairness of transactions.

• PIC/KPC enlisted the services of more than 300 advisors from these two companies and others, such as world class legal advisors of Ashurst and Baker Botts led by James A. Baker IV.

• Dow populated a data room with more than 140,000 pages of information for PIC/KPC and their advisors to review, and Dow answered more than 3,000 questions about the transaction during the 8 months of negotiations.

2. Exceptional value for price paid

• K-Dow will strengthen their existing businesses faster than either Dow or PIC could alone. The J-V will maximize its competitive advantage in both emerging and established geographies. This new venture will benefit from PIC’s commitment to global petrochemicals growth, KPC’s position as a top 10 global energy company and Dow’s petrochemical leadership.

• The long-term fundamental value of K-Dow, and the opportunity for PIC, remains intact. PIC is getting:

– Leading market positions in several petrochemical product families, including the #1 position in polyethylene, the world’s most common plastic, OVERNIGHT.

– If K-Dow were a publicly traded company it would be a Fortune 200 company on Day 1!

– A strong global footprint in petrochemicals

– Significant growth prospects

– The Polyethylene business historically has grown above GDP on an annual basis, and has been one of Dow’s most profitable, cash-generating businesses.

– This transaction also fits PIC’s strategy and Kuwait’s desire to diversify its economy by integrating downstream in the chemical chain

• “The valuation for this deal is in line with previous deals in the chemical industry, if not better. In fact, it is approximately 30 % lower than Sabic’s acquisition of GE Plastics.

• Kuwait is paying a net $6 billion (USD) for the deal – $3.5 billion less than originally announced a year ago. Because of the changes in the financial landscape, PIC’s payment to participate in this global venture was reduced from $9.5B to 6B, (when the special distribution payment of $1.5B to PIC in 1Q is delivered), resulting in PIC owning 50% of a global value-creating company with $15B in sales.

• The numbers being compared are the public market valuations for the entirety of The Dow Chemical Company (not the K-Dow portion) and are based on the volatile nature of the stock market. These numbers are not the value of Dow’s actual assets nor of those going into the joint venture.

• Nearly all companies globally have lost ‘valuations’ as the financial crisis has unfolded. At this point in time, there is a disconnection in the public market values of companies versus their intrinsic asset values. Another way of making this point is the sum of many companies assets are worth more than their value in the open market at the present time.

• Reports published in the past week by leading chemical sector securities analysts suggest PIC negotiated well, and the deal was fair and equitable.

– Analysts #1 comments: The closing price and net proceeds are a bit lower than expected for Dow; however, given recent market environment, we view this as a very fair deal for both parties. We believe this JV will be a world class player in the olefins/polyolefins chain in the future, due to its advantaged feedstock’s for growth opportunities, strong management with a history of operational excellence, and a lean, flexible financial position.

– Analyst #2 comments: New terms are less favorable to Dow. The re-cut deal suggests K-Dow will proceed, albeit on terms more favorable to PIC (Kuwait).

3. K-Dow will be good For Kuwait

• Kuwait, through Petrochemical Industries Company, will become a major player in the global petrochemicals industry, through K-Dow. K-Dow will be the largest polyethelyne producer in the world.

• 90% of Dow’s PE/PP capacity is in the 1st Quartile for Manufacturing costs based on 2007 Townsend Benchmark as compared to their peers.

• Dow will bring it’s long-standing reputation for well-run plants and good, safe and reliable operations to PIC.

• This venture will expand Kuwait’s influence around the globe — beyond the oil industry, into the downstream industries of petrochemicals on a global scale. Kuwaitis will share pride in being part of a global industry leader.

• K-Dow will have a full slate of growth projects ready to go on Day 1. With opportunities from China to Brazil to North Africa and the Middle East, K-Dow is positioned for success. In my view, 50% of the earnings of this great company will be worth more to Dow than 100% of what these businesses could create on their own.

• K-Dow is good for Kuwait. It will contribute to the development of the Kuwaiti economy by continuing the diversification and development of Kuwait’s downstream economy. Downstream industries are more job-intensive, thereby creating more employment opportunities for people.

• It will create new employment opportunities around the world for Kuwaitis and enable the transfer of knowledge and training to Kuwaitis for long-term success. Kuwaitis who join K-Dow will have the chance to gain broad global experience — working with K-Dow customers and other partners in Asia, Europe, Latin America and North America, in addition to the Gulf Region, to further Kuwait’s goal of driving private employment (verses government) which will increase Kuwait’s total competitiveness and reduce it’s reliance on Expatriates.

• K-Dow will join PIC’s other successful joint ventures with Dow: EQUATE, MEGlobal, Equipolymers, The Kuwait Olefins Company (TKOC), The Kuwait Styrene Company (TKSC)

• The name “K-Dow” was chosen to symbolize the combination of two great strengths: Kuwait plus Dow. K-Dow = Kuwait’s experience and capabilities + Dow’s existing businesses in plastics and chemicals

• Giving back to Kuwait. During 2009, K-Dow will identify opportunities for PIC to give back and contribute in Kuwait – through sponsorships, donations and internship programs for Kuwaiti students; both ‘parents’ of K-Dow (PIC and DOW) have a strong and generous reputation of supporting Kuwait and its people.

4. The Dow Chemical Company has been good for Kuwait
• Dow was a premier sponsor of the Kuwait America Foundation dinner earlier this year (March 12, 2008) in Washington, DC. This event helped to raise over $1,000,000 for Kuwaiti and Arab charities.

• Dow has a partnership with the Lothan Youth Achievement Center (LoYAC) of Kuwait, who is a proud supporter of the Kuwaiti people and we are proud to partner with them.

• Dow is currently the lead sponsor for LoYAC’s Center for Performing Arts and the F1 School Challenge. In 2009 we are studying the sponsorship of programs such as the International Internship, International Volunteering and ‘Service Is My Duty’ as they follow Dow’s community sustainability ethos more closely.

• We will participate, at the gold level, in the Kuwait Environmental Campaign — a strategic project to protect the environment

• Dow is also a Gold sponsor of the National Manpower “Challenge” Program, aimed at promoting national employment in the private sector in Kuwait.

5. K-Dow will make products that are part of daily life

• Polyethylene and polypropylene comprise more than half of world polymer demand. PE is the most widely used of all plastics and can be found in everyday products from food packaging, milk jugs and plastic containers to pipes and liners. PP is a versatile plastic used in fibers, packaging films, non-wovens, durable goods, automotive parts, and consumer applications.

• Amines (EA and EOA) are a family of chemicals with a broad range of properties, used in various applications from wood treating and pharmaceutical processing, to coatings and consumer products.

• Polycarbonate is an engineering thermoplastic used in applications such as optical media, electrical and lighting.

• EG is a key raw material used in a wide variety of products and applications including the manufacture of polyester fibers, polyethylene terephthalate resins (PET), antifreeze formulations and other industrial products.

• PET resins are used in beverage bottles and other applications.
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Despite opposition from a small group of lawmakers, the deal will get done..

From the Kuwait Times

KUWAIT: More lawmakers yesterday pressed the government to scrap a multibillion-dollar deal Kuwait signed with US giant Dow Chemical (NYSE:DOW), but the oil minister defended the deal, saying it passed through proper channels and was of great strategic importance for the country. “We are going ahead with the deal in accordance with the signed agreement,” Mohammad Al-Olaim told a press conference, saying the deal took two years of negotiations and studies with the assistance of the best international consultant houses

Meanwhile, a government official revealed that the government is reportedly set to enter negotiations with the Dow over the controversial penalty clause. Cabinet members also want to discuss the details of expected returns from the deal and to reevaluate Dow’s assets and performance in order to ensure there are sufficient guarantees for the deal to go ahead or to withdraw totally from the deal before the January deadline.

At the press conference, Olaim said the project was first approved by the Petrochemicals Industries Co (PIC) and later by Kuwait Petroleum Corp (KPC) before sending the project to the Supreme Petroleum Council (SPC). After discussing it, the SPC asked the company to renegotiate its value in light of the global financial crisis and PIC managed to reduce Kuwait’s share from $9 billion to $7.5 billion, he said.

When PIC sent the final proposal to SPC, it proposed three options: either to reject the deal, wait and see how the crisis develops or approve it. The SPC sanctioned the deal and it was signed last month, he said. The deal will enable PIC to be a partner in 40 plants spread in the United States, Chile, Argentina, Canada, Holland, Spain and Germany, besides owning the finest technology in the field. “The new company, K-Dow, is expected to become one of the five largest global petrochemical companies,” Olaim said.

He said that the documents of the deal were referred to the Audit Bureau in line with a law that requires oil companies to refer their projects to the bureau after they were ready. Olaim said that debate about the deal is acceptable “since we are in a democratic country”, but insisted that the “current environment is not conducive to development projects because of the high dose of politics”.

The minister said that certain newspapers have been targeting him because of things he has done to safeguard national and public interests, especially with the petition he filed against the ruling on the Kuwait Oil Tanker Company case. “They want me to pay the price for what I did to safeguard public funds in my capacity as oil minister,” said Olaim, who warned that the media was being used to influence the outcome of major contracts. “We must not politicize technical issues,” the minister said.

PIC chairwoman Maha Mulla Hussein said that Kuwait will not be required to pay a penalty of up to $2.5 billion if the Kuwaiti government rejects the deal before the start of next month, when the deal becomes officially effective. Olaim however made no direct reference to calls by MPs on the government to scrap the deal.

On Sunday, the Popular Action Bloc said it will grill the prime minister if the government does not scrap the deal before January 1 in order to avoid paying the penalty. The bloc said that the value of the deal was highly exaggerated since the market value of Dow Chemical dropped from $51 billion in 1997 to around $17 billion currently.

Islamist MP Khaled Al-Sultan yesterday charged that the plants Dow is contributing to the deal “are old and operate with outdated technology”, saying the decision to enter the joint venture “is not a wise investment”. Another Islamist MP, Abdullatif Al-Ameeri, said the deal is shrouded in many suspicions, adding that it is not feasible to buy 40-year-old plants in Europe and the United States when there are new plants in Asia. Ameeri said the internal rate of the project was initially set at 8-10 percent and after the global crisis it will drop sharply to around five percent. The lawmaker alleged that Dow Chemical offered the partnership to a neighboring country for $4-5 billion but it was offered for $9 billion to Kuwait.

MP Mohammad Al-Obeid said there are major problems and loopholes in the mechanism of the government’s dealing with public fund-related issues, such as the mystery surrounding the fourth refinery project, the Amana company and the K-Dow deal. The MP said the K-Dow deal raises several question marks about its economic feasibility and its importance while the world is experiencing a troubled financial situation. Al-Obeid questioned the wisdom of injecting $7.5 billion into the petrochemicals industry which is currently suffering from severe crises because of plummeting oil prices. He said that he would submit a parliamentary question about KPC’s investment strategy in the petrochemicals industry and its economic feasibility, as well as the legal procedures in the K-Dow project.

Fellow MP Musallam Al-Barrak said the only person who can save Kuwait and Kuwaiti people’s money from the K-Dow deal is the premier, who has the authority to do so. He said that partnership with this company would be harmful, adding that its factories were over 20 years old. Al-Barrak questioned the abnormally fast rate at which the high-ranking oil officials have been conducting the deal, with meetings being held between them daily, saying that this confirms that the K-Dow project is going ahead without a ny regard of the Cabinet.

Meanwhile, the Fatwa and Legislation Department has announced that the contract is unique and unfair to Kuwait. It said that whoever conducted the negotiations on KPC’s behalf did not have sufficient knowledge of contractual law and that this should not have been the case, particularly in such a major and important deal. The department has asked that the contract be systematically reviewed before coming into effect since its current conditions are unfairly harsh on Kuwait. It also said that that choice of timing for signing the contract was wrong, given the economic downturn which all companies are currently suffering the effects of.

The deal will be final in eight days. It has passed an exhaustive process for approval and despite a few lawmakers who can get the press’s ear, nothing from anyone with authority to actually do anything ought to lead investors to think other wise.

It is akin to Rep. Elijah Cummings going on CNBC and bitching about the AIG (AIG) situation and making threats. Ok, thank you for your opinion now go sit down please. Unless your name end in Frank or Dodd in the House of Representatives, or you are the head of a Committee, your opinion and threats are ,well, just more noise.

Let’s do a worse case scenario. Say it doesn’t. Dow gets the $2.5 billion breakup fee, calls off the Rohm and Haas (ROH) deal, pays them the $400 million breakup fee and walks with $2.1 billion. Now, with the company currently valued at $17 billion. Dow could take that money and just buyback 12% of the stock. Is that so bad? I don’t think so.

There will be demand for these assets. There is no rule, that if thus deal dies, there will not be another one 6 months from now.

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