The Market Is Wrong: DuPont
01/10/2011 12:01 am EST
Shares took a hit after a big acquisition. But investing editor Igor Greenwald thinks the chemicals giant got a bargain when it paid a premium for Danisco.
Shares of chemicals concern DuPont (NYSE: DD) were down as much as 5% at the morning lows (but barely 2% more recently) after the company announced a $6.3 billion cash-and-debt deal for Danish enzymes specialist Danisco.
Investors are understandably concerned that the 25% market premium DuPont agreed to pay overvalues its ethanol business partner. There’s also the matter of the deal cutting DuPont’s projected earnings by some 10% this year.
I had purchased shares of DuPont a bit below where they’re trading today in some retirement accounts I manage for family members, and today’s news only makes me want to buy more.
The proper frame of reference here is not the 25% market premium or the 10% earnings figure but another number: 1.95%. That’s the annual coupon on the five-year notes DuPont sold in September. In all, the company raised $2 billion at the time, locking in a 3.625% rate on ten-year notes and 4.9% on the 30-year variety.
DuPont has $6 billion of cash on its balance sheet earning virtually nil, and IT plans to use half of that for Danisco. The rest of the purchase price will be borrowed, at an average interest rate of, let’s say, 3%.
Given this low cost of capital, DuPont could probably pay 40 times earnings for something or other and come out ahead. As it happens, it’s paying 23 times Danisco’s earnings. For that price, it’s getting a strategically well-positioned global company that recently posted a 59% earnings increase. Oh, by the way: DuPont is generating a 37% return on equity from its businesses.
It definitely didn’t go shopping in the bargain bin by paying a premium for a company that had already run up a bunch as a result of an impressive turnaround and was already fetching higher multiples than its peers. But with the Federal Reserve signaling that cash is trash, this gamble could pay off handsomely long before DuPont has to return the principal to its bondholders.