After thorough evaluation of financial statements of both DuPont and Conoco, it was found necessary to separate equity of the two firms. Conoco, which was previously a subsidiary firm of DuPont, will be made totally independent from DuPont. DuPont intended to divestiture Conoco. The process of divestiture will be achieved in two phases. IPO curve out in the first phase, and the second phase will be the split off. The divestiture will be achieved systematically over a period of two years between years 1998 and 1999 (Gilson, 2010).
On September 28th 1998, the first phase started. DuPont made an announcement that it was interested in making an initial public offer of 25 % of Conoco shares. This would result in 150 million shares being sold to the public. This was a significant step towards participation in the divestiture of Conoco (Gilson, 2010).
In October 1998, Conoco divestiture execution started. In this phase of execution, an equity curve out of the secondary shares was issued by Conoco. Conoco sold 30 % of its shares to the public during the initial public offer. The importance of making this public offer and participating in the divestiture of Conoco was to dispose investment in the form of shares in the exchange market. It also enabled Conoco to perform its operations independently. This was to reduce loss of profits, increase focus on operations and, consequently, profits of DuPont (Goold, Campbell, & Alexander, 1994).
Report on DuPont Divestiture of Conoco
Introduction
DuPont was founded in 1802. The company used to produce gunpowder and supplied the United States Army under President Thomas Jefferson’s government. From the time it was started, it made numerous technological innovations in the business world. DuPont innovations have continued to serve markets worldwide. DuPont markets its products in different professional areas that include healthcare, nutrition and food industries, fashion and apparel, agriculture, electronics, and home and construction (Rock, Rock, & Kristie, 1990).
Conoco (Continental Oil and Transportation Company) was founded in 1875. It was initially an American Oil Company, but has since grown to become a brand of gasoline and service station owned by ConocoPhillips Company. Before the merging of two companies, Conoco headquarters were located in what is now known as ConocoPhillips headquarters in Houston’s Energy Corridor (Rock, Rock, & Kristie, 1990).
DuPont inventions include Teflon for pans, Stainmaster for carpets, Nylon stockings, Kevlar for bullet proof vests, Dacron for clothing, and synthetic fabric lycra. In 1998, DuPont was among the 15 largest companies in the United States. In the same year, DuPont's revenue reached $45.1 billion. The company operated over 200 manufacturing and processing facilities and had over 98,000 employees. DuPont had branches in 65 countries worldwide in 1998. By 1999, the company had a portfolio of over 2000 brands.
In an effort to assure adequacy in its supply of petroleum products to be used as a chemical feed stock, Conoco was sold to DuPont in 1981 for $7.8 billion. This was after Mobil, Dome Petroleum, and Sea gram were unable to buy Conoco due to unfavorable takeover offers. This was the largest merger in that time. Conoco became a fully owned DuPont subsidiary. Conoco, now operating as a DuPont subsidiary, became one of the largest global energy companies operating in 40 countries. The company has since been involved in many business activities, such as exploring for and developing crude oil. Conoco has also been involved in refining marketing, selling, and transporting crude oil and natural gas (Baker, Kiymaz, & Wiley 2011).
Financial Analysis on DuPont
In order to conduct effective financial analysis, it is necessary to look at the beginning and ending balance sheets. Other documents, such as the actual accrual or the accrual adjusted, and the statement of cash flow are also beneficial. Over the years, DuPont has been recognized for its low dependence on borrowings. The company assumed a considerable portion of debt of the newly bought company, Conoco. DuPont managers are faced with the task of establishing future optimal debt ratio of the company. Managers had two options at hand. They needed to decide whether the company should keep about 40 % of its asset being financed through debt or to lower company's borrowing to 25 %.
There are different methods that can be used by managers to come up with the most appropriate choice. Managers may use different qualitative and quantitative factors, such as return and risk. The company will be able to maximize its value through targeting 40 % debt ratio. Also managers should ensure high earnings per share and higher dividends per share. Return on equity will be higher since debt will be the main source of financing capital expenditure of the company. This will be due to leveraging. The company will be forced not to declare any equity issues until 1985 for it to maintain 40 % debt ratio. DuPont will be forced to acquire the needed funds through debt (Baker, Kiymaz, & Wiley 2011).
Ratios will be necessary to analyze a position of the company in the year 1998. This will help stakeholders get an insight about the effect of current capital structure. Throughout its history, DuPont used to have a policy of extreme financial conservatism. DuPont’s low debt ratio is a result of its success in the product market. This has made DuPont one of the few companies with AAA rating. This has allowed DuPont to maximize its financial flexibility.
According to the CFO report, DuPont sales grew at an average of 11.5% from 1994 to 1998. The cost expenditure had an average of 9.9% in the year 1999. Growth rate for DuPont is expected to increase after its separation from Conoco. Growth in sales of the company can be attributed to liberal financing policy. This helps the company to have more capital that can be used to boost up the sales. It is also evident that capital expenditure grew significantly after applying the liberal debt policy.
DuPont stock’s beta-coefficient indicates that firm's stock was experiencing great instability than the market average. Firm’s average stock price has been as low as $37.19. Debt has a significant effect on organization’s financial performance and policy of the company. Debt shield a firm from tax since interest income is tax deductible. DuPont is now planning to increase its tax expenditure by seeking external funding. The company needs guaranteed access to external capital markets, which have the ability to raise the amount at minimum costs. Such a state will enable DuPont to have a stable dept policy. This will allow DuPont to maintain its market share even during hard economic times
Using an example of dept ratio and interest coverage, it is evident that debt ratio of 25% would have interest coverage of 6.17. On the other hand, a debt ratio of 40% has interest coverage of 3.86. Lower interest coverage indicates that the company will have a bigger burden on debt expense. This is because low interest coverage indicates that firm’s ability to cover interest expenses is weak. For example, in the case where a firm has 40% debt ratio, the interest coverage is 3.86. This indicates that interest expenses will be covered by multiplying firm’s net income by 3.86. This will result in a smaller figure compared to when the net income is multiplied by 6.17 in the case of 25% debt ratio.
Overall, the company is exposed to a higher risk under the 40% debt ratio and a lower risk under the 25% debt ratio. However, the return would be greater under 40% debt ratio. The company will have to decide which option is better.
Analysis
SWOT Analysis of DuPont
SWOT analysis is used by different companies to analyze performance of the business. SWOT analysis helps a company to do in-depth research on company’s potential problems. SWOT analysis is also used to research potential growth of the business. DuPont experiences different internal and external factors in the business environment that affect its performance. Managers of DuPont use SWOT analysis to understand companies' strengths, weaknesses, opportunities, and threats.
Proficiency of the company is in strong research and development unit, which contains technological competency, which makes DuPont able to utilize latest technologies to carry out its analysis. The culture of employees of DuPont company makes the company succeed in different business sectors. For example, DuPont succeeded in Flooring System’s commercial carpet franchise because of the strong culture of employees as they developed the system. This gave them an advantage and increased the sales.
Corporate culture of DuPont is one of its other strengths. A strong culture increases chances of a business surviving in the market. A strong culture also gives an organization a competitive advantage over other companies. DuPont has ethical beliefs and core values, which improve company’s relation with its customers and employees.
Another strength that the company has is its dominance as a technology and brand leader in the industry. Due to advanced technology used at DuPont, the company has acquired market leader's status in some sectors such as flexographic printing and color communication. DuPont also enjoys market leader status in automotive coating suppliers. DuPont is the largest producer of titanium oxide white pigments. Being a market leader has helped the company improve its brand image and gave the company a competitive advantage.
Weaknesses
Some of the weaknesses of the DuPont Company is its low operating margin compared to competitors. This is caused by poor cost structure in the company. Thus, the company is unable to utilize its financial resources optimally in its business operations. Besides the company’s inability to control its financial resources, DuPont also suffers from lower operating profit margin. For example, records indicate that DuPont has operating margins of 7.7% compared to the industry average operating margin of 8.9%. DuPont’s operating margins are lower than those of some competitors. DuPont’s main competitors, Rohm and Hass Company, has an operating margin of 9.4%. This operating margin is higher compared to the average in the industry. This shows that DuPont may face problems if it does not find a method of managing the low profit margin. DuPont should find other ways that will enable the company to save costs while conducting its business.
DuPont has always been encouraged to break with Conoco. They always wanted Conoco to be an independent company. In 1996, analysts and investors speculated that DuPont would spin off Conoco. However, the move did not take place until 1998. DuPont is now planning to 20% of its major oil company in an initial public offering. In 1998, the value of Conoco was estimated by industry sources to be $22 billion. Its proposed initial public offering was about $5 billion. After the initial public offering, DuPont was still willing to sever Conoco completely by conducting another public offering, spinning off the remainder to shareholders, or selling the remaining stake outright.
100% Divestiture of Conoco in Two Stages
DuPont managers planned to divestiture Conoco in two stages. This implies the exit of DuPont from energy business. This will help both companies fully capitalize on market opportunities. After careful evaluation of possible methods of splitting two companies, managers found that the best way will be IPO and split-off. These methods have high chances of success and offer the most value for shareholders.
This method of divestiture is best for DuPont's shareholders since it will be an opportunity for DuPont to exit energy industry fast in a tax-efficient manner. After Conoco IPO, DuPont will be able to increase its financial flexibility. The split off will benefit DuPont shareholders because it will make it possible for DuPont to acquire a portion of shares. This will also give shareholders a very tax-efficient option for them to own both companies after the split. Therefore, it is necessary to set two companies in different paths. This will enable DuPont to concentrate all its resources on increasing its value.
Conoco will also be able to move forward and concentrate its attention and resources on its own growth. This is possible because Conoco was active in 40 countries around the world.
There are issues that can may make managers of DuPont not to consider 100% complete divestiture. One issue is that given the relative rigid need for gas, there will not be much revenue generated. Also, there is an expected ease in transition as the company changes from a gas station into a hydrogen station. This gives DuPont a potentially big market share. Such a transition is expected to increase company’s expenses on asset base.
Managers should not overlook some significant aspects of the market and arrive at a wrong decision. They must realize that the demand for petroleum, hydrogen, and gasoline fuels is not as high as it was when Conoco was opened. Inflation and increased global demand for petroleum, hydrogen, and gasoline fuels in developing countries may prevent real growth of Conoco.
Recommendation
According to the relationship between debt ratio and interest coverage, it is recommended that DuPont should target a debt ratio of 40%.
Justification
There is a major concern about the risk that is associated with the target of 40% debt ratio. This means that the expense of debt will be costly since its bond rating will drop. Some of the risks that risks lower interest coverage and reduced access to debt funds. This may lead to a situation where funds are not always available when needed, and thus the company may be unable to pay its interest on time. On the other hand, 40% debt ratio is below average in the industry. The 40% debt ratio is feasible because it will make the company more competitive in financing. Another advantage is that under the 40% debt ratio, company’s control will not be diluted. If DuPont reduces debt ratio to 25%, then there will be a need for larger equity. This affects current stockholders.
The company will have to weigh between flexibility and control under two options. This is because DuPont will be more flexible under 25%. However, current stockholder’s control over the company will be reduced. Under the 40% debt ratio there is no much flexibility. Company’s control should be prioritized. Also there will be a high tax saving resulting from the 40% debt ratio. This will provide the needed cash flow for the firm.