1998 DuPont spin off of Conoco by analyzing the transaction itself. Then, we look at one possible alternative and compare it with the actual long-term impacts of the sale. This is when we make specific recommendations about which choice was a financially prudent decision.
Over the last several years, corporate America has often turned to spin offs as a way to increase their bottom line numbers. This is because it is an effective tool in helping a firm to: divest itself of an unprofitable division and to raise to large amounts new investment capital. This money can be used to help repurchase stocks or make strategic acquisitions that will allow the firm to adapt with the changes that are happening in the market place. Once this occurs, is when a company can be able to refocus on core segments that will dramatically increase their profits margins. ("Spin Offs," 2011)
In the case of DuPont, the 1998 divestiture of Conoco is illustrating how the company was using this as a way to raise new capital. This is because executives believed that this segment was at its peak profit margins (with oil prices sitting at $20 per barrel). While at the same time, this helped to contribute dramatically to DuPont revenues. This is because Conoco was involved in different aspects of industry (which protected them against sudden drops in the price of crude oil). As a result, the spin off meant that executives would be able to address these two issues at the same time. To determine if this was the most appropriate course of action requires looking at the situation through the eyes of CFO. This will be accomplished by: analyzing the actions that took place and possible alternatives. These different elements will provide the greatest insights as to if the spin off was a financially prudent transaction over the long-term.
The Actions of DuPont
In 1998, the price of crude oil went into a major decline with prices collapsing to $20 per barrel. For the industry, this was causing everyone to face pressure from these lower costs. In some cases (i.e. Conoco), there were integrated producers that were protected against this kind of collapse. The reason why, is because they had operations in different segments of the industry including: drilling, refining, transportation and production. The combination of these factors meant that Conoco was providing them with consistent profits. While at the same time, it was also not producing as effectively, as executives had hoped when they purchased the company in 1981. This is because oil prices had increased to nearly $40 per barrel and it was feared that supplies were becoming tight. To prevent against this, DuPont decided to buy Conoco in the hope that it will provide them with a hedge against these kinds of rises in the future. (Spitz, 2004, pp. 31 -- 69)
This is a part of a strategy that many chemical manufacturers were utilizing at the time. The net impact of this kind of approach meant that a number of these firms would see their underlying profit margins increase exponentially. Evidence of this can be seen by looking at the below tables that are illustrating the impact of integrating oil / gas related firms with chemical producers from 1980 to 1989. As we are comparing the earnings of the top ranked firms in the industry during these time frames. (Spitz, 2004, pp. 31 -- 69)
Table 1: Top Ten Oil / Gas and Chemical Producers in 1979
Revenues (in millions)
(Spitz, 2004, pg. 46)
Table 2: Top Ten Oil / Gas and Chemical Producers in 1989
Revenues (in millions)
(Spitz, 2004, pg. 46)
These different figures are important, because they are showing how oil and gas mergers with chemical producers caused the earnings of the top players to increase exponentially. In the case of DuPont, many executives saw this as an opportunity to increase their working capital and exit a business that has lower profit margins from crude oil prices. This is despite the fact that earnings have increased exponentially for both firms. (Spitz, 2004, pp. 31 -- 69)
As a result, DuPont decided to divest itself in a series of two different steps. This was accomplished through the company conducting an IPO that sold 20% in 1998. The rest of what they owned was finally sold through a secondary offering. For executives, this transaction was considered to be something that helped to provide them with the greatest amounts of working capital possible. Evidence of this can be seen with comments from the CEO of the company (Charles Holliday) who said, "An IPO gives us maximum flexibility. DuPont will have access to cash from the IPO and, at the same time, will benefit from Conoco's ongoing financial contribution as we consider the options for divestiture." ("DuPont Plans IPO," 1998) This is significant, because it is illustrating how executives believed that divesting the firm of Conoco was the best option for increasing earnings. (Spitz, 2004, pp. 31 -- 69)
From the perspectives of the CFO, this makes sense to a certain extent. However, the fact that they were so ready to sell is an indication that they did not think about the long-term implications of their actions. This is because executives felt that the low price of crude oil was squeezing their profit margins. Over the course of time, this caused managers to believe that the purchase of Conoco failed to achieve its long-term objectives. The reason why, is it did not provide any kind of protection against rising energy prices (with them falling to multi-year lows since the purchase was completed). This is when many executives began to question the logic of this transaction (despite the fact that it was helping to increase earnings from: $9.7 billion to $15.24 billion in ten years). At which point, DuPont began to examine possible strategies for divesting itself of Conoco. (Spitz, 2004, pp. 31 -- 69)
On the surface, this seemed like it was a financially prudent transactions. However, since that time the prices of crude oil have climbed to as high $150 per barrel. While Conoco, was eventually purchased by Philips Petroleum. This is troubling, because the sharp increase in oil prices meant that the DuPont did not realize the full value of Conoco. The reason why, is because they are underselling themselves by wanting out of the industry when there prices for crude oil were at very low levels. If management was patient, they would have been able to realize the increasing profit margins and they could have divested or sold Conoco when oil prices were reaching their all-time highs. (Spitz, 2004, pg. 46)
Another possible solution was to engage in a partial spin off of Conoco. Under this kind of scenario, there would be a concentrated effort on having the firm sell a percentage of Conoco to shareholders. As management could have been able to maintain operational control and raise additional working capital. In the future, this would have allowed DuPont to be able to increase their stake in Conoco. What is happening is the increase in oil prices after 1998 created a fundamental shift in consumer demand. Part of the reason for this, is because many emerging economies such as India and China began to increase their demand for fossil fuels. This caused the available supplies on the market to decline. At which point, prices began to consistently climb higher over the next ten years. If DuPont had continued to own a stake in Conoco, the value of their investment could have increased dramatically based upon this changing reality. (Das, 2006, pg. 150)
The way that this could have occurred, is DuPont would have allowed Conoco to be spun off as an independent corporation. However, they would have maintained a majority stake in the firm. The way that this could have been accomplished is through having two different stages totaling a divestment of 20%. Under stage one; executives would sell 10% of their ownership in Conoco to the public in the form of an IPO. Then, about one to two years later, the final 10% would have been sold to investors.
If this basic approach had been taken, DuPont would have seen their earnings increase even more in comparison with completely divesting the firm. Evidence of this can be seen with the fact that they were acquired within three years of their spin off by Phillips Petroleum. This helped to increase Philips Petroleum's over all bottom line numbers. As the new firm, has seen significantly higher revenues in comparison with DuPont. The below table is illustrating how this purchase has helped to increase the earnings of the company over…