Dow Chemical’s Bid for the Privatization of PBB in Argentina – Essaylink

In the mid 1990s Dow Chemical is faced with growing opportunities in Latin American and, in particular, Argentina. For instance, in 1995, the Argentine government announced plans to privatize 51% of PBB, a company that produced ethylene and polyethylene, two essential feedstocks for the production of plastics. Dow Chemical senior managers are considering bidding on the privatization and, in the process, must consider how to incorporate the risks of the acquisition and its long-term potential into a valuation. The acquisition of PBB would realize Dow’s longstanding ambition to become the leading polyethylene producer in Latin America but, obviously, the deal need to make sense on its own.
The challenge lies in identifying the critical risks of a major investment opportunity in an emerging market and then deciding how these risks should be incorporated in the financial analysis of the deal. Using the project’s cash flows you should determine how a project’s critical risks map into its valuation through either discount rates or adjustments to cash flows. As part of the valuation exercise you first have to gain an understanding of how to break down the analysis of a complex industry into its cash flows, how to evaluate similarities and differences between country risk and project risk, and how to incorporate risks that are particular to emerging economies such as a currency depreciation affect specific businesses and their valuation.
In preparation for the valuation exercise you might want to read Esty, B. (1999), “Improved Techniques for Valuing Large-Scale Projects,” Journal of Project Finance 5 (Spring 1999). The following question might be helpful in guiding your group discussions:
1.How would you convince Dow headquarters to invest in this project?
(a) What are the major risks? How would they influence operations at PBB under Dow management?
(b) To what degree do the risks affect the valuation? The bidding?
(c) How would you incorporate the various risks into the valuation of PBB from Dow’s perspective?
2.How would you conduct a valuation of this project? What are the typical steps of a valuation exercise in preparation for a bid?
3.What is PBB worth to Dow and how would you bid for this project? How are valuation and bidding strategy related?
(a) Where lie the dangers in bidding for PBB? What could go wrong and what are the consequences?
(b) How could Dow avoid falling victim to common problems affecting aggressive bidders in auctions for assets?
(c) How do you think does the distribution of information between Dow, PBB, and the Argentine government affect the respective parties’ behavior? What does it mean for Dow’s bidding strategy?
4. Formulate bidding strategies for PBB on the basis of three scenarios (low, expected, high).
(a) How would you bid? What is the biggest danger in bidding for such a project in a first bid sealed auction? Is it any different from other auction under uncertainty?
(b) How does the fact that you are bidding for a real option (the project will be developed in three stages after all) affect your bidding strategy?
(c) What would your next steps be if you were to win the bid? How would the evolution of world ethylene and polyethylene prices affect your investment and operating strategies?
5. What was the auction’s outcome and what has happened since then? Report on events since the bidding and carry out a post-mortem analysis of the project.

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