Chemours, DuPont and Teflon – Understanding the Dimensions of the Iceberg

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Graham Copley / Nick Lipinski

203.901.1629/203.989.0412

gcopley@/nlipinski@ssrllc.com

January 6th, 2017

Chemours, DuPont and Teflon – Understanding the Dimensions of the Iceberg

  • Yesterday’s judgement and award in Ohio with respect to the Chemours “C8” litigation risk, only helps to confirm the cautionary stance that we took once the first case was heard in 2015.
    • This could become a major liability for both companies, and without some sort of broad indemnification from DuPont could be far more serious for CC than is currently implied in the stock.
  • While Chemours and DuPont will likely continue to contest the awards, a $10.5 million punitive award on top of a $2m compensatory award for one plaintiff sets a very worrying precedent.
    • Around 15-20% of the 3500 plaintiff group are alleged to have or have had cancer or pre-cancerous conditions, but this still results in a very large number if you do the simple math.
    • It is not an unreasonable assumption that this could turn into a $2-4bn settlement if things do not start moving in the direction of the defendants.
  • We note that in 2001 Dow Chemical in its 10K discussed a potential liability from asbestos post the Union Carbide acquisition of $233 million, all of which was to be covered by insurance. By the same time the following year this estimate of liability had increased to $2.2 billion – see chart!
    • At this point as much as $1.0 billion was not covered by an expected insurance receivable and Dow took an $800 million plus charge in that year.
    • In this case Dow/Union Carbide was only looking at the tip of the iceberg in 2001.
  • Taking the “once bitten – twice shy” approach we would encourage Dow and its shareholders to pressure DuPont to get this matter settled before the merger is completed. Underestimating the liability at Carbide cost Dow’s shareholders a great deal of money
    • Dow’s share price was very weak during the 2001-2002 period and only rallied once the higher liability was disclosed in March of 2003
    • We believe that this issue is dragging on valuations for both DuPont and Dow today and that some sort of settlement might actually be positive for the stocks.
  • The lack of reaction to the award in Chemours stock suggests that investors expect DuPont to bail out Chemours – certainly Chemours does not have the cash flows to set aside as much money as might be needed.
    • We would not own CC here – we think that the company will have to share some of the costs and that the risks of this as well as other possible litigation are not priced into the stock.
    • There is a very wide range of possible outcomes for Chemours, but given that some of those outcomes result in minimal equity value or perhaps significant dilution we see much better ways to play a TiO2 cycle – such as HUN – see research also published today
  • Worst case for DD would be a payout of as much as $4bn in our view – the company would take the charge up front but probably pay out over a 5-year period. The charge would be an after-tax hit of around $1.10 per Dow/DD share. It might be a hit to target valuations – but as we remain far from potential valuations today, a settlement – even at this level – might be a positive catalyst
    • We remain positive on the DOW/DD deal and in recent research referred to this issue as a possible large road bump for DD
  • In addition to the chart of Dow’s asbestos liability we also include a couple of excerpts from Dow 10K’s during that period – appropriate actuarial estimates of liability in 2001 turned out to be off by a factor of 10 within 12 months.

Exhibit 1

Source: Company Reports and SSR Analysis

Quote from Dow 2002 10K

“For pending cases, the Corporation had asbestos- related litigation accruals of $233 million and $118 million at December 31, 2001 and 2000, respectively, and related insurance recovery receivables of $223 million and $108 million at December 31, 2001 and 2000, respectively. The litigation accrual at December 31, 2001, was determined by considering the number of pending claims filed against the Corporation and Amchem, taking into account claims administration records indicating the severity of the alleged injury. Because many of the pending claims are Non- Specific Claims, the Corporation has calculated several probable liability outcomes based on estimates and historic distributions of personal injury claim types and settlement and resolution amounts. The liability estimates ranged from a low of $158 million to a high of $277 million. Upon review by management, it was determined that the most reasonable estimate was $233 million, which is well within the estimable range. The Corporation’s asbestos litigation accrual at 37 December 31, 2001, increased compared with the end of 2000 principally as a result of the higher level of claims that were filed during the third quarter of 2001.”

Quote from Dow 2003 10K

“Combined with the previously mentioned increase in the asbestos- related liability at December 31, 2002, this resulted in a net income statement impact to Union Carbide of $828 million, $522 million on an after- tax basis, in the fourth quarter of 2002. The insurance receivable related to the asbestos liability was determined by Union Carbide after a thorough review of applicable insurance policies and the 1985 Wellington Agreement, to which Union Carbide and many of its liability insurers are signatory parties, as well as other insurance settlements, with due consideration given to applicable deductibles, retentions and policy limits, and taking into account the solvency and historical payment experience of various insurance carriers. At December 31, 2003, Union Carbide’s receivable for insurance recoveries related to its asbestos liability was $1.0 billion.”

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