Dow Chemical Hits The Trenches
Phyllis Berman, 09.30.03, 2:55 PM ET , Forbes.com

NEW YORK - Is "duck and cover" the new corporate motto at Dow Chemical?

With downgrades happening across the chemical industry, including yesterday's downgrade of Crompton (nyse: CK - news - people ), analysts are holding their breath to see when and how Standard & Poor's will rate Union Carbide, the Dow (nyse: DOW - news - people ) subsidiary that was once a miner and marketer of raw asbestos. After all, in early September, the chemicals giant saw Moody's reaffirm its senior unsecured debt rating in the low single-A tier. But the ratings agency downgraded Union Carbide's debt to junk.

In fact, in an unusual note, Moody's stated that Dow simply wasn't willing to supply much information about the asbestos liabilities for which it had been asked. Who knows what Moody's asked, but among the things the market doesn't know are such essentials as the number of claims brought against the company so far and the timing of insurance payments it should receive to cover these claims. Dow's silence may be merely a way to deprive the tort lawyers who represent asbestos claimants of any advantage against the company. But without that information, Moody's was treating Dow and Carbide as two separate entities.

Dow spokeswoman Cindy Newman said that the company would not comment on either Union Carbide's new debt rating or its legal strategy regarding Carbide's asbestos claims.

That strategy changed dramatically when William S. Stavropoulos was reinstated as chief executive on Dec. 12, 2002, the same day that Michael Parker, a 34-year veteran of the company, was fired after serving less than two years. (Stavropoulos had stepped down in 2000 because he had already served five years as CEO, the maximum under Dow corporate policy.)

It was under Parker that Dow in January 2002 accepted some of Carbide's asbestos liabilities in the U.S. and settled a Texas asbestos lawsuit originally filed against the unit. The news caused its stock to plummet 30% in little more than a week's time, wiping out $7.16 billion in equity.

Once Stavropoulos was back on board, the stock started to move up. The strength of Dow's stock was solidified when Stavropoulos announced he had hired a consulting firm that put an estimate on all of the company's asbestos exposure. According to the company's calculations, insurance receivables would more than cover that exposure.

Since then, Dow has become even more aggressive. CreditSights' Senior Analyst Andrew Brady explains Dow's strategy: "Dow has been hunkering down for a long ugly fight against these [asbestos] claims, and with precedents like Dow Corning and Bhopal...it is not new to legal wars." One piece of Dow's legal strategy, according to Brady, is that Dow recently replaced Carbide's $1.5 billion unsecured credit line with a secured $1 billion note with a 30-day demand provision.

Why do that? According to Brady, Dow accomplished two objectives. First, it was able to borrow at the investment-grade Dow level and effectively fund Carbide with cheap credit (versus paying market rates for a Carbide bank line). Secondly, Dow created a secured claim on Carbide's assets for itself. "If asbestos claims overwhelm the sub," says Brady, "Dow will have the right of first refusal to throw Carbide into bankruptcy, and at that point, Dow will have a first-priority claim on Carbide's assets."

All well and good, but the real question now is, should the claims overwhelm Carbide, can Stavropoulos defend against attacks by plaintiffs' lawyers on Dow's corporate veil? In its annual report, Dow asserts that the litigation and the asbestos contingencies are a Union Carbide issue and not related to Dow. It notes, however, that Dow personnel have been "retained" by Union Carbide to provide their experience in mass tort litigation. But plaintiffs' lawyers know a deep pocket when they see one, and they will do anything they can to get in it.

So far, at least, Dow's stock price is close to its 52-week high, as are many other stocks that the market is betting will benefit from an economic recovery. That's despite the fact that it was Stavropoulos who signed the Union Carbide deal in the first place in July 1999.

In fact, the Street credits him with two successful restructurings of the company. With the exception of BASF (nyse: BF - news - people ), every company in the chemical business was choosing either to produce commodity chemicals like Royal Dutch Petroleum (nyse: RD - news - people ), Occidental Petroleum (nyse: OXY - news - people ) and BP (nyse: BP - news - people ), or get out of commodity products altogether like Bayer (nyse: BAY - news - people ) and Imperial Chemical Industries (nyse: ICI - news - people ). Stavropoulos choose not only to stay in both businesses, but also to grow in both, turning his company into the largest in the industry.

Can Stavropoulos beat off the tort lawyers with his silence? If not, can he at least limit the damage to the subsidiary? Stay tuned.

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