Privatization of PBB in Argentina

Firstly, rapid society transformation is taking place in Argentina. Economy is developing in a fast pace and political environment is becoming more and more stable. During the 1980s, Argentina experienced long periods of hyperinflation, stagflation, and huge fiscal deficit. Economy of Argentina started to recover after Carlos Menem took power along with his Convertibility Plan. Living standard in Argentina is anticipated to continue to improve; food, packaging industries and supermarkets sectors have experienced dramatic development since 1991, increasing demand for polyethylene.

Secondly, supply of primary materials such as petroleum and gas is abundant in Bahia Blanca, and energy price in the area is low. Supply of primary materials and electricity are crucial to success of polyethylene production. Thirdly, competition of polyethylene industry in Argentina is moderate; there are only two major players in the industry, and products of the two companies are different, PBB specializes in ethylene and HDPE production, PBB’s main competitor, Polisur, specializes in LDPE and HDPE production. The probability of price war is low in Argentina, and thus, revenue is relatively stable and predictable.

Acquiring PBB offers Dow the opportunity to enter Argentina market, and this is the first step for Dow to take over control of Bahia Blanca’s polyethylene activities. The main risks beyond the general industry risks of this project for Dow are country risks. There are three main risks associated with country risks, political risks, economic risks and financial risks. Political risks of Argentina seemed to be small. The political system in Argentina was relatively stable, political environment had been stable for about 12 years, and no expropriation had been reported for the past 50 years. The political environment was expected to remain stable in the future, especially after Carlos Menem took power.

Economic risks are high here in Argentina. Argentina is a developing country, and economy system of the country was not well established as in developed country such as the US. During 1980s, long periods of hyperinflation, stagflation and huge fiscal deficits hit Argentina economy heavily, GDP shrank and unemployment rate increased. Situation began to improve in 1989 when the convertibility plan had been implemented.

Financial risks, especially currency risks are the risks we concern the most. Dow is an American company and all profits generated by Dow Argentina will be converted into USD and wired back to the States, in other words, value of Dow Argentina is captured by Argentina peso to USD exchange rate. If Peso depreciates by a large amount, amount of USD received by Dow will decreased and Dow may at the end make a loss in Argentina due to very weak Peso. A stable Peso to USD exchange rate is crucial to Dow. Between early 1970s and 1991, at least eight major currency crises took place in Argentina.

The most recent banking and credit crises, as known as Tequila crisis, triggered a great depreciation of Argentina Peso. The crisis was ended when Peso was tied to USD. Although convertibility law remains in force in Argentina, it cannot prevent another major currency crisis from happening in Argentina. Maintaining the convertibility law requires huge amount of foreign currency reserve. No one is sure that the Argentina government can always maintain that amount of foreign reserve to tie Peso to the USD.

We will value the whole project including all three stages using discount cash flow method (DCF). Cash flows we are using here are free cash flows generated in every stage. Free cash flow can be calculated by adding back depreciation expense to net income and subtracting change in working capital and capital expenditure from net income. It makes sense to value projects by discounting free cash flow since free cash flow reflects company’s real ability to generate cash flow and thus profit. Management can overstate or understate profit of companies legally under accounting acts, and valuing companies by discounting future profit may lead to a wrong picture; therefore, we will value this project by discounting free cash flows.