E.I. Du Pont De Nemours and Co.: Titanium Dioxide

E.I. du Pont de Nemours and Co.: Titanium Dioxide

CASE WRITE-UP TO BE HANDED IN BY GROUP

Executive Summary

Points to Consider in Executive Summary

1. What are Du Pont's competitive advantages in the TiO2 market as of 1972? How permanent or defensible are they? What must Du Pont do to retain its competitive advantages in the future?

• Du Pont’s competitive advantage is that it is currently the only company that has the operational knowledge necessary to make production of TiO2 using ilmenite ore economically viable
• Given recent changes in the market i) shortage of rutile ore and ii) newly enacted environmental protection legislation affecting sulfate process plants, the know-how Du Pont has in ilmenite ore process is particularly valuable at this point
• Although this method is widely known, it is hard and time consuming to scale it up, so that competitors would take a while to reach the scale and know how Du Pont currently has
•  The competitive advantage is not permanent given the fact that the technology is known and can be copied, however Du Pont still has an advantage to be able to move faster than competitors and increase capacity, making it less attractive for new entrants
• Finally, Du Pont’s pretax profit margin was expected to be around 40%, 2x the margin that competitors building new ilmenite capacity would be able to realize so that this gives them more flexibility

1. Given the forecasts provided in the case, what are the relevant cash flows associated with the following three strategies for managing DuPont's TiO2 business?

Strategy I: Status Quo. Hold production capacity at 325,000 tons per year. Strategy II: Maintain Strategy. Build capacity to 482,000 tons by 1985.

Strategy III: Growth Strategy. Build capacity to 685,000 tons per year by 1985.

Notice that the status quo is not directly discussed in the case, but just gives a benchmark of comparison between the two strategies being considered (maintain vs. growth).

• See attached spreadsheet

• Comments:

• Assuming the numbers given, the increment in NPV vs Status Quo for Strategy 2 is 103,432 using a WACC of 9.1% (see WACC assumptions in spreadsheet)

• Assuming the numbers given, the increment in NPV vs Status Quo for Strategy 3 is 241,574 using a WACC of 8.2% (see WACC assumptions in spreadsheet)

• Even if we used same WACC for both, the NPV of strategy 3 is bigger than strategy 2. However, in strategy 3, a much bigger part of the NPV is in the terminal value

• The % of NPV in the terminal value for strategy 2 is 17.9% while for strategy 3 this number is 31.5%

• Using 40% margins as an assumption, even when TV = 0, the NPV is positive up until a WACC of ~9.5%-10%, which seems reasonable

• Overall, using these numbers, expansion seems to be a good option – the problem is if margins fall overtime because of competition, oversupply, normalization of the problem with the other processes etc..  

1.  How much risk and uncertainty surround these future cash flows? What are particular sources of risk facing Du Pont?

• Competition risk and margin compression: despite Du Pont’s current competitive advantage, competitors can gain experience over time and build capacity causing margins to erode. Cash Flow calculations assume a constant operating margin @ 40% but if competition aggressively adds capacity in the coming years, that could lead to a big downside for Du Pont’s margin and expected FCF

• Assuming margins fall overtime until they reach 20% in 1985, the result changes significantly
• In that scenario, NPV for strategy 2 vs Status Quo would be -31,277 (including TV) and -103,072 if TV = 0
• For strategy 3 the NPV would 25,548 (including TV) and -158,676 if TV=0

• Supply / Demand risk: the sudden increase in demand came from 2 specific events that could be normalized in the future. If the shortage of rutile ore and / or the legislation impacting sulfate process plants come back to normal, the market will be oversupplied with the increased capacity therefore affecting companies’ profitability, market prices, etc.  

1. How might competitors respond to Du Pont's choice of either strategy in the TiO2 market?

1. What other factors should Du Pont consider in making this decision?

• Financial risk: Pursuing high capex strategies can constrain the company / reduce flexibility and increase risk of financial distress going forward.

• When leverage increases too much, the risk of financial distress can also increase. In the case of Du Pont, however, because the company’s leverage is currently very low, they still have a lot of room to increase it before financial distress becomes a real risk

• Risk of Antitrust charges: Aggressive defense of market share often gave rise to antitrust charges in the past and the cost and risk of those charges have to be taken into consideration in a scenario where the company reaches 45% and 65%+ market share

1. Which strategy, maintain or growth, looks more attractive for Du Pont? What are the key factors leading to your conclusion?

FYI, in 1972, bond yields and recent inflation data were approximately as follows:

Long-term Treasuries - 6.2%

Aaa Corporate bonds = 7.2%

Baa Corporate bonds = 7.8%

Inflation rate (CPI) = 3.2%

Assignment hints

The continuation or terminal value is especially important for strategies with large CAPEX during the forecast period.

Case page 4: Ongoing capital expenditure for maintenance and replacement were expected to approximate depreciation allowances over time.

Case page 4: Should TiO2 production terminate at any point in the future, it was believed that Du Pont’s investment in working capital and the book value of other assets could be completely recovered.