Dow Chemical buys Union Carbide
What's a Fool to do?

by Ann Coleman (TMFAnnC)

ALEXANDRIA, VA (August 5, 1999) -- Good news yesterday for Foolish Four investors who were lucky enough to be holding Union Carbide (NYSE: UK) in their Foolish Four portfolios. The chemical giant is being purchased by much bigger giant Dow Chemical (NYSE: DOW).

As described, the merger is an excellent deal for Union Carbide shareholders, who will receive 0.537 shares of Dow stock in exchange for each share of Union Carbide stock. With Dow selling for $124.69 at the close of business Tuesday, that meant that the management of Dow valued Union Carbide at $67. Union Carbide closed that day at $48 13/16. It looks like Dow valued Union Carbide rather more highly than the market did. And that is very typical for a Foolish Four stock.

Gee, this makes two typical Foolish Four stock stories in two weeks. Last week we talked about how 3M rose on a good earnings report, and today we see a slumbering giant that has been undervalued by Wall Street rising almost 30% in two days. For Fools who bought it months ago when it was selling in the high 30s to low 40s, the recent rise is very nice windfall, indeed.

As Foolish Four investors, what we are seeing is business as usual. A global industrial giant has been neglected by investors, yet its true value can't be ignored forever. In this case, the value was recognized by another company that obviously thinks Union Carbide, even at $67 a share, is a very good deal.

So what do Foolish Four investors do now? Well, I would suggest a nice dinner out with your best friend or spouse, or staying home with a bottle of champagne. Other than that you don't need to do anything. Remember, this is the relax-and-ignore-it portfolio.

First of all, the merger isn't scheduled to take place for months. Union Carbide shareholders will have to approve the deal, and the U.S. government antitrust lawyers will have to take a look at it. Once those two hurdles are cleared, you can expect that Union Carbide stock will trade more or less in lockstep with Dow at a ratio of 0.537:1. The rapid rise of Union Carbide to something close to that ratio already shows that most investors do not see those hurdles as particularly high, although there may be some uncertainty about the antitrust review.

The other question that Union Carbide investors have is: Should I sell now and lock in this great gain? This is a very popular question. It happens very time a Foolish Four stock does well. There are two answers.

The first answer is "No." The Foolish Four strategy that has worked so well over the 38 years that we have tested it and never tried to lock in gains, and if you want to follow the strategy exactly, you simply hold your stock for a full year, even if your Union Carbide shares are replaced by shares of Dow before the time comes to sell them. (There won't be any capital gains problems even if you sell shares of Dow that you have only owned a few days as long as they replaced Union Carbide shares that you have held for at least a year and a day.)

The second answer is "Sure." You are the master of your fate and the captain of your soul and you can choose to invest your money in any way you see fit.

If you are in the second camp, you now need to decide if you think Dow Chemical is a stock you want to own, or be tied to. If you think your money is at risk with Dow (and, of course, we have no way to know that the company won't turn out to be hiding dozens of purple, two-headed babies that were the result of strange chemical experiments carried on a la The X Files)... well, actually, if you think like that, you probably wouldn't have bought Union Carbide in the first place. So we will assume you are cool with chemical companies.

The rapid rise in Union Carbide over the last two days is not the result of some kind of market overreaction to good news. It is a very concrete adjustment of value now that Dow has made a bid for the company. There is no reason for the value to fall other than the vagaries of the market and the fortunes of Dow Chemical.

Dow will be the world's second-largest chemical company, after DuPont (NYSE: DD), when the merger is complete. Dow's shares are up about 30% this year. More important, maybe, is that although Dow's price slumped a bit when the merger was announced, it has rebounded, suggesting that the market views this merger as a good one for the company. No one knows what the market will do, but I see little downside to holding Dow for someone who was prepared to hold Union Carbide.

When Union Carbide is absorbed by Dow Chemical, what will take its place on the Dow (no relation) Jones Industrial Average? That question is being debated over at Dow Jones & Co. They could decide to simply replace Union Carbide with Dow. Or they could drop it and add another company all together. In either case, such a move doesn't need to affect Foolish Four investors.

The beauty of this strategy is that you simply do it. If the component stocks of the DJIA change, you ignore it until it comes time to renew your portfolio, at which time you may or may not be buying one of the new stocks. If a stock is dropped from the Dow, bought out, merged with another company, or whatever, you just sit tight. Sitting tight won't necessarily prove to be the "right" choice every time, mind you. But, over the long run, it probably works better than trying to "do something" every time there is a change.

And it leaves so much more time for life.

Fool on and prosper!

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08/05/99 Close
Stock  Change   Last
CAT  -1  1/16  56.13
JPM  +1  3/8   125.50
MMM  +2 11/16  94.44
IP   +   5/16  55.25

                  Day    Month   Year   History
        FOOL-4   +0.62%   2.07%  25.45%  27.31%
        DJIA     +1.12%   1.30%  18.35%  17.88%
        S&P 500  +0.64%  -1.13%   7.45%   7.71%
        NASDAQ   +1.02%  -2.75%  17.02%  18.62%

    Rec'd   #  Security     In At       Now    Change

 12/24/98   24 Caterpillar   43.08     56.13    30.28%
 12/24/98   14 3M            73.57     94.44    28.36%
 12/24/98   22 Int'l Paper   43.55     55.25    26.87%
 12/24/98    9 JP Morgan    105.51    125.50    18.95%

    Rec'd   #  Security     In At     Value    Change

 12/24/98   24 Caterpillar 1034.00   1347.00   $313.00
 12/24/98   14 3M          1030.00   1322.13   $292.13
 12/24/98   22 Int'l Paper  958.12   1215.50   $257.38
 12/24/98    9 JP Morgan    949.62   1129.50   $179.88

              Dividends Received      $49.99
                             Cash     $28.26
                            TOTAL   $5092.38