Plea to Dow Chemical Shows Paulson's Still An Arb At Heart

John Paulson is best known as the hedge fund manager who called the subprime mortgage crisis spectacularly right, but his plea to Dow Chemical Co. (DOW) to complete its $15.3 billion acquisition of Rohm & Haas Co. (ROH) shows Paulson remains fully committed to his main strategy: merger arbitrage.

Paulson, who runs $36 billion Paulson & Co., now owns more than 9% of Rohm & Haas stock after buying more than three million shares during the fourth quarter, according to a filing made with the Securities and Exchange Commission. Paulson, not normally an activist investor, is taking unusual steps to turn around what until now has been a money-losing investment.

Paulson said in a letter Wednesday to Dow Chemical Chief Executive Andrew Liveris that Dow should cut its dividend to a penny and sell common stock and bonds to pay off the $13 billion in bridge financing needed to complete the deal.

Merger arbitrage had been Paulson's main focus ever since he started his hedge fund in 1994, after working as a managing director in mergers and acquisitions at Bear Stearns. But in 2007, Paulson put on a perfectly timed bet against subprime mortgages, earning millions for his investors and more than $3 billion for himself. He continues to invest in financial services, but he has never stopped with the merger arbitrage, holding large stakes in Rohm & Haas and other buyout targets, like Genentech Inc. (DNA) and Merrill Lynch & Co.

Dow agreed to buy Rohm & Haas back in July for $78 a share, a 74% premium to the prior day's closing price. Since then, Dow has been stung by a weakening chemicals market, which contributed to a $1.55 billion fourth-quarter loss, and a decision by the Kuwait Investment Authority to back out of a joint venture that Dow was counting on to help finance the acquisition. Earlier this week, Dow said a completed buyout would trigger debt defaults. The company is fighting the deal in court, saying it is bad for both sides.

Rohm & Haas shares were up 1.9% at $54.75 in recent trading, but have given up about a quarter of their value since the deal with Dow was announced.

Paulson's hedge funds have all been faring well, with most posting double-digit gains in 2008, according to investors. That said, considering Paulson bought his original 14.9 million shares in the third quarter when the deal was announced and Rohm & Haas shares traded in the $70s, the investment hasn't worked out so well.

The original investment, if Paulson isn't hedged, has resulted in losses of well over $200 million, considering the depreciation of Rohm & Haas' stock price. The more than three million shares bought in the fourth quarter have also lost Paulson money.

A spokesman for Paulson declined to comment for this story.

Other merger arbitrage and event-driven hedge fund companies also own Rohm & Haas shares, including York Capital Management and Mason Capital Management. One anonymous hedge-fund manager, who already owned more than a million Rohm & Haas shares, said he is buying more now in anticipation of Dow losing in court.

Paulson's letter to Dow is a bit out of character, considering that he has rarely played an activist role in his investments. It is also rare in that it is a letter to Dow, a company whose stock Paulson doesn't even own.

Technically speaking, Paulson's not even being an activist here. The firm filed with the SEC a Schedule 13G - the form reserved for passive investors - rather than a Schedule 13D, which is used by investors who may plan on talking to management.

But since it is Dow management - and not Rohm & Haas's - that Paulson is trying to push, declaring itself an activist isn't necessary.

Dow shares were up 14 cents to $10.91 in late trading Thursday. The shares have lost about two-thirds of their value since the company announced the acquisition plans.

-By Joseph Checkler, Dow Jones Newswires; 201-938-4297; [e-mail]

(Thomas Gryta and Kerry Grace contributed to this article.)