Or, read the ag bull M&A small print.
BHP Billiton’s hostile bid for PotashCorp received a bit more resistance on Thursday, with indications of rival interest from Sinochem.
Now Citigroup’s analysts have also looked into the offer’s strategic innards, coming up with five questions that also throw some doubt on the offer.
The first three deal with a key rationale for grabbing PotashCorp now — that potash prices will stay high and stable with global food demand. Perhaps, but note these pointers:
Issue 1: Does Potash in BHPB portfolio increase the diversification? — Our analysis suggests that by adding Potash Corp to BHPB it would have increased the volatility of earnings for the company over the past ten years. Higher volatile earnings have historically resulted in a P/E derating for mining companies.
Issue 2: What long term potash price do you need — By modeling Potash Corp as a stand alone entity (albeit with a higher capital base, equal to ~$45bn – our theoretical acquisition price), we have derived a required potash price needed to generate a ROIC of 5.0% – equal to the cost of debt. The result is a potash price of $475/t at potash production of 9.4Mt.
Issue 3: Resource Rent Tax — Canada’s Potash industry has a resource rent tax which can vary between $50/t and $100/t based on production, capex, and commodity prices. This impacts the cost curve position of POT Corp. In addition, by BHPB acquiring POT Corp, it may set a precedent for other governments, in particular Australia, that they are willing to accept taxes at these levels.
Well, when it comes to political risk like this — who knows. The Australian resource tax depends a lot in the first instance on the weekend’s elections there, which will either return a Labor government willing to tax… or one that won’t be.
BHP Billiton might have just as many problems with shareholders though, according to Citigroup’s last two points:
We also compared the POT acquisition vs a buy-back of equivalent value to the potential POT acquisition, funded from the same borrowing terms. Figure 14 [above] clearly highlights the advantage (~30%) to BHPB shareholders of a buy-back on FCF/share basis. Not only does this mean that the buy-back would be preferable to the acquisition on a FCF/share basis, but also that BHPB’s stand alone FCF/share is diluted in years 2011 and 2012 by the acquisition.
Moreover, Citigroup have tested the size of the deal against the UK FSA’s threshold requirements for it to be considered a class 1 transaction liable to shareholder vote. Using market prices from 17 August, they reckon that the deal just about edges over one such requirement — the enterprise value of the target being 25 per cent of the acquirer (click to enlarge chart):
This could get a bit complicated.
Related links:
A legacy of potash – FT Alphaville
BHP’s Potash war gets personal – FT Alphaville
BHP offer for PotashCorp faces scrutiny – FT