BHP Billiton made a hostile $40 billion all-cash bid to acquire Canada's Potash Corporation of Saskatchewan. The offer is pitched at a 20% premium to PotashCorp's August 11 closing price or a 33% premium to the two-month volume weighted average price. PotashCorp's board unanimously rejected the offer as inadequate. The offer is open to October 19 unless extended.
BHP says the bid:
-- is consistent with its strategy of adding Tier 1 assets;
-- lends further commodity and geographical diversification;
-- accelerates entry into the fertilizer industry;
-- is a natural fit with existing greenfield Saskatchewan land holdings;
-- will be earnings accretive in the second full fiscal year following consolidation;
-- will not halt progress in plans to develop its own Jansen potash mine;
-- is conditional upon 50% acceptances and termination of the PotashCorp shareholder rights plan; and
-- will be debt funded.
The rights plan is a poison-pill defense that triggers an issue of new shares if any one party acquires a stake of 20% or more in PotashCorp. One share purchase right is issued for each common share at a substantial discount to the prevailing price. Some "permitted bids" will not trigger the rights if they are open for a minimum 90 days and are supported by a majority of shareholders.
We estimate BHP has around $5.0 billion in net debt, about 9% leverage. At the end of June, PotashCorp had net debt of $3.4 billion. A cash bid at the price suggested would take BHP's net debt to $48 billion, or 92% leverage (net debt/equity). But interest coverage would remain high and leverage could quickly fall to below 30% within two years, or faster if noncore asset sales assisted. Rio Tinto's harrowing experience with Alcan will no doubt be fresh in shareholders' minds. But Rio's leverage peaked at more than 200% with Alcan, headlong into the global financial crisis.
We are both surprised and not. PotashCorp's assets are large, low-cost, long-life, expandable, and export-oriented--a fertile stomping ground for the likes of BHP. Similarities to other bulks like iron ore and coal are obvious. BHP is developing its own potash assets, and many believed it would work from a grass-roots level only. But if it can buy existing infrastructure and simultaneously take out the major competitor, that is a far better option, particularly since the potash market doesn't have the depth afforded by resources staples coal and iron ore. Best to have as much pricing power as possible, given the heavy up-front capital required.
There are very real risks, and the move requires somewhat of a leap of faith. This is more about the future with declining arable land, growing populations, and water shortages. Still, the end result would be a business constituting around one sixth of BHP overall. BHP has a bit of room to get it wrong here without it being a company killer. Alcan, by comparison, was more than one third of Rio. And the potential upside to BHP is very considerable. We aren't changing our earnings forecasts or valuation for BHP as a result of the bid.
