Bid Success Would Vault BHP to Top Potash Spot

We believe BHP Billiton will need to increase its offer before PotashCorp seriously considers any tie-up

Elizabeth Collins, CFA 18 August, 2010 | 9:20AM
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On Tuesday, PotashCorp announced its rejection of a $130 per share unsolicited bid from BHP Billiton. The Anglo-Australian mining giant has made no secret of its desire to enter the potash mining industry and has begun investing in greenfield potash projects in Saskatchewan. Greenfield projects take several years to develop, and it seems that BHP has grown impatient. The acquisition of PotashCorp would immediately vault BHP into the position of the world's largest producer of potash and further solidify its status as the global mining giant.

The timing of the attempted deal reflects where we are in the cycle. After a run-up in potash demand and prices in early 2008, fertilizer markets came to a virtual standstill and languished for most of 2009. Falling crop prices, tight credit conditions, reduced applications, and destocking all contributed to anaemic demand for potash. As the global leader, PotashCorp accepted the burden of reducing production to keep supply and demand in balance as much as possible. Now, we have achieved price discovery between producers and consumers, crop prices are strengthening, and growers are returning to applying more-normal levels of fertilizer.

PotashCorp is vehemently arguing that BHP's bid prevents PotashCorp shareholders from participating in the potential upside of further growth in potash demand, pricing, and production. That is fair; if we assume that potash markets return to the frenzy we saw in early 2008--and that such robust levels of demand and pricing are sustainable--then PotashCorp is arguably undervalued today. We must mention, however, the flip-side scenario. There are plenty of potash production expansion projects on the drawing board, and a situation of long-term oversupply is not hard to imagine, especially if demand growth doesn't cooperate. Still, it seems fair that PotashCorp shareholders demand at least a premium for control.

We believe BHP Billiton will need to increase its offer before PotashCorp seriously considers any tie-up. It's also possible that another potential buyer will step in. We think Vale could come to the table. The Brazilian iron ore behemoth has also made recent strides into the potash industry, and it certainly has enough cash to bite off a large acquisition. That said, the firm's massive capital expenditure plans for the coming years could mitigate its interest in an all-cash deal.

Elizabeth Collins, CFA, is an equity analyst with Morningstar.

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Elizabeth Collins, CFA  is an associate director of equity research with Morningstar.

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