Canada to BHP: Keep Your Greedy Hands Off My Potash!

In case you haven’t heard, there’s been yet another dramatic development in the continuing saga with BHP Billiton (BHP) and its yearning for Potash (POT).  In most M&A cases, regulatory approval is annoying and time-consuming, but not necessarily a deal-breaker.  Not so in this case.  This week, the Canadian government announced that it would not approve BHP’s $39 billion acquisition of Potash.

This governmental approval is required under the Investment in Canada Act, which the government invokes to ensure all acquisitions benefit Canada.  The Investment in Canada Act became law in 1985, with the only blocked foreign takeover occurring in 2008, when MacDonald Dettwiler (MDA.TO) tried to sell one of its divisions to MDA-ATK, an American firm.

Although political pressure is high given that this merger would change Canada’s natural resources landscape, there are precedents for such a deal.  Last year, Cargill acquired a large stake in Mosaic (MOS), a potash producer in Saskatchewan, after other mining companies, such as Inco, Falconbridge, and Alcan, consolidated in a wave between 2006 and 2007.

Ultimately, the disagreements stem from the future role of Canpotex, that quasi-cartel of Canadian potash producers which aims to keep the price of potash high by limiting supply.  BHP has made it clear that it wants to increase production, which if I recall Economics 101 correctly, means a decline in prices.

In mid-October, BHP’s talks with the province of Saskatchewan faltered, even though BHP agreed to be very generous!  The province, concerned about how it would recover lost tax revenue if the deal consummated, asked BHP for billions in upfront payments.

BHP agreed to adjust the timing on the construction of a new potash mine in the province in order to spread out a $2 billion tax deduction.  It also will be able to deduct about $1 billion in interest on debt used to acquire Potash.  Saskatchewan wants them to throw that deduction away, in addition to pouring hundreds of millions into an infrastructure fund.  To the former, BHP said, no freaking way.  To the latter, they offered the fund what the province considered a measly $360 million.  This was not enough, as Saskatchewan rejected the deal and encouraged the Canadian government to follow in tandem.

The premier of this province, Brad Wall, encouraged the Canadian government to block the deal.  At the beginning of November, Saskatchewan turned up the heat on the Canadian government after governmental authorities released a report in the National Post that suggested tentative approval of the deal: such a deal, Saskatchewan threatened, would be a massive betrayal!

This pressure must have been ultimately successful, because the Canadian government announced Wednesday that they refused to approve the deal.

But wait! Isn’t the Canadian government conservative? Aren’t they proponents of laissez-faire capitalism?

This is a special circumstance, they argue.  Many business leaders are on board with the government’s decision, particularly after hard feelings arose after previous mining consolidations in the region.  Also, Canada produces half the global supply of potash, and wouldn’t want to allow BHP to put its greedy hands on crucial natural resources.

Speculation that the Canadian government would ultimately reject the deal started infecting the stock price at the end of October, despite a strong quarterly earnings release around the same time.  After this week’s shocking announcement, Potash has been trading down approximately 5%.  Will BHP offer a higher price? It has 30 days to change the Canadian government’s mind.  Or, will it pull a Rio Tinto (RIO) and bail?

Meanwhile, Potash keeps promising an alternative bid from a White Knight, but so far, no prince has come.  Potash’s chief executive, William J. Doyle, urged his investors to be patient: “I laugh when I see people presume or assume a certain outcome.”  We should be glad it’s humorous to him, because Potash’s shareholders and the Canadian government sure aren’t laughing.

After all of this posturing one would hope something better would come along, especially after meetings with 15 alternative bidders.  Options traders certainly thought so, at least in the first few days of November.

Hope springs eternal, as the beginning of November brought a potential new bidder, PhosAgro, a Russian fertilizer producer.  Apparently, Vedomosti, a Russian business newspaper, intercepted a letter from the chairman of PhosAgro to Prime Minister Putin, asking for support.  In this scenario, “support” means a little bit of bank lender arm-tugging on behalf of PhosAgro, as well as political backing.

Why would Russia want to be involved? Like China, Russia would like to secure its food supply, particularly after a series of natural disasters over the past year left the country with a limited supply of some grains.  This deal would provide Russia with 70% control of the global potash supply, although it already possesses a large part of the market share.

PhosAgro was reportedly in talks to acquire other potash-producing businesses in Russia, but the acquisition of Potash may be more politically feasible because it will likely pass anti-trust scrutiny.

The question now is, will PhosAgro propose? If it does, will Potash be happier with the bid, assuming it’s higher? Or, will it continue to play hard-to-get?  The regulatory hurdles in this deal may end up being more like regulatory cliffs, particularly because so much is at stake for both Canada and the company who gains access to such a large  share of the market for potash.

Disclosure: No positions in the stocks mentioned.