The Potash Clash: Will BHP Back Off?

This week we’ll discuss the continuing saga of the Potash Corporation of Saskatchewan (POT) and its disgust with BHP Billiton’s (BHP) $38.6 billion, $130/share cash tender offer. Although BHP announced its bid in August, the back-and-forth will likely continue into early 2011.

First, a little background.  Potash holds the majority market share in fertilizer production, and one of its primary products is potash, a crop nutrient.  BHP Billiton, a British-Australian mining company, wishes to diversify its revenue sources to reduce its reliance on iron ore prices, and feels Potash is a good fit at the right price.

The best way to conceptualize this takeover battle is through an analogy: let’s pretend that Potash is a young girl of marrying age, perhaps a little too confident in her looks, while BHP is the rich ogre looking to marry her.

BHP initially offered $130/share, which Potash’s board promptly rejected as “too low.”  In other words, in order to get Potash to agree to the marriage, BHP will have to promise a greater monetary reward to mitigate the bride’s future suffering, which will likely involve selling off some of Potash’s major assets, possibly including its nitrogen and phosphate businesses, which are worth approximately $12 billion.  BHP’s defense? It’s paying cold, hard cash.   Potash shareholders now have a recently extended deadline of November 18th to accept or reject the tender offer.

However, since the initial offer, Potash shares have hovered in the mid $140s, suggesting that investors expect more than what BHP announced it was initially willing to pay.  In the meantime, BHP’s shares have been on a volatile trend upwards since the end of August.

Source: Yahoo! Finance

Source: Yahoo! Finance

The general rule of thumb for merger arbitrageurs is to buy the target and short the acquirer because M&A transactions often involve a significant premium.  In this case, shorting BHP may not be the best strategy, as the CEO Marius Kloppers has assured the public it has no qualms about walking away from the transaction should another bidder offer a much higher price.  Perhaps this explains the recent run-up in BHP’s stock.  Plus, BHP’s recent earnings release was strong due to increased production of oil and iron ore and higher raw materials prices, with profits of $12.7 billion, an increase from $5.9 billion a year earlier.  While Potash may consider BHP an ugly jerk, she knows he can deliver the goods.

In the meantime, Potash is waiting for a White Knight in Shining Armor.  “You should not limit your imagination as to what sectors [potential Knights] are from,” claims Potash’s CEO, William J. Doyle, which has left many investors speculating that China’s state-owned Sinochem, the parent company of China’s largest fertilizer distributor, may try to outbid BHP.

Why Sinochem?  The Chinese aren’t too keen on this potential match, as they have skin in the game.  China relies on fertilizer and one of its main components, potash, for food production.  Future population growth will increase demand for food, and consequently fertilizer.   China doesn’t want BHP to obtain control of the market for potash, particularly in such a volatile price climate, and aims to maintain a firm grip on a wide variety of natural resources in order to avoid being at the mercy of any one company or country.  Sinochem and a potential consortium of other parties are rumored to be discussing a possible counterbid.

Regulatory issues further complicate the potential merger.  Potash has now decided it will sue BHP and attempt to block the takeover due to BHP’s “false and misleading statements” regarding a potash mine that BHP claims it plans to build upon acquiring Potash.  Potash claims that this new mine announcement was really a dirty tactic to depress Potash’s stock price so it could swoop in and acquire on the cheap.

Furthermore, before any transaction occurs, BHP must climb a mountain of regulatory hurdles.  This past Thursday, BHP received antitrust clearance from the FTC, but it still must face the Canadian regulators who will likely offer more resistance.

Ultimately time will only tell whether Potash will find a more appealing or wealthier suitor.  I’m putting my bet on a wealthier and more eager suitor, as it’s clear that BHP isn’t that desperate.

Disclosure: No positions in the stocks mentioned.