Thursday, 2 July 2015

Potash Corp are going to have to go hostile if they want K+S

Continuing the agricultural sector attempted M&A (which kicked off with Monsanto's approach to Syngenta - as most recently discussed on Financial Orbit here) was the approach last month by Potash Corp listed in the US/Canada to buy Germany's K+S.  Earlier today K+S formally rejected Potash Corp's Euro41 a share approach noting on a conference call that:

  • 'Strongly believe proposal should be rejected...'
  • 'their bid is opportunistic'
  • 'not convinced has a sustained approach in continued our potash and salt activities' 
  • 'does not reflect fundamental value'
  • 'not in best interest of stakeholders' 
  • 'the K+S business should be valued from a sum-of-the-parts perspective'
  • completely disregards value of the Legacy project (a K+S expansion project in Canada) which they observe has a book value of Euro11 with a DCF Euro21 and an operational/financial profile of the site being commissioned from summer '16, being cash flow positive in FY17 and generating positive ebit from FY18 onwards


I thought however in the conference call Q&A the real nub of the Potash Corp approach came to light with the observation following an analyst comment that a prospective 'fair summary' would be that following a takeover there would be the potential closing of K+S' German mines to expand production in Canada. 

Dispassionately this makes huge sense.  I have talked about Potash Corp a number of times on this website over the last 18 months plus and noted near the end of last year (link here) that 

'the key becomes cost control/having first quartile assets. This is undoubtedly one of Potash Corp's strong points.  Let's not forget this was one reason a few years ago BHP Billiton made a bid for the company so good to see ongoing cost control.  As with any mining company that's hugely important if there is a risk of supply/demand imbalance'


On the conference call K+S talked about their Legacy mine (which is based in Canada) having production costs of C$90+ (pre depreciation and amortisation undoubtedly) which would make it potentially competitive with the Potash Corp output.  Now given K+S muted versus history returns at the moment despite selling their potash output at over Euro300/t allows you to fairly easily back out that the German plants are higher cost. 


So you can see where the battle lines are being drawn.  It seems pretty obvious to me that Potash Corp are going to have to appeal directly to the shareholders if they want to buy K+S.  

Therefore, what is a reasonable price for K+S?

Well the company is the number one salt company in the world and even though the clearly weather influenced de-icing business is material, this is a sensible business with a solid demand profile.  Certainly Euro500m of ebit at a x10 multiple for a Euro5bn valuation is not madness.  


Then we have the potash division - with its German historic focus and Canadian potential.  As I observed at the above link, Potash Corp the industry leader is valued at around x14 forward EV/ebit. Even though there is a 'control premium' to acquire the Legacy asset I think if you pay more than x10 ebit for the K+S potash assets you are overpaying given the aforementioned higher cost nature of the German assets (not to mention the global supply/demand tension that still exists - after all who could forget this).  So for me the value of the division is around Euro7bn.  


Of course there is Euro1.6bn worth of debt which given the Legacy build-out costs I believe will push overall company net debt to Euro3bn+ over the next year.

So adding these numbers together I get c. Euro9bn.  And the current market cap of K+S?  A little over Euro7bn...so you could justify a Euro45+ price.


All of these are ifs and buts though because any broader tension in the potash (especially) market moves around that division's multiple/valuation materially. 

But - for control - I think the above is fair.  So to my mind Potash Corp are going to have to bid Euro45+ for a chance to own K+S.  As the latter's management noted on today's conference call when asked about a more dynamic scenario like a hostile bid: 

'the shareholders have to decide...and we will respect their decision'

So what do you do?  A bit like my above linked Syngenta-Monsanto analysis you have to scenario attribute.  A 50% chance of Euro45 and an equivalent chance of a return to Euro30 gives a blended price of Euro37.5...or basically today's share price.  Therefore to me ceteris paribus below Euro35 looks an interesting price to be getting involved with K+S on a semi-speculative nature.

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