Wednesday, 31 October 2012

Potash Corp - An Acquisition of Israel Chemicals?

A number of outlets are reporting that Potash Corp is in discussions with the Israeli government about acquiring or merging with Israel Chemicals Corporation.  Potash Corp already owns 14% of the company, has long intended to gain control of ICL, and management has recently been hinting at M & A opportunities that they're exploring.  Still, the news took some by surprise.  After all, fertilizer is a strategically important asset, and after BHP Billiton's offer for Potash Corp in 2010 was rejected, many expected it to be a long time before any similar attempts were made.  That CEO Bill Doyle has met in person with Prime Minister Benjamin Netanyahu suggests that the matter is being seriously considered by the Israeli government, though.
Despite Potash Corp's sterling record of capital allocation in general, and common stock investing in particular, shareholders should be wary.  Reports suggest that Potash Corp is considering issuing stock to fund the acquisition.  Using stock as a form of currency can only be justified if that currency is fully valued, or overvalued.  Potash Corp stock, however, is currently very cheap.  It's possible of course that ICL's stock is trading at an even more discounted price, but that's unlikely to remain the case when a takeover premium is added.

Reports suggest that it will cost Potash Corp around $13 billion to gain control of the remaining stock, making ICL too big to acquire with cash.  If a company is too big to acquire, though, a deal should not be pursued.  At $40 per share, Potash Corp would have to issue an additional 325 million shares, diluting current shareholders by 38%.  Management has indicated that if they see no hope of eventually gaining control of the companies they hold minority interests in, they would exit their position(s). 
If Potash Corp were to sell their position in Israel Chemicals Corp at current prices, and used the proceeds to repurchase its own stock, it might reduce shares outstanding by around 4%, after accounting for taxes.  There is scant evidence that the market has ever rewarded Potash Corp for its stock investments, so it’s difficult to argue that POT's stock would suffer.  EPS, though, would increase by a noticeable, but not dramatic, amount.  And by reinvesting in their own assets, which they are intimately familiar with, Potash Corp would also be making a less risky move. 
It's difficult to draw any firm conclusions until the terms of a deal are made official, but there's reason to fear that Potash Corp is about to make an expensive mistake.  Government intervention saved Potash Corp shareholders from a low bid a couple years back; many investors will now be hoping that government intervention prevents their firm from paying too much.

My original write-up on Potash Corp is here.
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