Commodities

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Believe it or not, the URL www.worldclasscropinputsupplier.com is not the most questionable thing about the $27 billion Potash-Agrium merger.

Obviously, when selling a deal that revolves primarily around fertilizer, coming up with snappy, SFW euphemisms is hard. So maybe "crop input supplier" is best, especially as it does capture some of the awkwardness of the deal.

First up, structure: The deal is billed as a merger of equals, but Potash is technically the buyer here, with its shareholders set to own about 52 percent of the combined entity. They will receive 0.4 of a share in the new company for each current share, while Agrium holders will receive 2.23 shares. Based on Potash Corp.'s share price on Aug. 29 -- the day before news of talks emerged -- the exchange ratio implies a valuation for Agrium of about $89.48, exactly where it closed that day. This is usual for a nil-premium combination.

Still, Agrium has massively outperformed over the past five years, mostly because it has a far more stable retail business that's less tied to a slump in potash prices that has pole-axed the likes of Potash. Exhibit A? Agrium has managed to maintain its dividend, whereas Potash has cut its shareholder payout in the past year -- twice.

Playing for Squat
Agrium shares have stayed relatively flat over the past few years, whereas Potash has slumped significantly of late. And yet Agrium is getting no premium
Source: Bloomberg

Potash seems to be throwing a bone of sorts to Agrium by agreeing to make its CEO Chuck Magro the leader of the new company. It's a somewhat hollow bone, though, considering that Potash CEO Jochen Tilk will become executive chairman and "have executive responsibility for the new company's business strategy function." Which means Magro will do … what, exactly?

The Potash-Agrium combination comes amid a wave of deals in the chemicals sector. It also actually has a number of similarities with Monday's other mega-deal in the news: the proposed transaction between Praxair and Munich-based Linde. Both sets of companies were attempting to structure mergers of equals, despite big discrepancies in their historical revenue and profitability profiles. Both were all about synergies.

The big difference, of course, is that Praxair and Linde saw the writing on the wall and had the good sense to call off their talks amid concerns about cutbacks at the German company's headquarters. (Read more about that deal from Gadfly's Chris Bryant.)

Chemical Attraction
Takeover volume has exploded in the chemicals industry, led by a series of mega-mergers between agricultural chemicals companies.
Source: Bloomberg

Potash and Agrium downplayed the possibility of job losses when outlining their targeted synergies, which will amount to $500 million a year and cost perhaps $100 million to realize. Neither is shutting down their main offices, even though headquarters will move to Potash's Saskatoon base. Instead, "optimization" of logistics, production and the back office are expected to provide the bulk of the gains.

The companies say the $500 million target translates into "up to $5 billion in value creation," based on slapping a 10x Ebitda multiple on them. Investors are, of course, perfectly entitled to do that, and the stocks trade at about that multiple on a weighted basis for 2018, according to Bloomberg figures.

But the long history of mergers not quite living up to their initial promise suggests perhaps taking a more conservative approach. Netting off costs and applying a tax rate of 30 percent and a discount rate of 10 percent yields a net present value of $2.85 billion actually flowing to shareholders. On that basis, getting to $5 billion requires using a somewhat heroic discount rate of just over 6 percent.

Still, even $2.85 billion equates to 11 percent of the combined market cap on August 29. This is the fulcrum of the deal. Because, apart from the awkward management structure, the bigger issue here is that the merger doesn't solve Potash's main problem, which is chronic excess supply in potash mining. Rather, it now exposes Agrium's shareholders to the same issue. The latter must hope synergies somehow compensate for the loss of any valuation premium they held due to Agrium's insulation from mining. At the very least, the all-stock structure gives them an option on long-term price recovery.

It is possible that marrying mining with retail will deliver something, via shifting product more efficiently to where demand is highest, pairing Potash's multiple sources of supply with Agrium's customer data and relationships. But this is a bit like OPEC trying to deal with the oil glut by buying gas stations.

What the fertilizer market requires, and what Potash attempted previously with its failed takeover attempt for K+S, is horizontal rationalization -- shutting down supply. Vertical integration offers a decidedly second-best approach.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
Liam Denning in New York at ldenning1@bloomberg.net
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net