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PotashCorp on the Chinese Market and ‘Ludicrous’ Takeover Proposals

That a fertilizer can become the next gold may seem hard to believe. That a fertilizer can become the next gold may seemhard to believe.  However, when Canadian company Potash Corp, a fertilizer producer based in Saskatchewan, overtook the country’s largest chartered banks, tech powerhouses and oil companies in 2008, the idea did not seem so bizarre anymore.

Briefly, but surely, PotashCorp became Canada’s largest company in mid-2008, taking its market capitalization to $67 billion and then beyond — to No. 1 on the Toronto Stock Exchange. The company left behind corporations such as the Royal Bank, Research in Motion and EnCana, all of which had led the TSX in market cap in the previous couple of years.

Suddenly, PotashCorp and its fellow producers held more power than most investors ever imagined. In 2007 and 2008, potash prices soared from under US$200 a tonne to more than US$1,000 and the fertilizer companies raked in record profits.

Not surprisingly, the sector has drawn the interest of rival mining companies, particularly BHP Billiton. The world’s biggest mining company launched a US$ 40 billion hostile takeover bid of the Canadian firm in late August this year, after having had an initial offer rejected.

However, the government of Saskatchewan rejected the proposed takeover in late October and urged Ottawa to do the same, since they did not see “any substantial benefits for the province.”

Suddenly, PotashCorp and its fellow producers held morepower than most investors ever imagined. In 2007 and 2008,potash prices soared from under US$200 a tonne to more than US$1,000 and the fertilizer companies raked in record profits.Not surprisingly, the  sector has drawn the interest of rivalmining companies, particularly BHP Billiton. The world’s biggestmining company launched a US$ 40 billion hostile takeover bid of the Canadian firm in late August this year, after having had aninitial offer rejected.However, the government of Saskatchewan rejected theproposed takeover in late October and urged Ottawa to do thesame, since they did not see “any substantial benefits for theprovince.”

According to analysts such as Peter Morgan, a client adviser at stockbroker Patersons in Australia, PotashCorp represents almost everything BHP looks for in an investment: long- life and low-cost resources, low political risk in Canada and Saskatchewan in particular and a concentrated market that gives the producers a lot of power to set prices.

Potash equals potassium, a nutrient that farmers need to apply to their crops if they hope to maximize their output. It is only found in 12 countries and, with its virtually endless reserves, Saskatchewan is the Saudi Arabia of potash. This makes PotashCorp the world’s single biggest fertilizer company and the only one with a lot of growth prospects.

The company was privatized by the Saskatchewan government in the late 1980s, but it stayed under the radar when there was no sign of a potash shortage.

The turning point came in the last decade, when exploding middle classes in China and India began changing their diets from rice and beans to include more meat and poultry.  Feeding animals requires more grain, which requires more potash fertilizer.

The general decline in arable land as farms and cropland were paved over to make way for industry also impacted the value of the entire agri-industry. The world realized that it needed to produce more food from less land. It also saw an increased demand for nitrogen, phosphate and potassium — the core components of industrial fertilizers — which can dramatically increase the harvest of everything from wheat to beans.

Predictably, the Australian iron ore miner considered a takeover of PotashCorp as far back as 2006, but instead opted to start from scratch and spend billions of dollars to develop its own Saskatchewan potash mine, called Jansen.

However, Bill Doyle, President and CEO of PotashCorp, has alleged in several interviews that BHP never planned to develop Jansen. Instead, he claimed that it tried to use the threat of new supply from Saskatchewan to drive down PotashCorp’s share price and set up a takeover. While BHP has dismissed this as a conspiracy theory, Doyle talked it up again in an interview with the Canadian newspaper The National Post.

“This whole Jansen project I think was a charade,” he said. “They’ve made all these announcements, many of them absolutely timed with our earnings announcements. The timing is beyond coincidental.”

Doyle is convinced that potash prices are poised to take off in the coming months as the agriculture sector recovers from the global recession. He views BHP’s proposal as an attempt to capitalize before that happens.

At the end of September, PotashCorp filed a lawsuit accusing BHP of misleading investors to try to win control of the world’s largest potash producer at a lowball price. The Australia-based company fought back by filing a motion to dismiss the lawsuit and alleged that PotashCorp is using the legal tool as a way to get competitive information.

It seems that the war is far from over. In fact, Doyle has said that “BHP will not be the only bidder,” remarking that the company is in talks with a wide range of potential investors to try to trump BHP’s hostile offer.

A Chinese-led consortium bid or the purchase of a major stake in PotashCorp are considered to be the Saskatoon company’s most likely defence to fend off BHP’s bid.

Meanwhile the Saskatchewan government is weighing the implications of the BHP bid. The independent Conference Board of Canada released a report Oct. 4 saying that the deal could cost the province $2 billion over the next decade, through BHP’s ability to minimize the amount of corporate tax it pays.

It seems that the war is far from over. In fact, Doyle hassaid that “BHP will not be the only bidder,” remarking that thecompany is in talks with a wide range of potential investors totry to trump BHP’s hostile offer.A Chinese-led consortium bid or the purchase of a majorstake in PotashCorp are considered to be the Saskatoon company’smost likely defence to fend off BHP’s bid.

Meanwhile the Saskatchewan government is weighing theimplications of the BHP bid. The independent Conference Boardof Canada released a report Oct. 4 saying that the deal couldcost the province $2 billion over the next decade, through BHP’sability to minimize the amount of corporate tax it pays.

Hottest Commodity

Potash’s main value lies in being the primary source of potassium which, along with the above-mentioned nitrogen and phosphate, is one of three nutrients absolutely essential for plant growth. And while humankind has managed in the past without cars, Internet or jewels, it has never done without food.

That is why potash is considered one of the hottest commodities today. Its demand is virtually unlimited; there is no viable substitute for it and its supply is controlled by a handful of companies in just a few countries. In addition, potash is considered key to avoiding a global food crunch, according to international experts such as those gathered at the BMO Capital Markets 2009 Agriculture, Protein and Fertilizer Conference in New York last year.

Furthermore, the International Fertilizer Industry Association predicts that global demand for fertilizer in 2010-11 will rise by 4.8 percent to 170.4 million metric tons.

That makes the proposed acquisition a big growth opportunity for BHP, particularly because the share prices of fertilizer makers, including those that produce potash, are relatively low since demand for potash faded during the global recession.

China

PotashCorp has a long term relationship with China. The company sells all of its offshore potash from Saskatchewan through Canpotex, Saskatchewan’s potash supplier to offshore markets, and China has been a long-standing and valued customer of Canpotex for years.

Bill Johnson, director of Public Affairs at PotashCorp, explains that Canpotex not only has experience in the Chinese market; the company has been marketing Saskatchewan potash for close to 40 years and it also maintains offices in Singapore, Hong Kong and Tokyo, along with Saskatoon and Vancouver.

By 2020, China’s population is expected to reach double its 1970 level, with an increasing percentage of its people living in cities. The average income for China’s urban population has nearly tripled over the past 10 years and is now more than three times that of people in rural areas. Growth in urban incomes is a positive development but the issue of lagging rural incomes is now a top priority for the Chinese government.

In an effort to improve this situation, China has set a target of doubling the incomes of farmers from 2008 levels by 2020. To support this target, the country has increased subsidies to farmers and raised the minimum purchase prices for key crops.  It is also beginning to allow the transfer of land-use rights, which should ultimately lead to the formation of larger and more efficient farms.

China is not only a major importer of fertilizer; its arable land is also known for being of poor quality. This is yet another reason that the Chinese market is so appealing for potash producers.

BHP, as depicted in a recent USA Today article, is better known for digging up iron ore and shipping it to resource-hungry manufacturers in China, India and elsewhere. However, with relatively few producers and producing countries — Russia and Belarus chase Canada’s dominance — the high capital intensityand long lead times for new developments give potash an “attractiveindustry structure with high barriers to entry and highmargins,” says Lyndon Fagan, a mining analyst at RBS in Sydney.

The potash bid is BHP’s first major takeover attempt since it abandoned its $68 billion takeover of rival Rio Tinto in 2008. China, already disgruntled about the high prices it pays BHP, Rio and other Australian resource companies for iron ore, was a vocal opponent of the deal, fearing that it would give BHP even more power over prices.

Relations between Australia and China faced additional strain last year after four Rio Tinto employees were arrested in Shanghai on charges of stealing commercial secrets. Rio later fired them after they confessed to taking bribes from employees at Chinese steel mills in return for preferential access to iron ore supplies. They were convicted and sentenced to prison.

With potash, BHP would be entering another industry that regularly butts heads with China over prices. Contract talks between Canadian potash producers and China broke down this year after Beijing demanded a much lower price than the producers were prepared to accept.

BHP could be required to win approval from Chinese anti-monopoly regulators for a possible acquisition because PotashCorp owns a 22 percent stake in Sinofert Holdings, Ltd., China’s biggest potash producer and fertilizer importer.

When deciding whether to approve takeovers, China’s government looks at companies’ worldwide operations and market share and has ordered companies to make changes in operations abroad to win approval for acquisitions.

In 2009, China required Panasonic Corp. and Sanyo Electric Co. to sell off some battery production assets in Japan to win approval for a merger, on the grounds that their goods were sold in China even though they were made abroad.

Out of 140 proposed mergers reviewed under China’s 2-year-old anti-monopoly law, regulators rejected one — Coca- Cola Co.’s proposed acquisition of Chinese fruit juice maker Huiyuan — and imposed conditions such as selling off assets on five others, according to the Ministry of Commerce. Those six cases all involved foreign companies.

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