Agrium (AGU) and Potash Corp. of Saskatchewan (POT) have announced a merger of equals, potentially creating the world’s largest crop nutrient company.
Given our stand-alone company fair value estimates--$20 per share for PotashCorp and $96 per share for Agrium--the deal terms (52% ownership of the combined company by PotashCorp shareholders) favor Agrium shareholders, in our view. Excluding synergies and using the announced share exchange ratio, our PotashCorp fair value estimate would fall about 10% and our Agrium fair value estimate would rise by a similar percentage. This is a function of our belief that PotashCorp is more undervalued than Agrium. Including our estimate of cost synergies, our PotashCorp fair value estimate remains $20 (CAD $26) and our Agrium fair value estimate jumps to $114 (CAD $149). We don’t think the merger will affect fertilizer pricing much, and our long-term pricing assumptions are unchanged.
We think management’s synergy target will prove optimistic. The company hopes to achieve an annual run rate of $500 million in operating synergies two years after the deal closes (expected in mid-2017). Although we think opportunities in selling, general, and administrative costs are ripe for cutting, procurement targets, for example, could be harder to achieve. In general, we think it’s best to take merger management synergy targets with a grain of salt, given that enthusiastic targets are difficult to verify ex-post. We include a run rate of roughly $350 million in annual cost cuts in our model.
We think antitrust regulators will allow the deal to proceed, since fertilizer markets would remain competitive with Agrium controlling less than 3% of global potash capacity. We expect to award the combined company a narrow economic moat rating, based on cost advantages in potash for both PotashCorp and Agrium and Agrium’s solid cost position in nitrogen.
As we expected, enthusiasm for this deal outside the effects on PotashCorp and Agrium, as exemplified by the positive moves in other fertilizer stocks following the disclosure of deal talks, has faded. In particular, Mosaic’s (MOS) shares, which jumped a surprising 9% when the Agrium-Potash merger rumors surfaced, are now trading below their prerumor price.
We think the likelihood of higher potash prices directly related to the deal is limited as Agrium is a second-tier player in the global potash market. Agrium controls roughly 2 million metric tons of the 60 million metric ton market and already comarkets its potash sales outside North America with PotashCorp and Mosaic. Combining operations would give the merged company a bigger piece of the already concentrated market pie, but through their relationship in Canpotex, PotashCorp and Agrium already comarket potash sales outside North America, which accounts for more than one third of Agrium’s volume.
Perhaps the North American market would be slightly less competitive, thus leading to higher pricing, but we think the opportunity for price hikes are very limited. Mosaic will still stand as a large North American competitor, and if prices in the region rise too quickly, Eastern European producers would be quick ramp up exports to North America, as they have done in the past to exploit regional pricing differentials.
The combined company could decide to shut in more potash production to aid prices and tighten the market, but we doubt the shutdowns would be severe enough to catalyze a dramatic rebound in prices. Agrium just doesn’t control a large piece of the total potash market, and each ton shut down obviously means lower sales volume and a hit to profits.
In phosphate and nitrogen, which are more fragmented markets, the possibility of more concentration leading to higher pricing is even more limited. In nitrogen, Agrium’s largest fertilizer business, the 10 largest nitrogen producers account for less 20% of global ammonia capacity. Compare this with the potash market, where the top 10 producers account for well over 90% of industry capacity. For these reasons, we think this deal could pass antitrust regulators without meaningful asset divestitures.
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