Merrill Lynch/BAM is out with a major call on Potash (NYSE:POT) saying BHP Billiton should buy the potash producer.
Firm estimates that an all-cash bid for POT at a 30% premium could be 13% EPS accretive in years 1 and 2. From discussions with clients during recent marketing, they believe the market is receptive to BHP acquiring potash assets.
Why is POT the right deal for BHP?
1) BHP has an interest in being a world-scale producer of Potash. This deal provides instant scale. 2) BHP wants to own world class long life, large scale, low cost assets. We think POT ticks all these boxes. 3) POT dovetails nicely with BHP's existing land position and Greenfield project in Canada. 4) BHP's balance sheet is ungeared and the company generates huge cashflows. An all cash acquisition regears the company and adds an appropriate, complementary asset. Merrill believes that Potash as an industry matches BHP's core competencies i.e. 1) Project development 2) Resource operation management 3) Resource marketing.
Kudos for being ungeared into downturn but missed bottom
BHP Billiton was widely admired by investors for entering into the downturn with little/no debt having walked away from its bid for Rio Tinto. However, whether because it couldn't move quickly enough or because its bids for available assets were too low, in firm's view BHP did not use its balance sheet to its advantage during the downturn. To be fair, the high quality assets that BHP wants to acquire are rarely going to be distressed and the downturn was relatively short lived.
Why now? Sentiment regarding potash nearing a low
Merrill believes that negative sentiment regarding Potash gives BHP a second chance at acquiring assets at a cycle low. Consider the following:
- Ag chemical companies have issued profit warnings.
- Price dropped below Merrill's estimate of long term price for the first time in years.
They think that bearishness is likely to persist up until China settles which could be 2-3 months out and could be a powerful catalyst. Distributor inventory levels in the Americas are low and will need to be restocked.
In Merrill's view if there ever was a time to buy a big potash producer, this is it.
BHP already owns Potash assets
Potash assets would not be a new M&A target for BHP, with the company having previously commented that potash is a good industry that suits its skill set i.e. mining, project development and product marketing and trading. In mid-2008, BHP acquired Anglo Potash for C$263 million.
