In October last year, Potash Corp. (NYSE:POT) dropped its bid for German rival K+S after the latter rejected the rather generous offer from POT. When POT first confirmed the takeover offer in June last year, I had discussed in an article why the deal made a great deal of strategic sense.
The breakup of the Belarusian Potash Company (BPC) in the summer of 2013 changed the dynamics of the global potash market. BPC was one of the two cartels operating in the worldwide potash market until then. The other being Canpotex, a joint venture between Agrium (NYSE:AGU), Mosaic (NYSE:MOS) and Potash. The two cartels controlled much of the global supplies and essentially were price makers. BPC's demise has made major potash producers price takers. In this scenario, consolidation in the potash industry makes a great deal of sense. Therefore, Potash's decision to bid for K+S was the right one.
Had the transaction been completed, by 2017, the combined company would have mined more than a quarter of global potash capacity, according to Scotiabank. Scotiabank further noted that Canpotex would have been able to control 44% of the global potash capacity by 2017. But since Potash had already offered a hefty premium (Potash's offer valued K+S at euro 41 per share), the Canadian miner did not have much room to improve upon its offer. Indeed, although I was in favor of POT acquiring K+S, I was not in favor of POT significantly boosting its offer to complete the deal. To Potash's credit, it did show a great deal of financial discipline and it was the main reason why its dropped its bid in October.
The major losers in POT dropping the bid were K+S shareholders. In fact, several German investors in the company pushed the management to agree to Potash's offer. Their rationale was that the significant drop in commodities prices made the deal more appealing. Based on the same rationale, a bid now would be even more appealing.
The turmoil in global commodities market has only worsened since then and this is why I believe that were Potash to relaunch its bid, there will be a higher probability of it going through. But with the management of K+S reluctant to complete a transaction, the only option Potash would have is to launch a hostile takeover bid. It might get support from K+S shareholders though. A few days before Potash dropped the bid, Juergen Kurz of DSW, a retail investor association in Germany, said that they would be open to an official offer from Potash even if it is hostile.
Potash shares are now down to $16. Since the start of this year, the stock has dropped another 6% and nearly 50% since the second half of 2015. The negative sentiment on commodities, coupled with a bearish outlook for potash, has pushed Potash shares to current levels. Although the long-term fundamentals of the potash market, which are dependent on the need to feed the ever growing global population, are still intact, the environment is likely to remain challenging in the near-term. As I had noted in a recent article on Potash Corp., estimates from Food and Agriculture Organization (FAO) show that the demand for potash is expected to increase by 2.6% between 2014 and 2018, while supply is expected to increase by 4.2%. Further, AHDB, expects the downward pressure on price to continue for the foreseeable future. The only way the outlook for potash prices can improve somewhat is if the market moves towards the state it was in before the breakup of BPC. That is to say that few producers control most of the world potash supplies. Consolidation, therefore, is the only way for potash producers to bring some stability to the market.
The only obstacles to a bid from Potash, like before, would be regulatory. and political apart from the reluctance of the management. Regulators and politicians do not favor such major cross border deals. Indeed, political support for K+S rejecting Potash's offer last year was strong. In the end though, K+S's main job is to create value for its shareholders. If there is an hostile offer from Potash this time, I expect it to have strong support from shareholders. Relaunching the bid could also prove to be a short-term catalyst for Potash stock price.
Disclosure: I am/we are long POT.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.