Potash price crucial to how far BHP can stretch

August 24, 2010

Potash prices are crucial to how far BHP Billiton can stretch its $39 billion hostile bid for Canada’s Potash Corporation of Saskatchewan. The miner’s offer is essentially a bet on demand for the commodity, which accounts for the bulk of the fertiliser giant’s value.

According to calculations by Reuters Breakingviews, every $50 increase in the long-term price of a tonne of potash adds about $20 to Potash Corp’s value. BHP’s offer reflects the current market. But if prices rocket, so too will the value of its target.

To value Potash Corp, start by looking at its other businesses. The company’s phosphate and nitrogen divisions are worth roughly $11 billion, according to Morgan Stanley’s estimates of what it would cost to rebuild them. Potash Corp also owns stakes in smaller listed rivals which have a current market value of $8 billion.

Putting a value on the potash business is trickier. Deutsche Bank estimates that building 2 million tonnes of new potash capacity requires a $4 billion investment. On that basis, replacing Potash Corp’s 11.2 million tonnes of capacity would cost $22.4 billion.

Knock off net debt, forecast to be about $3.5 billion next year, and company’s standalone value is around $38 billion — just shy of BHP Billiton’s current offer.

Yet that valuation doesn’t capture Potash Corp’s plans to increase potash capacity to more than 17 million tonnes by 2015 — and BHP’s intention to run the business at a level close to this much higher rate.

Assuming long-term prices remain at their current level of $350 per tonne, and that BHP runs the operations at 90 percent of future capacity, the potash business could generate EBITDA of around $3.2 billion after deducting local taxes. Apply a peer group multiple of 9 times, and the whole company is worth almost $44 billion, or $148 per share. That’s around where Potash Corp’s shares are currently trading.

But what if long-term prices rise? That’s not so far-fetched — only two years ago, potash peaked at $600 per tonne. If the price rises to $500 per tonne, Potash Corp shares could be worth $207 each — close to the levels they reached during the commodity boom. But if prices dip to $300 per tonne, BHP Billiton’s current offer already looks full.

Of course, this value will not be fully realised until Potash Corp has finished its expansion in 2015. Any offer must take this into account. Nevertheless, BHP is betting on the future value of a commodity. The company’s ability to raise its bid depends largely on whether investors share its outlook.

How do changes in the long-term price of potash affect the value of Potash Corp? How much scope is there for BHP Billiton to increase its offer? Click here to run the numbers.

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BHP won’t buy POT now because now Potash is fairly priced. I used the Agricultural Commodities historical data to shed some light on the BHP maneuver.

I charted POT against Agricultural Commodities. The 6 month chart tells a good story:


Look how poorly POT was doing against its economic backdrop. BHP saw this, and the second it put a bid in, POT rocketed up to reflect the move in underlying commodities since July. The trend in Agro Commodities seems to be pointing up, so you know why Potash would decline BHP’s offer.

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