BHP shows it doesn’t need Potash Corp

August 25, 2010

BHP Billiton has shown it doesn’t need to buy Canada’s Potash Corp. The Anglo-Australian miner’s impressive annual results are a reminder of the financial firepower behind its $39 billion hostile bid for the world’s largest fertiliser group. But they also show that BHP is not broken — and that chief executive Marius Kloppers does not need to bet a strong balance sheet on further diversification.

The miner can clearly afford to pay more than the $130 per share offer that it has taken directly to Potash’s shareholders. BHP generated EBITDA of $24.5 billion in the year to June 30, up 10 percent, driven by record production in oil and iron ore. At the end of the financial year, gearing stood at just 6 percent.

Still, BHP has yet to make a compelling strategic case for buying Potash. The miner is already sufficiently diversified by customer, commodity and geography to have delivered its sixth consecutive year of 40 percent plus operating margins despite the global financial crisis. The offer for Potash, if successful, would deprive BHP investors of a significant potential cash return.

With an increasing correlation between commodities and associated equity plays over the past two years, it is hard to see how BHP benefits by adding a tenth division. Potash might even be worth more standalone than within the miner, argues Citigroup, which says the fertiliser group would have increased the volatility of BHP’s earnings on a historic basis. So much for the benefits of extra diversity.

BHP has said it will remain financially disciplined, and its current bid doesn’t look overpriced. If the miner raises its offer to the $150 level where Potash’s New York listed shares are now trading, it will need to seek the approval of its own shareholders. BHP’s shares trade on a forward price to earnings ratio of 7.4 times, a slight premium to the sector. Given Kloppers’ advantageous position, the temptation to let discipline slip will be strong. But he can also afford to walk away should Potash’s shares run away from him. If he wants to avoid turning BHP’s premium into a discount, he must be prepared to do so.

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