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I want to say one word to you. Just one word: "Plas ... ," er, "potash"
By now you've heard the news -- there's a possible bidding war going on at PotashCorp (NYSE: POT ) . Yesterday, it was revealed that Australian mining magnate BHP Billiton (NYSE: BHP ) had made an unsolicited offer to purchase PotashCorp for the princely price of $130 per share -- $38.6 billion in all. Yet ... Canada's premier potash producer politely refused.
According to PotashCorp, $130 is a price way below its worth. Instead, PotashCorp suggested that a number closer to its mid-2008 high of $240 might be more appropriate. But rather than accede to this modest request, this morning we learned that BHP is going nuclear with a hostile takeover offer, hoping that if management won't play ball, PotashCorp shareholders themselves will see the reasonableness of its offer and sell out to BHP.
Investors seem to doubt that will work out, however, and have already pushed the price on PotashCorp shares way up beyond BHP's initial offer. In this, they're being spurred in part by analysts who speculate that Rio Tinto (NYSE: RTP ) or Vale (Nasdaq: VALE ) will make competing bids, and argue that even if rivals don't appear, PotashCorp will extract a higher purchase price from BHP. But there are also the fundamentals to consider ...
JPMorgan Chase on fertilizer
In a research report that appears to have been prepared before BHP made its bid, JPMorgan Chase urged investors yesterday to pick up some shares of PotashCorp rival Agrium (NYSE: AGU ) , arguing fervently in favor of the stock's undervaluation on replacement costs.
Says JP: "We believe that Agrium's replacement value represents a premium of 76% to the current share price of $65.87..." In contrast, JP downgraded a third fertilizer play, Mosaic (NYSE: MOS ) , to "neutral," saying the company's replacement value is a mere 62% higher than its stock price. (Apparently, to JPMorgan's way of thinking, when a stock is 62% undervalued it's only worth holding. But 76% undervalued is: "Buy, buy, buy!")
So, why all the fuss over fertilizer, you ask? According to JPMorgan the argument comes in three parts. First, grain prices are rising -- quite possibly a consequence of the wildfires and hot summer being experienced in Russia this year. Secondly, JPMorgan believes farmers will try to capitalize on the price hikes by increasing production, and will buy fertilizer in bulk "before year end" to help with this. Last but not least, the market value of fertilizer companies has increased accordingly.
What's the fuss?
In less than 48 hours, we've seen Mosaic gain 12% in market cap (despite JPMorgan's reservations). Agrium's up a whopping 5% (despite JPMorgan's pro-testations). Meanwhile, Intrepid Potash (NYSE: IPI ) is up 4%. And as for PotashCorp -- well, you know what's going on there. But it does raise a question for investors today.
Namely, is it wise for BHP to be offering a 16% premium to PotashCorp's pre-bid share price? (Investors don't seem to think so, bidding down BHP shares in response to the move.) More pertinently, should individual investors be offering to pay a premium nearly twice the size of what BHP is offering?
One word: No.
I don't think so, and here's why: Whatever JPMorgan may tell you about the "replacement cost" of fertilizer miners, and how the stocks should be selling for prices closer to that cost, the banker isn't convinced of the rightness of its argument to actually recommend buying Mosaic, for example. And JPMorgan's right to hesitate.
Consider this: Selling for more than 30 times trailing earnings, but with only 8% long-term growth posited for the future, Mosaic sells for a PEG ratio of nearly 2.0. Agrium, the stock that JPMorgan prefers, trades for 19.6 times earnings on 5% expected growth. And Intrepid, at 60 times earnings but with growth projections stuck in the 2% range, is arguably the most overpriced stock of the bunch.
Talk of "replacement costs" notwithstanding, I just don't see value in these shares at today's prices -- not based on what the companies actually earn on their assets. When I look at the stock that started all this silliness -- at 31 times earnings and 9% projected growth, PotashCorp to me looks nearly as overvalued as its rivals. Toss in the fact that the company generates free cash flow at just half the rate it reports GAAP profits, and it's pricier still.
My advice? If you own these shares today, and BHP is willing to overpay you to take 'em off your hands, don't look a gift horse in the mouth. Like the song says: "Go on take the money and run."