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This Company's Boardroom Drama Is Heating Up

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It isn't often that investors are treated to boardroom drama, but Agrium (NYSE: AGU  ) investors have had that good fortune since October, when JANA Partners, a hedge fund, gave a presentation on how Agrium should be reorganized. In a nutshell, JANA believes that Agrium could unlock significant shareholder value by spinning off its retail division, increasing the dividend and share repurchases, and making certain operational changes in both the retail and wholesale divisions.

JANA recently condensed its original thesis down to what it calls "The 5 Cs": cost management, controls, capital allocation, conglomerate structure, and corporate governance. Agrium, meanwhile, recently gave a rebuttal presentation, stating that "JANA gets an 'F' for its 5 Cs." In the words of Inigo Montoya, let me explain. No, there is too much. Let me sum up.

1. Cost management
One of JANA's main complaints is that Agrium operates too many retail stores. Agrium's stores are run more like distribution centers, with customers making orders by phone and having them shipped out, generally within a 50-mile radius.

JANA has found that almost three-quarters of Agrium retail locations are within 25 miles of another store, creating significant redundancy that could be eliminated to cut costs and improve store-level metrics. Agrium counters that it has already closed about 20% of its stores, and that judging stores based on proximity to each other fails to account for things like competitors' locations and market demand. After all, 80% of Americans live within 20 miles of a Starbucks, and that doesn't seem to be a problem.

JANA also takes issue with Agrium's growing sales, general, and administrative costs. Since initiating its integrated strategy in 2005, SG&A costs have grown almost twice as fast as net income. Contrast this with Agrium's chief competitors, PotashCorp (NYSE: POT  ) , Mosaic (NYSE: MOS  ) , and CF Industries, each of which has had not only great net income growth, but also far lower SG&A growth.

2. Controls
This is one area Agrium could stand to work on. The company provides very detailed information on its wholesale division, but not much on retail. I agree with JANA that it would be good if the company were to start giving typical store-level metrics like same-store sales and sales per square foot. Without store-level metrics, it's hard for investors and analysts to know whether Agrium really does need all those overlapping stores, or if they're just cannibalizing sales from each other.

3. Capital allocation
Agrium could do the most immediate good for shareholders by following JANA's advice regarding capital allocation. JANA would like to see Agrium stop investing so much in its business and start distributing more capital to shareholders. This might sound like a corporate raider using the company's balance sheet as a piggy bank, but that's not the case.

Until recently, Agrium hadn't raised its paltry dividend for almost 10 years, despite growing cash flows. Competitors such as PotashCorp, Mosaic, and CF are also stingy with their dividends, but that's no excuse.

The greater problem, according to JANA, is that Agrium is investing in its business, and not, well, in its business. At the 2012 Investor Day, Agrium announced plans to increase its nitrogen capacity, despite also asserting that its wholesale assets alone were worth more than the company's entire enterprise value. In other words, Agrium believes its existing assets are being undervalued by the market, but instead of doing the easy thing and repurchasing shares, the company is spending money to unnecessarily develop new assets.

4. Conglomerate structure
In short, JANA wants Agrium to ditch its retail division. The most compelling reason is that Agrium's conglomerate structure makes the company as a whole difficult to analyze. None of Agrium's chief competitors have retail divisions, so the analysts covering Agrium and its competitors are well versed in analyzing big fertilizer companies, but not so much with farm supply retailers. As a result, the misunderstood retail division ends up misvalued, dragging down the company's overall valuation. JANA argues that if the retail division were spun off, shareholders of both businesses would benefit.

5. Corporate governance
This is where JANA's board member nominations come in. Three of JANA's nominees have at least 20 years of experience managing some of Agrium's direct retail competitors. Agrium, meanwhile, currently has no board members with significant retail experience, and CEO Michael Wilson even stated recently that retail experience is not a prerequisite to be on the board. Given that retail is a large part of Agrium's business, it seems that management would make it a priority to have board members with retail experience, rather than focusing solely on wholesale.

The Foolish bottom line
One argument Agrium has made is that the outperformance of the company's stock versus an average of CF, Mosaic, PotashCorp, and Yara has proved the success of its strategy.

JANA takes issue with this comparison for two reasons. First, it compares Agrium only with its wholesale competitors and ignores its retail and advanced technologies divisions. Second, Yara and CF are both pure-play nitrogen producers, but Yara is based in Europe and has consequently benefited far less from the North American natural gas boom than Agrium or CF. CF's stock has doubled in the past five years, while Yara is just about flat. Averaging the two makes Agrium's performance look a lot better by comparison.

JANA's comparison is far more accurate, using just CF as a comparison for Agrium's nitrogen operations, and an average of Mosaic and PotashCorp for its potash and phosphate operations; it also includes a weighted basket of retail and advanced technologies competitors. Agrium shows heavy underperformance under this new comparison, putting more burden on the company to prove its case.

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