At long last, it's official. PotashCorp (POT) and Agrium (NYSE: AGU) are merging. According to the companies, this merger of near-equals (S&P Global Market Intelligence values PotashCorp stock at $13.5 billion in market capitalization, Agrium at $12.2 billion) will create the "third largest natural resource company in Canada" and the "largest crop nutrient company in the world."
But what does this mean to you?
The news is out
Earlier this week, PotashCorp and Agrium issued twin announcements of their impending merger. Touting the opportunity to "generate up to $500 million of annual operating synergies," generate "substantial cash flow" and maintain "strong credit ratings," it's clear that management of both companies is on board with the merger. Wall Street is on board with the deal, too, with analysts at Stifel Nicolaus praising it, and rewarding PotashCorp stock with an upgrade on Tuesday.
But whether this is truly good news for investors remains to be seen -- so let's take a look.
Reviewing the mechanics
According to the companies, the merger will work like this: Owners of PotashCorp stock will trade in their shares for new shares of the as-yet-unnamed merged company -- let's just call it "NewCo" -- at the rate of 0.4 new shares per one share of PotashCorp traded in. Owners of Agrium stock -- each share of which costs about 5.5 times as much as a share of PotashCorp today -- will accordingly receive relatively more shares of NewCo. The exact ratio will be 2.23 shares of NewCo stock per share of Agrium stock handed over.
This will all result in today's PotashCorp stock holders owning 52% of the shares of NewCo, and Agrium stock holders 48%.
The companies are targeting a mid-2017 date for closing the transaction. Before that can happen, however, shareholders of both companies must approve it, and government regulators will certainly want to review the deal as well -- and may demand divestitures or impose other conditions before signing off.
Crunching the numbers
According to the companies, NewCo will have:
- "close to 20,000 employees."
- "a pro forma enterprise value of $36 billion, based on each company's net debt."
- "revenue of approximately $20.6 billion."
- "EBITDA of $4.7 billion before synergies."
Now let's see what these numbers imply.
According to S&P Global data, Agrium and PotashCorp combined employ about 20,250 souls today. A reduction to "close to 20,000" implies only a modest number of layoffs -- but also raises questions about how, precisely, the companies intend to squeeze "$500 million" worth of synergies out of the merger.
S&P Global data show PotashCorp's balance sheet to be loaded with $4.6 billion in debt against cash levels of just $143 million. Agrium, too, is debt-heavy, with $5.6 billion in debt and $307 million in cash. Thus, the two companies combined should sport net debt levels of roughly $9.8 billion. This implies that management expects its combined market capitalization to be roughly $26.2 billion post-merger -- only slightly superior to today's combined market cap of $25.7 billion.
PotashCorp and Agrium generated a combined $18.7 billion in revenue over the past 12 months. Management's projection of $20.6 billion post-merger revenue implies that they're hoping to grow their combined business by about 10% by the time this merger is done.
In fact, however, PotashCorp's revenue declined 42% last quarter, while Agrium shrank 8%. Turning those sour results into 10% volume growth in fertilizer revenues will be a neat trick.
Similarly, the two companies generated combined earnings before interest, taxes, depreciation, and amortization (EBITDA) of $3.5 billion over the past 12 months. But according to management, one simple merger, and voila! -- that turns into 33% growth, and "$4.7 billion" post-merger.
Given that management is promising even more profits from synergies on top of that magically munificent increase in EBITDA, this will be a remarkable feat of prestidigitation indeed.
The bottom line
Over the past 12 months, PotashCorp and Agrium's combined EBITDA of $3.5 billion yielded just $1.55 billion in actual net profit. Taking management's promises at face value, and 33% growth might turn that into $2 billion in net income, or thereabouts, for NewCo.
Weighed against management's promised market capitalization of $26.2 billion, that works out to a P/E ratio of just 13.1 on NewCo -- and a strong argument in favor of the combined stock being cheap enough to buy. (Especially at a 33% growth rate!) As I hope I've managed to convey in the preceding paragraphs, however, you need to take an awful lot of management's numbers on faith to believe that valuation.
While I won't say PotashCorp and Agrium's numbers are wrong, necessarily, I will be very interested to check back in a year or so, to see how "right" they turned out to be.