Potash Corporation (NYSE:POT) has an urge to merge.
This saga begins on June 25, the day Potash announced it had made a "friendly proposal" to acquire German potash and magnesium miner K+S Aktiengesellschaft. Praising its peer as a "best-in-class" producer of potash, with assets "complementary" to its own, but operations with "minimal overlap" (reducing antimonopoly concerns), Potash offered to acquire K+S for approximately $45.24 per share, a price Potash described as a "57 percent premium to the volume weighted average share price during the prior 12 months."
K+S, whose shares currently sell for just $40 and change, nonetheless declined -- but the matter didn't end there.
As reported by Reuters in subsequent days, Potash has apparently assured K+S of its best intentions, and its willingness to consider raising its bid from the current valuation of about $8.6 billion -- if K+S can prove it's worth more than that. K+S, for its part, is apparently equally interested if it can be assured that, firstly, an acquisition by Potash will not entail job reductions in Germany, and secondly... if Potash might offer just a bit more money, please?
How much more?
If Reuter's reportage is to be believed, the price hike K+S is looking for could be as little as 5% of Potash's original offered price. Just $47.44 per share, $9 billion total, or $400 million more than Potash originally offered, could be enough to do the trick.
That seems like a piddling sum to risk derailing a deal over. But if this is truly K+S's target price for itself, then it makes for a nice, round number for outside investors to work with -- and determine whether this deal makes sense.
Mining numbers at Potash and K+S
So, does it makes sense? After all, Potash prices began plateauing in 2011 -- then entered into a three-year decline that's only recently leveled off again. At the same time, K+S's capital spending has just grown and grown. According to data from S&P Capital IQ, K+S Aktiengesellschaft has made $4.4 billion in sales over the past 12 months, earned net profit of $466 million thereon, but generated free cash flow of negative $441 million for its trouble.
For comparison, Potash's corresponding numbers are $6.5 billion (revenue), $1.6 billion (earnings), and $1.4 billion (positive free cash flow). It's that last number that tells you why Potash Corporation, with less than 50% more revenues than its target, sells for a market capitalization 2.7 times as great. Simply put, Potash is a whole lot better at generating cash from its business than is K+S.
That right there gives us one good reason for hoping Potash will walk away from this deal. The fact that a $9 billion purchase price would value K+S at more than 19 times earnings (Potash costs only 15 times earnings) similarly argues against Potash getting a good price on this deal.
That said, there's still one big reason Potash might want to pay K+S its "extra 5%," and up its bid to $9 billion: price-to-sales.
The potential for Potash
At $24.4 billion in market cap, Potash shares sell for 3.8 times revenue. K+S shares, in contrast, would cost only 2 times sales at a $9 billion valuation. This suggests Potash, which is apparently a sharper operator than its target, might be able to squeeze more profit per revenue dollar out of K+S operations than K+S management is currently capable of. The acquirer's ability to shut down less profitable operations and reduce production so as to support higher global potash prices, would further improve its chances of turning K+S into a better money maker.
Long story short, there's strong potential for Potash to boost profits if a merger goes through. If a merger doesn't happen, Potash stock's own attractive valuation of just 15 times earnings, with 7% projected earnings growth, and a 5.2% dividend yield, suggest Potash stock is a decent value all on its own.
Either way, I don't see much likelihood of investors getting hurt too badly, whichever way these merger negotiations play out.