What the Potash Buyout Tells Us

The bidding war for fertilizer company Potash Corp of
Saskatchewan (NYSE:POT) is getting very interesting. Last week, the company
rejected a $34 billion buyout bid from mining giant BHP Billiton (NYSE:BHP).
BHP countered by saying it would make the bid a $38 billion hostile bid,
which means BHP takes its offer directly to the shareholders.

To counter this move, Potash Corp has been in talks with
other companies to see if they can get the buyout bid higher. China’s
Sinochem and Brazil’s Vale have been mentioned as having interest. And
Potash’s board is already saying that a “superior offer” is expected. That’s
good, because Potash Corp. currently has a market cap of $44 billion, and

Now, this buyout process is interesting in its own merits.
As a company, Potash is a cash cow, throwing off $1.42 billion in net
earnings and $2.58 billion in operating cash flow on $4.9 billion in
revenues. One might look at the forward P/E of 19 and conclude the stock was
expensive. But when you consider that earnings would pay for the buyout in
less than 20 years (based on forward estimates), maybe it’s not so expensive.

But what does this
buyout tell us about the current market?

Well, it tells us that the prospects for fertilizer are very
good. It’s obvious that growing populations eat more food. But it’s less
obvious that as the standard of living in a country improves, people choose
to eat more meat. It takes 9 pounds of grain to make 1 pound of meat. So we
might expect an exponential rise in fertilizer demand on steady population
and income growth.

Of course, this dynamic is most obviously at play in
emerging markets like China. I’d say it’s no coincidence that one of the
companies that may counter the BHP offer is Chinese.

Another thing this buyout process tells us is that the
global economy is not as bad as off as some like to think. If companies
believed that the economy (both U.S. and global) were headed back to
recession, they wouldn’t be making buyout offers now. They’d wait until
prices were lower.

But we’ve seen a steady string of merger and acquisition
activity over the last few months. $165 billion worth in the raw-materials
space alone.

Also, don’t ignore
the fact that Potash/BHP saga is playing out in the commodities sector.
Commodities are very sensitive to growth expectations. And while we’ve seen
volatility in pricing for oil, copper and other commodities, base price
levels indicate a growing economy.

Bloomberg reports that the 32 mining, seed and chemical
companies on the S&P 500 trade with the highest P/E of any industry at

As one chief investment officer said: If the market
really believed the double-dip story, which I don’t think the stock market
believes, materials (commodities) stocks would not be doing this