The year long dance between Terra, Agrium, Yara, and CF Industries came to an end. CF won the bidding for TRA and took it away from Yara and in the same breath fended Agrium advances.
The peculiar thing is CF used its shares as a currency when it was beaten down in January 2009, however used an almost all cash offer in its winning offer in 2010 after its shares have a considerable run and traded at 52 week high. Why would the company uses its shares when it was trading at what it seems a large discount to intrinsic value while uses cash when the shares have recovered. Another peculiar aspect is CF has proclaimed that AGU offer undervalues the company but it was happy to use its own undervalued shares as a currency for takeover of TRA. The length of the merger process might have increased the mental investment and cost to CF executives making it harder to forgo those costs and walk away. although these costs should be considered sunk costs and not factor in making and acquisition in March 2010. Maybe it became win at all costs. I am not sure what changed in the span of 12 months to justify more than 100% increase in value paid to Terra. The merger announcement talked about being".. the largest nitrogen producer in the world among publicly traded companies as measured by production capacity". May be CF wants to the biggest and baddest at the exp of shareholders. What is the return CF is going to get:
- The acquisition of TRA is mostly a mechanism to fend off AGU hostile takeover. To defend against this unwanted advance CF overpaid. As Yara offered to buy TRA from underneath CF and CF struggling to find a white knight instead of Terra reaping a premium offer. In this vein, at least one person pointed out that once Yara did a deal with Terra, CF lost its white knight. CF was left facing a low bid by Agrium and its bidding here made sense in order to prevent a deal with Agrium for a low price forced by CF’s own coming election.
- The TRA acquisition is not a tuck in acquisition but almost a merger of equal. CF and TRA are of similar size in terms of market cap and Ent value. TRA had $1.5 B in sales as of 2009, $2.5b in 2008 while CF had $2.6B as of 2009.
- CF might got caught in a bidding frenzy for Terra that lead it to over bid for Terra. the increase in offers are as follow:
- March 10, 2010 final and winning offer: $47 or $4.6 market cap. 37.15 in cash and the balance in CF shares
- Dec 15, 2009 third offer: 45.91
- Nov 1, 2009, second offer : $40.50
- Jan 15, 2009 initial offer : $20.98 or $2.1 in market cap this was an all stock offer
CF simply overbid for TRA to escape being bought by Agrium. Please consider:
- CF offer values Terra at $47 per share. The offer represents:
- 2.9 x sales (TRA highest achieved 2.2x at that market top in 2007)
- 9.5x book value
- 30.5 x earnings (highest achieved 25x in 2007)
- 22.7 x Cash Flow
- CF overpaid for the company as the DCF value of TRA as a stand alone company, assuming 10% growth rate for 10 yrs and 5% terminal rate for Cash Flow of $3.19 per share, is $41.68.
- CF claims that it paid 8x TRA's EBITDA (see merger presentation footnotes). That claim is more spin than reality for several reasons:
- CF averaged 3 years to get the EBITDA of 622 while 2009's is mere 402
- 2008 was an abnormal year for Ag where prices have shot up for Fertilizers and ag in general. CF includes 2008 to average out to 622 in EBITDA. TRA never approached that level in EBTDA or came close. would that be repeated again? so to include a record year in your EBITDA will increase average and lower the multiple to make the transaction more salable to shareholders, which by the way are precluded from voting on the transaction thank to CF management to not be bogged down with a limitation in their pursuit of TRA.
- CF claims "~$1.54Bn of combined EBITDA (including run-rate synergies): Based on 2010 CF management EBITDA guidance, excluding minority interests, of $752MM for CF (see non-GAAP reconciliation on p.6), plus $655MM of 2010 EBITDA per Terra (refer to Footnote 1 on prior page), plus $135MM of run-rate synergies" However, CF used its guidance for 2010 and the 3 year historical average for TRA to arrive at that number. Talk about apples and oranges.
- "I believe a $100/st nitrogen production margin ($3/MMBtu natural gas for 1 metric ton ammonia production in Yara's thinking) is as good as it will get going forward, and based on this, $600 million is the high water mark for earnings from this asset set. This is based on 6.5 million tons of annual nitrogen production, less SG&A. Terra's EBITDA hit $964 million in 2008, which was an extraordinary year for the company. "
- CF will pay about 6 percent of its entire market capitalization in fees. On a per share basis, I calculate this to be about $5.75 per CF share. This does not include the $123 million termination fee that CF is paying to Yara on Terra’s behalf as a result of TRA terminating with their merger agreement to accept CF's offer.
- CF will issue equity to fund TRA acquisition, lots of it; it can be dilutive. The company will issue $2 Billion worth of shares: $1B for TRA shareholders and another to the public. Total issuance represents 30% of current and new shares based on today's market price.
- TRA UK assets are declining due to pound devaluation
- valuation of integrated companies:
- what kind of return can CF garner on the acquisition? I reckon no more than 15% in ROIC, this is the best case scenario. The ROIC figure is covering assumed cot of capital of 12%, however, I have my doubts about their EBITDA and synergies claim as detailed here. If I start calculating more accurate ROIC figures using accurate EBITDA like better cycle than just 3 yrs and including an average of non recurring charges...etc I sure they do not earn their cost of capital.
- The invested capital is the cost of the acquisition which are:
- offer: $4.6 Billion
- termination fee to Yara: $123 million
- bankers fee incurred by CF: $270 million
- Grand total : ~ $5 Billion
- $622 (based on the 3 year average EBITDA of TRA)
- $135 million in synergies
Perils of Integration
- Do CF have merger integration experience? CF did not make a large acquisition like this and was not a serial acquirer of smaller operations so that begs the question how will they integrate?
- I want to handicap CF management so lets look at their track record by calculating ROIC.
- CF has capacity to add debt as it has lower leverage . It will add $4.05 billion in financing to its balance sheet to complete the acquisition.
- what does the combined company look like?
- CF claims "flexible balance sheet with ~$1.7Bn of Net Debt by the end of 2010 (Based on CF management expectation of $2,034MM of debt less $321MM of cash (excluding $134MM of auction-rate securities)"
- CF claims that there is $135 million in annual synergies ( those synergies were $100 million at the time of the initial offer) from the elimination of:
- duplicate corporate functions: it should be very little if any to be considered material and worthy of synergy.
- optimization of transportation/ distribution : need to look closer at this claim
- greater economies of scale in purchasing and procurement: but 50% of their production cost is natural gas and the commodity is not driven by volume but rather by proximity to distribution network or closeness to production hubs. However natural gas is cheap at the moment given them larger margins and NG is expected to be low priced for the foreseeable future. Nevertheless it is an advantage that can be enjoyed by the entire industry rather from economies of scale as a result of the merger.
- It is hard to see exactly where CF is going to get the extra $75 million in synergies they asset they can deliver, over and above the $60 million that Yara said it can achieve, the latter being more evident.
- distribution channels are different since Terra's customer base is industrial and CF's is agricultural