Potash Overpriced: Still Trading Above BHP Bid Price

Photo source: AP and the Wall Street Journal

When mega mining firm BHP Billiton dropped its hostile bid for Potash Corp. of Saskatchewan, most, including myself, expected the share price to fall back to $110 US. This was the value of the company pre-BHP bid. However, to my amazement, the shares are still trading above the $130-a-share bid, contradicting the efficient market theory.

If the theory were upheld, the shares would have dropped back to $110. The surge in the stock's value was primarily due to a rumour that BHP would increase its $130/share bid after its original bid was being rejected by shareholders. After BHP ran into political games against the Canadian federal government and provincial government of Saskatchewan, the Potash board, and Canadian citizens, it decided not to pursue the world's largest fertilizer company. Once it was dropped, this padded value should have been removed from the price, but this did not happen.

What fundamental or technical conditions have allowed the price of Potash to remain above the BHP bid?

One possible reason to justify the current 26 P/E ratio would have to be the positive earnings report on October 28. Potash reported earnings of $1.32 per share trumping estimates of $1.10 and increasing year-over-year net income 60 per cent. But initial reaction had the stock overpriced; traders sent the shares down below $135 on the news.

Another possibility would be the $2 billion buy-back program recently approved. The company, which only has $300 million in cash, will be selling bonds to finance the deal. But $2 billion represents less than 5 per cent of the company's outstanding float, which would only move the shares about 5 to 6 per cent up from normal valuations.

No positive changes have occurred on the fundamental front since August. Its timid dividend, paying out just 0.28 per cent yield, has been unchanged. The board and management team remains the same and even potash fertilizer prices estimates for 2011 have not seen drastic upward movement. Upgrades and downgrades by JPMorgan and Standards & Poors have done little to push the price up or down, and the S&P currently has a negative outlook on the company too.

Of course, an argument is not completely valid until we have a precedent. Fortunately, this is not the first time in recent history where a Canadian company was a target of a buyout which failed to transpire.

Back in 2007, BCE surged in the spring from $25 to $45 CDN on anticipation that the company would be bought out by the Ontario Teacher's Pension Plan. It easily passed legal concerns and received financial backing by a multitude of banks, even with stricter restrictions after the sub-prime crisis. It was one step away from privatization. But almost two years later in November 2008, a statement of solvency could not be produced by KPMG, a requirement of the deal, thus the deal was cancelled. As a result, the shares dropped back to $25 and would even trade below $20 for a few months.

The point is, even after two years including seven earnings reports, which would have showed changing profitability, changes in the Canadian telecommunications landscape, and changes in the global economy, the extra value in BCE shares directly due to the privatization were ultimately removed from the stock. Conversely, Potash Corp has yet to correct back to $110 to reflect this, even temporarily.