Talking Point

Grain of truth

Will Sinochem be Potash Corp’s white knight against BHP Billiton?

Ready to welcome a Chinese investor? Potash’s boss Bill Doyle

“When I first went to China in 1979, we were eating monkeys’ brains, crickets and sea urchins,” Bill Doyle told Bloomberg. “Today you go to China and they ask you if you want to split a beef tenderloin.”

Doyle’s view on Chinese consumption habits matter more than most. That’s because he’s CEO of Potash Corp of Saskatchewan, the maker of the nutrient that goes into a lot of the world’s fertilisers. Thanks to China’s rising prosperity – and increasing taste for meat – Potash is a company in demand.

That fact hasn’t escaped global commodities giant, BHP Billiton, which made a $39 billion bid for Potash Corp in mid-August. Doyle has rejected the offer and the takeover’s outcome is still uncertain. But it has Beijing worried. Chinese consortia are even emerging as possible ‘white knight’ bidders.

Why is China so concerned?

It’s a big potash customer. As TIME magazine points, China “uses more chemicals on its crops than any other country.”

That means it’s worried about the supply of fertiliser. “As one of the biggest importers of potash, China does not want to see more concentration in this market,” Emilien Mazo, an analyst with Louis Dreyfus Commodities told Reuters.

Potash Corp is the world’s largest fertiliser producer, with an output set to reach 17 million tonnes within the next five years.

BHP – a late entrant to the fertiliser business in 2006 – has been scaling up its market share via acquisitions. Two years ago it bought Canada’s second biggest fertiliser maker, Athabasca Potash. The Anglo-Australian resources firm plans to up its own capacity to 10 million tonnes per year.

China imports half its potash, making it very vulnerable to price changes, especially with its fertiliser needs growing at 6% per year. Should BHP gain control of Potash Corp it will create an industry player of massive influence. Enough power, perhaps, to shape fertiliser pricing globally.

What about China’s own fertiliser business?

China Business, a newspaper, reckons that Beijing feels the bid could threaten its domestic business too. That’s because Potash Corp owns 22% of Sinofert, which in turn has a key stake in Qinghai Salt Lake Potash, China’s largest potash fertiliser firm. “If BHP Billiton is successful in this acquisition, Sinofert falls indirectly into the hands of BHP, which endangers the safety of the domestic potash fertiliser industry,” is the China Business view.

Sinofert – the sole importer of Potash Corp’s products into China – is also a subsidiary of Sinochem, a state-owned firm that straddles chemicals and oil refining, as well as fertiliser trading (see WiC7). Media have quoted a Sinochem executive’s concerns at the “significant impact” of BHP’s takeover attempt, saying the company is “closely watching the deal” and has held talks with Potash’s board.

The speculation now is whether Sinochem – with its access to cheap borrowing – will launch a rival bid. The Wall Street Journal yesterday reported that it has hired HSBC as an adviser. Meanwhile local private equity heavyweight Hopu may also assemble a bidding consortium that includes China’s sovereign wealth fund, the Journal reports.

Is there a precedent?

Yes, there is, according to the China Economic Times. It points out that while it is “rare” for Chinese firms to be cast in the role of white knight, it has happened before, and once again BHP was on the receiving end.

Back in 2008, Beijing was similarly panicked when BHP made a big takeover move, this time trying to buy Rio Tinto and establish an iron ore behemoth. Rio executives wanted to block BHP, and a Chinese state firm obliged. Chinalco acquired 9% of Rio. BHP withdrew its bid.

Could such an outcome be on the cards again? There’s no love lost between Beijing and BHP, with constant friction over iron ore prices (see WiC56). And given the sheer size of BHP’s bid for Potash, perhaps only a Chinese consortium has the means – and motivation – to act.

How strong is that urge?

Fertilisers play to one of Beijing’s greatest fears: loss of food security. As reported in WiC40 (‘The thin red line’), the leadership worries about not having enough food to feed its population. To that goal, official policy decrees that the country must have at least 120 million hectares of arable land (at the beginning of last year it had 121.7 million hectares).

But agricultural land has been on an inexorable decline as Chinese real estate developers look to build more tower blocks, and local governments sell land to balance their budgets. For example, the National Business Daily reckons that last year the city of Beijing lost 30% of its farmland to property development.

Indeed, Zhang Ping, minister of the National Development and Reform Commission, warned this week that “acute shortages” of reserve farmland pose a severe threat to the country meeting its food security policies.

Ergo the importance of fertiliser; productivity becomes all the more crucial when you are trying to increase food supplies on a dwindling stock of agricultural land.

A losing battle?

China’s grain output this year is expected to decline marginally, according to the Chinese Academy of Agriculture, but could still reach 500 million tonnes. But vagaries in this year’s weather could see the harvest weaken, forcing higher levels of imports. That would end China’s self-sufficiency in grains.

If the example of soybeans is anything to go by, it is only a matter of time before self-suffiency is lost. Before 1995 China exported soybeans. Today it is the world’s biggest importer, sucking in 40 million tonnes of them this year.

The same trend looks to be underway with maize (or corn). The Financial Times reports that China will move from a state of virtual self-sufficiency in the crop to importing 1 million tonnes of it this year. The US Grains Council forecasts the Chinese will be importing 15 million tonnes by 2015.

As Potash’s Doyle indicated in his remarks about local dietary habits, the reason for this is that the Chinese – as they get richer – are eating more meat, and less rice. To produce all that extra meat, you need to feed the animals more soybeans and corn…

The other fear is inflation…

It’s not just about food security goals. The government is also worried about the connected problem of food inflation. On international markets wheat has soared 50% in price in two months. In China rice prices are up 17% from a year ago, and fresh vegetables are 22% dearer.

Rising prices for food hit China harder than other countries, says HSBC, as food items make up a higher share of spending from local wallets. It adds there is a high correlation between increases in foodstuff prices internationally, and the subsequent prices paid by Chinese shoppers.

In fact, food is given a 32.5% weighting in the country’s consumer price index. So rising food prices can have a big impact on China’s CPI – which breached the central bank’s 3% comfort zone in July. (Many people think the real rate of inflation is much higher than the official 3.3%. Michael Pettis of Peking University says it could well be as high as 6%).

Which brings us back to Potash Corp. The last thing Beijing wants is for BHP to buy the Canadian firm, and then capitalise on its new bargaining power to push up prices (based on this year’s round of fractious iron ore negotiations, the concerns are understandable).

BHP is arguing something different; that it plans to exit current cartel pricing arrangements, run its fertiliser operations at full capacity, and win share with competitive pricing.

What next?

If a ‘white knight’ consortium fails to emerge, Beijing may look at other options. On Wednesday, CBN reported that China may use its antitrust bureau to veto the deal. It has intervened in international M&A before, blocking Pfizer’s acquisition of Wyeth and compelling the US firm to dispose of an animal vaccine business (see WiC63). But challenging BHP on antitrust grounds would be a feat of much greater magnitude. This battle looks far from over…


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