Description

Executive Thesis:

MOS will be repurchasing at least 20% of its shares O/S (and likely 30% by 3Q’14).  There is a lockup expiration for shares formerly held by Cargill (and split-off) on 11/26, we believe that prior to this Mosaic will raise incremental debt + use part of its $3.7B of cash on hand to repurchase these shares – causing meaningful accretion and upside.

Situation Overview:

MOS is likely to leverage to buy a 1/3 or 2/3 portion of the Cargill interests' remaining stake (129MM shrs or 426MM o/s) in Q4'13.  Mosaic's cash position ($3.7B) and low debt ($1.1B) make this possible as management has been hinting at a 1.5x adj. debt/EBITDA target, which yields about $4.5B of adj. debt.  MOS generates $1.5-2B fcf/yr and would be able to buy back all of the Cargill interests' shares by year end 2014 with minimal additive net debt.  Potentially this would shrink the share count by 30% after all shares are bought by MOS.  The Cargill interests are motivated shareholders as they consist of a split-off to former Cargill shareholders as well as the bulk of assets of the Cargill Charitable Trust, which is looking to liquidate its holdings in MOS.  The structure of any transaction would begin with a 20-day test period after which the average daily price for that period would determine the price MOS would pay for the shares.  It’s likely that MOS would do a combination Term Loan B / revolver to finance the transaction as net cash on hand ($2.7B) and cashflow generation (>$1.5B/yr on a maintenance capex basis) would be enough to repay any incremental debt by YE 2015.

Entry Catalysts:

MOS had recently gotten the Cargill charity trust’s potential sale of MOS stock postponed from June, 2013 to coincide with Cargill interest’s lockup expiration on 11/26/2013 – this postponement was viewed unfavorably by special situation holders.  In addition to this fertilizers performed poorly through Spring-early Summer 2013 (MOS -15% from March peak vs. mkt + 18% YTD) – given our belief that MOS will step in and repurchase at least 86MM of the 126MM on lockup in 4Q’13-1Q’14 as well as a bottoming of sentiment within ag, now looks like a great entry point.

            Why now as an entry point?

The argument to enter the trade after Mosaic has announced a successful debt placement (or price-fix period for Mosaic shares) would likely be too late as the stock would then gap higher.  The risk to waiting is that once a deal is close (e.g. – MOS is rumored to be preparing to place debt) the special situation investors who were in the stock and tired out after the June postponement will re-enter the trade, leaving a very small (or no) window. 

Why MOS vs. POT?

POT was already an acquisition target during 2-3Q’10, BHP’s unsolicited bid was ultimately blocked by the Canadian gov’t with POT management’s approval – this takes POT off the table as an M&A candidate for the most likely acquirers (BHP/Rio Tinto – BHP much more likely).  MOS capitalizing 30% of its share base at lower levels AND currently trading at $750 EV/ton (vs. replacement of $1500/t) makes it a much more attractive M&A target than POT, who’s management team seems intent on remaining independent.  The case for a virtuous cycle in MOS over the next 2-4 months (i.e. – if MOS gets financing the mkt will see it can repurchase the entire Cargill stakes, and further from this then becomes a more likely acquisition target) is where most of the upside is captured vs. POT despite their similar earnings exposures.

Major risks to the thesis revolve around 1) Mosaic’s ability to obtain debt financing to purchase the Cargill shares and 2) the potential for soft commodity prices to continue falling through the harvest season (when yields are known to the market).

Exit Catalysts/Timeline:

MOS is likely to start to market additional debt in the early Fall to build cash for a takeout of ~86MM/shrs of the Cargill interests’ shares – this will likely get the street thinking about deal accretion under a full 126MM/shr takeout scenario (MOS would then buy back the remaining shares in 1H’14).  We view this trade as occurring through 1Q’14 – post any debt placement announcement (which would be near the 11/26 Cargill lockup expiry) MOS would likely head higher, and then re-rate into 2014 as Street gives management credit for ROC-focus and cash generation/return to shareholders as well as MOS now being a viable acquisition candidate (Cargill ownership effectively blocked MOS being a target for an interested buyer like BHP).

Timeline:

-          6/26: Charitable trusts postpone filing shelf registration until 11/26 after Cargill interests reject accelerating their share lockup to match June election

-          7/29: Uralkali announces disbanding of BPC cartel, predicts potash pricing could fall to $300/t FOB Europe from $400/t levels as they increase production

-          Aug.: BHP will announce its plans for the Jansen greenfield expansion in Saskatchewan ($10-12B project - $1.5B spent, potentially 8-10MM/tpa and a threat to global pricing)

-          Sept.: MOS reports re-statements for FY adjustment into CY reporting standard (beginning for the 2013 calendar year)

-          Q3-Q4: India announces a new potash tender, mkt would look to this as the global near-term pricing floor

-          Oct-Dec: MOS places incremental debt (Term-A + revolver most likely – will occur after CY/FY restatements) – $2.5-3B incremental borrowing

-          11/26: lockup expires for Cargill interests/trusts to place 86MM of 126MM shares – MOS can call the entire stake via negotiation

-          Q4-Q1’14: MOS repurchases Cargill shares under trailing 20-day average formula; becomes a new M&A tgt (likely coinciding with a BHP cancellation/delay of Jansen)

High-Frequency Datapoints:

-          North American potash/phosphate inventories – ~15^th of each month

-          Fertilizer pricing data – weekly/daily (Fertilizer Week/Green Markets)

Recap Math/Valuation:

Assuming MOS de-rates to 11.5x from current 13-12x on our numbers, we still get 25-35% upside on ‘14/’15 EPS on the $1.30-1.50 EPS accretion from removing 30% of the share count.

           Estimates vs consensus:

Even under a rough sampling of new Street estimates post Uralkali’s announcement, we get significant accretion and potentially more upside than our base estimates (Bloomberg/Street have still not uploaded their numbers, this was a hand census):

Post-Event Consensus:

MOS vs. POT Multiple:

Generally POT has traded at a 1-3x mult premium to MOS, expanding to 10x when BHP made an ultimately failed bid in 3Q’10 – at that time MOS was not considered a target as well due to the Cargill ownership effectively blocking M&A.  Now this situation is reversed and we could see POT trade 1x below MOS as the later is now an M&A target post-recap and has a more favorable nutrient profile in 45/55 P+K exposure.

At any rate it could be argued that a trade consisting of MOS/POT hedged 1:1 would make the most sense to isolate accretion from the recap.

MOS avg. mult:

-          Curr: 11.2x

-          Avg: 16.6x

POT avg. mult:

-          Curr: 11.7x

-          Avg: 18.5x

SPX (same period):

-          Curr: 15.3x

-          Avg: 14.2x

Risks:

-          China/India tenders in Q3/Q4 (generally tons sold below seaborne spot) come in below mkt’s assumed cost support of $260-280/t FOB Europe

-          INR depreciation – erodes buying power of a purchaser of 6-8MM/tpa of a 55-60MM/tpa mkt

-          BHP approves full Jansen project funding – potentially takes out a buyer of MOS

-          BPC cartel break-up causes accelerating potash volumes/ price collapse

MOS/Cargill Interests:

Cargill had merged Mosaic (formerly Cargill Plant Nutrition) with IMC Corp in 2004 – Cargill chose to keep the FMC listing but retain its 70% ownership.  In Feb 2011 Cargill split off former interests from itself using MOS shares (debt holders, a Cargill charitable trust and other Cargill equity owners) allowing Cargill interests to exchange their positions for liquid, trading stock.  These blocks were allowed to sell in pieces in 2011 and then at a lockup expiration in June 26th, 2013 , followed by another expiration in November, 2013. 

The remaining shares are 126MM of Mosaic’s 426MM total (30%) – 2/3 of this is held by a charitable trust whose assets consist mainly of MOS stock (they are a very ready seller) while the remainder is Cargill/former Cargill shareholders.  Mosaic had attempted to accelerate Cargill’s lockup expiration to June 26^th but Cargill wouldn’t go along, so the charitable trust then postponed their rights to sell to correspond with the Cargill interests (11/26) – Mosaic will likely repurchase 2/3 of these shares sometime after the lockup in November under a formula in which it would pay a rolling-20 day average share price after a declaration date.

How The Cartels Work:

The two global cartels, BPC & Canpotex, control ~77% of the global potash mkt.

Potash demand is ~50-60MM/tpa, with 2013 expected around 55-56MM/tpa and a growth rate of ~3-4%, over the past few years it has been estimated that India has been under-consuming and will need to “catch up” about 3-4MM/t YoY.  Global utilization is estimated at 75-80% currently (100% wouldn’t be optimal due to the seasonality of ag demand).

Canpotex (Canadian producers Mosaic, PotashCorp & Agrium) markets tonnage sold outside North America by the three major Canadian producers.  In addition to this PotashCorp owns strategic equity stakes in non-aligned producers: 14% of ICL, 32% of SQM, 28% of APC and 22% of SinoFert (Chinese fertilizer trading/importation).

BPC is comprised of former Soviet Union miners Belaruskali (owned by the Belarusian government, and officially for sale) and Uralkali (privately owned).

The two cartels control 70% of the global tonnage

Global potash supply is controlled by the following producers, split into two cartels (Canpotex & BPC) and several tag-along producers:

Canpotex

            PotashCorp: 9.5MM

            Mosaic:        8.5MM

            Agrium:        1.9MM

            Total:           20MM/tpa

            BPC:

            Uralkali:       10.5MM

            Belaruskali:  8.75MM

            Total:           19.25MM

            POT Equity Interests:

            ICL:             5MM

            SQM:           2MM

            APC:            2.5MM

            Other:

            IPI:              800k

            Vale:            800k

            K+S:            5.0MM

Belarusian Economy/Dynamics:

-       Fertilizers: 8% of Belarus’ gross exports (key generator of foreign currency)

-       A fall in potash prices could lead to an increase in the full-year trade deficit of nearly $1 billion to around $5.3 billion, VTB Capital said.

-       Belarus' rouble hit 8,880 per dollar on Tuesday, its weakest in a month, reflecting worries about the loss of export revenues to Minsk and concerns it may use devaluation to boost its accounts.

-       Belaruskali (state-owned potash producer) has a cash cost of $60-70/t and produces 10-11MM/tpa of K fertilizer per year

-       Belaruskali: 10MM/mt pa

• US$3B/yr vs. US$4B/yr prior government income
• Assume $80-100/t cash costs (potentially lower)
• Net receipts to Belarusian economy would be $3B

Belarusian Government Budget:

Losing cash from exports is the last thing the Belarusian government needs. It is struggling to hold its international reserve assets at no less than today’s level of $8bn at a time when it faces a spike in foreign debt repayments. The government faces loan repayments of $3.1bn in 2013 and about the same amount in 2014.

The current level of reserves is equal to about two months of import cover. That is enough to support the stability of the currency for now, but the pressure on Belarusian finances is growing as export revenues fall sharply and the current account deficit expands. According to official statistics, in January to April 2013, the deficit stood at $2.97bn, or 15.2 per cent of GDP.

Meanwhile, there are no signs of the government being able to attract significant support from multinational lenders or other countries. And the authorities, apparently, are not ready to resume privatisations, stalled since 2012.

            Belarus Gov’t Statistics:

-       Potash income = $4B gross receipts ($3.0-3.5B in net income)

Leverage Requirements for MOS:

-       S&P LT Local/Foreign: BBB

-       POT ‘A-‘ S&P rating has been affirmed with negative outlook (8/6/2013)

• A- requires:
  • Debt/EBITDA < 2x
  • FFO/Debt > 45%
  • S&P LT expectations: Debt/EBITDA

Catalyst