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  SaskPool succeeds in Agricore takeover

BENJ GALLANDER and BEN STADELMANN

Friday, May 11, 2007

What a battle. It's been six months since the first salvo was fired in Saskatchewan Wheat Pool's quest to purchase Agricore United. Last November's hostile bid was spurned by Agricore's board, which was not surprising given that there was no cash component to the stock swap offer that valued Agricore's shares at around $10.

But what was astonishing was the supreme confidence of SaskPool's chief executive officer, Mayo Schmidt, in his ability to make a deal. It soon became apparent that the initial offer was just a lowball bid to get the ball rolling. Indeed, the machinations of corporate takeover strategy often mimic the ornate negotiations of buying a rug in Istanbul's Grand Bazaar.

Schmidt's pursuit seemed doomed in February when white knight James Richardson International rode from Winnipeg to Agricore's rescue. But Schmidt remains one dogged CEO, as he proved when bringing SWP back from the brink of bankruptcy, and apparently he was able to use the rival bid as evidence to bolster his case with investors that building a scaled up Canadian agribusiness was a good bet.

The Street was eager to open its wallet. Genuity Capital, TD Securities and National Bank helped fill a war chest with subscriptions for $225 million, then another $275 million and finally another $316 million. So brisk was interest in these issues that over-allotment options were exercised for all three, which iced the cake with an extra $103 million. A big chunk of the cashola came from New York's Third Avenue Management, a value investment firm captained by our acquaintance, hard-core contrarian Marty Whitman.

Schmidt's other front of attack was with Canadian and U.S. regulators, who were concerned about diminished grain handling competition. However, that impending problem was overcome with the sale of nine handling facilities and a Vancouver port terminal to U.S.-based Cargill. With the blessing of bureaucrats in hand, and a grain elevator sized mound of cash, Schmidt was finally able to come to an accommodation with JRI to carve up Agricore and split the pieces.

We are no strangers to takeover wars; at least one stock in the Contra the Heard portfolio has been bought out in each of the past 14 years. But it is less usual for one of our stocks to be the hunter, rather than the hunted. When SaskPool was purchased for the portfolio at $5.67 in November 2005, it seemed that the company had reached stability after years of uncertainty and a comprehensive restructuring. One attractive feature was the much-improved balance sheet and low share count. That is certainly less true now.

However, other favourable trends remain intact. They have just gained more common currency with the investment community. China's rising living standard means meat consumption is growing rapidly, generating demand for animal feed. The world's arable land is under pressure from urban sprawl and environmental degradation. And the emerging biofuel industry holds the potential for using up excess grain, particularly in years when it is difficult to sell lower-quality product.

The bulked-up SaskPool will have about $4 billion in annual revenue and about a 40 percent share of western grain handling. That's large enough to create economies of scale in the procurement and loading of freight cars. Other cost savings resulting from the merger are reckoned to tally to $70 million annually. The 2006 harvest was above average, and since much of that is still in the pipeline, the bottom line for the next couple of quarters should be decent.

All this makes our initial sell target of $12.74, set in 2005, look potentially conservative. To move beyond that price, SaskPool will have to avoid the pitfalls that have bedevilled the company in the past. The fight for Agricore was very expensive, and once the dust settles the new company will have about $600 million in debt. If drought returns to the Prairies the interest payments will be crushing.

In a conference call, Schmidt waxed fondly on how the Agricore acquisition would bring diversification to the Pool's business. This is the same CEO who aggressively dismantled SaskPool's unwieldy portfolio of businesses to concentrate on "core assets."

It's one thing to cobble together a "Canadian Champion" agribusiness large enough to compete on the global stage. It's quite another to run it efficiently and profitably. Of course, reduced future competition increases the allowance for error.


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