Potash: The deal that didn't have to die

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Marius Kloppers strode into a downtown Chicago hotel in the middle of a searing heat wave to launch an ambitious takeover strategy that had been on ice for more than five years.

The South African-born chief executive officer of Australian mining titan BHP had arranged to meet secretly on Aug. 12 in a room at the Four Seasons with Bill Doyle, the platinum-haired chief of Potash Corp.

Mr. Kloppers explained to Mr. Doyle that, after quietly coveting Potash Corp. for years, BHP had authorized him to offer nearly $40-billion (U.S.) to take over the company, a 20 per cent premium from the previous day's trading. Complimenting Mr. Doyle on the "unbelievable" value he had created for shareholders, Mr. Kloppers confided that he had "choked" several times at Potash's high stock price.

When the two men finished the cordial 35-minute meeting, Mr. Kloppers had every reason to believe that the takeover odds were on his side. Potash prices were still climbing out of the cyclical basement, and few other companies in the world could match BHP's financial heft to top the bid. A government-backed company from China probably could, but no Chinese entity has ever tried to make such a large acquisition in a developed, democratic country. Even better, the widely held Saskatchewan company had no blocking shareholders. The Canadian government had never rejected a foreign takeover of a major resource company, and just three years ago allowed Rio Tinto PLC to take over Alcan Inc. of Montreal in a deal of similar size.

It was a great pitch. But what Mr. Kloppers didn't understand that day was that he was making it to the wrong man.

Nearly 2,000 kilometres to the northwest, in a city the BHP boss had never visited, was someone he had yet to meet who would play a large role in determining the fate of the blockbuster offer for the world's largest fertilizer producer.

Brad Wall, the Premier of Saskatchewan, would wait four more weeks for Mr. Kloppers to pay his respects. The delay would be one of several critical missteps that would eventually poison the relations between BHP and Mr. Wall's business-friendly government and people it represents. Less than three months after that Chicago meeting, that takeover proposal that BHP dubbed Project Porcupine has degenerated into one of the prickliest corporate and political messes ever seen on the Canadian takeover field.

For Mr. Kloppers, this week's rejection of the deal is a serious blow, not just because it is the third time in three years as CEO that BHP has failed to close a major transaction but because Potash Corp. was his perfect target. A company of BHP's size - it has a market capitalization of about $240-billion and produced $18-billion in operating cash flow in its latest fiscal year - needs to make very large investments to grow. It isn't easy to find them, especially given the company's stated strategy of owning only high-quality assets. "We allocate capital only to long-life, low cost, Tier 1, upstream, export-oriented or selling into large markets type of assets," Mr. Kloppers said. Potash Corp. "absolutely fits that."

Now, barring an unlikely last-minute change of heart by the Harper government, it is beyond its grasp. BHP's bid set off a cacophonous debate over the deal that threatened to loosen the Conservative party's grip on its Western Canadian stronghold, stirred a latent nationalism in the country's staid business community and sent an abrupt message to the world that Canada is not quite as open as it used to be to foreign investment.

The most remarkable thing of all is that no one saw it coming.

BHP Billiton made some fundamental mistakes in its pursuit of Potash Corp, say mining, mergers and acquisitions experts and analysts. It needed to convince investors, politicians and the public that its takeover proposal would enrich them, financially and economically, and it failed on all counts.

"This for sure did not have to happen. They could have built support for this deal," said veteran government affairs adviser Jamie Watt, chairman of Navigator, an Ottawa-based government relations consulting group that was not involved in the transaction.

"I don't think BHP spent 10 minutes looking at the local politics," said Pierre Lassonde, chairman of Franco-Nevada Corp. and former president of Newmont Mining Corp., the world's second-largest gold miner. BHP executives assumed, wrongly, that the relaxed attitude toward foreign takeovers that existed before the financial crisis still prevailed today. "They looked at Inco, Falconbridge, Noranda - all gone - and said 'That's enough for me.'"

The road to becoming a target

The company that is now being championed as a "strategic resource" by the government of Canada and a growing chorus of business supporters has, in fact, been slipping away from its Canadian roots for years.

When Saskatchewan privatized Potash Corp. in 1989 by publicly selling its stock, it looked as if the province was unloading a loser. The only way Saskatchewan would be able to attract investors to such a financial basket case, advisers told the province at the time, would be for the government to sell down its interest in the company and abandon any rights to approve the company's ownership.

Mr. Doyle, who came CEO on Canada Day, July 1, 1999, slowly returned the company to health. But even as its financial fortunes improved, the company began a slow retreat from Saskatchewan. Citing his wife's concerns about local schools, Mr. Doyle sold the family's sprawling riverfront home in Saskatoon to move to a suburb of Chicago in 2002. Many executive office functions followed him.

Mr. Doyle's new locale matched a sense among locals that Potash Corp. was growing distant from the community. When the Saskatchewan Roughriders went looking for a corporate sponsor to upgrade their aging Regina stadium in 2006, it was Potash Corp.'s smaller competitor, Mosaic Co., that stepped on the field with a $3.75-million investment that gave it naming rights to the venue.

"The name on that stadium is not Potash," said Ken Rasmussen, associate director at the University of Regina's graduate school of public policy. "There are folks that have a lot of bad things to say about Potash Corp. They haven't been doing a lot for Saskatchewan."

Far away in Melbourne, a small team of executives at BHP's headquarters watched the shifts at Potash Corp. The Australian giant had been plotting an expansion into the thriving potash sector for more than a decade and in 2006 a team headed by Mr. Kloppers, then a senior executive overseeing the company's non-ferrous mineral divisions, and Alberto Calderon, now its chief commercial officer, made a proposal to then-CEO Chip Goodyear. Mr. Kloppers, according to court documents, had instructed Mr. Calderon to "stalk [Potash Corp]with intent" and he urged Mr. Goodyear to approve a plan to offer $13-billion to acquire the Saskatchewan company.

The duo failed to convince Mr. Goodyear. But a year later, the CEO's job was handed to Mr. Kloppers, a chemical engineer who had quickly risen through the ranks by earning a reputation as a decisive and expansionary leader. BHP's ambitious new CEO first turned his acquisitive eye to an audacious $66-billion bid to merge with its rival Rio Tinto Group.

The bid foundered, but Mr. Kloppers did not come away empty handed. Andrew Mackenzie, a Glasgow-born senior executive from Rio Tinto, agreed to join BHP in 2008. According to internal documents filed in a Chicago court, Mr. Kloppers' marching orders were to concentrate "above all [on]being the new entrant in potash."

BHP had already purchased a company with rights to a potash mine east of Saskatoon that became known as the Jansen mine. A few months after joining BHP, Mr. Mackenzie forwarded a memo from one of his executives to Mr. Kloppers warning that the company would have to spend heavily for several years before it could hope to bring the mine to production in 2015. Considering the challenges, the memo noted that an acquisition of Potash Corp "would still be attractive relative to the cost to build" Jansen.

According to court documents, BHP pursued a two-pronged strategy over the next two years. In public, it unveiled plans to spend hundreds of millions of dollars to develop Jansen, the province's first new potash mine in thirty years. A new BHP office was opened in Saskatoon and the company generously sponsored the World Junior Hockey Championship in the city. Jansen, Mr. Kloppers told analysts in August, 2009, was a "magnificent asset."

Behind the scenes, BHP had its eye on another strategy. Court documents show that beginning in March, 2009, company executives were having "fireside" chats with directors about a taking a run at Potash Corp. In May, 2010, after global markets had recovered from the worst of the crisis, BHP launched a secret acquisition strategy for Potash Corp. that became known internally as Project Porcupine, which led to the Aug. 12 meeting in Chicago between Mr. Kloppers and Mr. Doyle.

From the beginning, things did not go perfectly for BHP. On Aug. 17 at 8 p.m. Melbourne time, Potash Corp.'s board of directors stole BHP's thunder by announcing the hostile takeover offer. Typically, target companies engage in discussions with potential suitors to explore the potential for a sweetened offer. But according to one person close to Potash Corp., the company's executive team and board members were so "insulted" by the bid of $130 a share (U.S.) that they instead opted to raise the stakes, and the company's stock price, by revealing their Australian suitor.

The relatively slim takeover premium of 16 per cent appears to have been calculated on the assumption - correct as it turned out - that no rival bidder would emerge. But a senior Canadian investment banker said the low offer failed to whet the appetite of Canada's biggest and most powerful investors - the pension funds. If those funds and other big-name investors couldn't resist the offer, he said, they would have put enormous political pressure on Premier Wall and top federal politicians to approve the deal.

"It was a big mistake low-balling the bid," said the investment banker, who did not want to be identified. "It was a crap premium when you consider the stock was trading well off its all-time high and it was obvious the [commodities]cycle had bottomed out. The missing voice in the whole debate was the Potash shareholders. If BHP had made a real bid, there would have been a cacophony of large shareholders telling the governments to butt out."

Outed by its target, BHP unveiled its formal bid. But what set off shock waves in the province was Mr. Kloppers' response to a question about his plans to market Potash Corp's output. "Philosophically, I have to refer back to our baseline demeanor, which is to market our product ourselves, stand in front of the customers ourselves, run our assets at full capacity and take the market prices," he said.

In Saskatchewan, Mr. Kloppers' remarks meant one thing: BHP was planning to dismantle Canpotex, the powerful potash marketing arm owned by Potash Corp., Minnesota-based Mosaic Co. and Calgary-based Agrium Inc., that markets potash from Saskatchewan to customers outside of North America. The cartel-like organization has helped keep potash prices high, boosting the royalties paid to the province of Saskatchewan. If Canpotex were gutted, potash miners would lose control of pricing, meaning prices would be more likely to fall than rise.

Tony Robson, the co-head of mining research at BMO Nesbitt Burns in Toronto, said BHP made a fatal error by threatening to tamper with Canpotex. "The biggest mistake was politics," he said. "BHP and its Canadian advisers underestimated the impact [to the province's revenues]of leaving Canpotex. It's very clear the province gets its potash income from price, not volume."

Suddenly, this was no longer just a takeover to Brad Wall's conservative-minded government; it was a potential assault on the small province's treasury. "This is not like other hollowing-out deals," said the chairman of a Canadian investment bank who asked to remain unnamed. "This is the only time a sale threatened to destabilize the revenue base of an entire province. BHP should have promised to keep Canpotex and promised to contribute to the revenue hole potentially created by tax planning or royalty avoidance."

Mr. Kloppers, though, waited four weeks before paying a visit to the Premier. A parade of executives, including Mr. Mackenzie, Graham Kerr and government and legal consultants, did go and talk to senior Saskatchewan government officials. But sources say each of them stuck to Mr. Kloppers' script that BHP was better off selling potash on its own.

The battle begins

While Kloppers stayed away from Saskatchewan, Potash Corp.'s itinerant CEO began building political bridges.

He started on Aug. 16, the night before Potash Corp. lifted the veil on BHP's takeover overture. Mr. Doyle called Mr. Wall in his Swift Current home just as the Premier was about to head out to see the movie Inception with his wife, Tami. Mr. Doyle advised the Premier that the company would be announcing a hostile takeover offer the next day.

After the short call, Mr. Wall turned to his wife and said: "There is going to be a hostile takeover of PCS by the world's largest mining company." He then paused and added: "Hope this movie is good."

Mr. Wall isn't sure how the film was. He sat through it thinking only about potash.

By the time Mr. Kloppers did arrive in Saskatoon on Sept. 19, BHP's plan was not unfolding according to the planned script.

To begin with, it took the exhausted CEO 24 hours to travel to Saskatoon from Melbourne after he missed a connecting flight in Los Angeles. Underdressed in jeans and a rugby shirt for a cold, rainy day in Saskatoon, Mr. Kloppers walked quickly to a local pub for supper, hugging his chest to keep himself warm.

Mr. Kloppers was wearing a dark suit the next morning when he arrived at the province's nondescript Saskatoon cabinet office for his first meeting with Mr. Wall. Up until this point, Mr. Wall and his ministers had expressed caution, but little in the way of public dissatisfaction about BHP's offer. They wanted to hear from Mr. Kloppers what he had to say about Canpotex and the province's revenue concerns.

Mr. Wall and his Energy Minister, Bill Boyd, were not smiling when they filed out. The meeting had not gone as well as they expected. At a press conference later that day to announce a by-election, Mr. Wall did not hide his displeasure when reporters asked about the meeting.

The days after the discussions were not good for BHP. Shortly after Mr. Kloppers' visit, the CEO appeared to flip flop on Canpotex by telling reporters in Toronto that it would be "silly" to upset the cartel structure. BHP's apparent attempt to placate Saskatchewan, however, only added to the province's suspicions about the Australian miner's intentions. On Oct. 4, when the Conference Board of Canada released a report commissioned by the province that concluded that BHP's offer posed "minimal risk" to the province, Saskatchewan Energy Minister Bill Boyd came out swinging. Instead of cheering the report, he focused on the dire warning that the takeover proposal could reduce provincial revenues "by at least $2 billion over the next 10 years."

While the government stewed, Potash helped stir up some Prairie populism with a "pledge to Saskatchewan" to return some of its Chicago jobs to Saskatoon, improve its relations with aboriginal communities and step up local philanthropy. Before long, Potash Corp.'s absentee CEO was greeted like a local football hero at one local university rally complete with pom-pom-waving cheerleaders and cheering students.

BHP would have one more chance to win over Mr. Wall and his cabinet. In the third week of October, BHP's Mr. Mackenzie and other senior executives began laying out their detailed plan to address Saskatchewan's revenue concerns. During what one person described as a series of "tense discussions," BHP presented a post-takeover plan for Potash Corp. and BHP's Jansen mine that would preserve the $2-billion in revenue the province feared losing.

What happened next is the subject of an intense debate between BHP and the province. Saskatchewan officials, according to sources, had misgivings about the complex structure of company's plans for Jansen and asked the company for assurances that another $1-billion in revenues would be protected over the decade.

To furious BHP officials the demand was unexpected and unreasonable; they said they had run out of time and money.

Saskatchewan officials insist they were prudently seeking protection for a vital revenue source.

Regardless of who is right, the truth that emerged from the difficult sessions was that trust had been badly damaged between the two sides.

Days after the impasse, Mr. Mackenzie would privately concede: "We didn't grasp how significant potash is to Saskatchewan."

That point was hammered home by Mr. Wall on Oct. 21 during what political observers would later describe as the speech of his political life. Invoking the famous 1904 nationalist cry of Prime Minister Wilfrid Laurier, the impassioned Premier told a packed luncheon audience in Regina that the next century could be Canada's "if we get it right."

Getting it right for Saskatchewan, Mr. Wall said, meant saying no to the acquisition of province's largest resource. "It's a strategic resource and we should act like it. The country should act like it."

The rallying cry left Ottawa with few options. Although Prime Minister Stephen Harper had questioned the parentage of Potash Corp. earlier by highlighting the international addresses of a majority of its shareholders, the reality was that BHP had given his minority Conservative government very little reason to support the deal.

For its part, BHP will not publicly acknowledge having made any glaring mistakes. Privately, a company insider admits that creating the impression Canpotex would be dismantled was the wrong thing to do. That was one of the company's earliest and most damaging missteps, though certainly not the last.

Had the company executed its plan perfectly, there's still a chance the outcome would have been exactly the same, of course. But those errors awoke something that made it easier for the Harper government to say no. By misreading the mood in Saskatchewan, Marius Kloppers missed out on his prize.