Potash Corp. and the waning role of stock options

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Much of the talk about a potential tie-up of Potash Corp. of Saskatchewan Inc. and Agrium Inc. has focused – accurately – on how the two fertilizer companies would be merging from positions of weakness, not strength. All you have to do to realize that is to look at the companies' share prices, particularly Potash Corp.'s.

We can also look at Potash Corp.'s stock options, and how the company has used them, to get a perspective on this deal. Specifically: Did the company's compensation programs incentivize its leaders to push back against a 2010 offer from BHP Billiton Ltd. that now looks like a missed opportunity? And, by contrast, does Potash Corp.'s new pay mix make an Agrium deal look more appealing?

Regular readers may recognize this topic. In October, 2010, I calculated that top executives and board members of the Saskatoon-based company would make more than $700-million from BHP Billiton's offer of a (split-adjusted) $43.33 (U.S.) per share, the bulk of the money coming from the company's stock-option program (click here and here). Then-CEO Bill Doyle stood to make $400-million of that, with two others standing to make more than $100-million if BHP Billiton bumped up its offer.

The riches came because stock options were the primary way Potash Corp. created long-term incentives for its executives – and over the long term, Potash Corp. stock rose 15,000 per cent from 1990 to 2010, goosed in large part by the rise in the price for its namesake commodity.

The BHP Billiton deal ultimately collapsed when Canada's Competition Bureau came to the conclusion that Potash is one of this country's strategic assets. But Mr. Doyle and the company's board argued strongly against the bid on its financial terms, saying that it undervalued the company. Implicitly, at least, they said shareholders would see greater returns if Potash Corp. were left to trade freely on the TSX and New York Stock Exchange.

You might think that such robust payouts would have encouraged the executives to take the money and run. I think the opposite occurred, though: The riches convinced Potash Corp. leaders that the company was an unstoppable wealth-creation machine – and a buyout would cause them to leave even more money on the table.

How much did past performance of Potash Corp. stock – and the hundreds of millions of shareholder wealth it created – influence their view of future results? We may never know. But we do know, with the benefit of hindsight, that while Potash Corp. stock indeed exceeded the BHP Billiton offer through the summer of 2011, the shares are down roughly 70 per cent from their highs on the New York Stock Exchange. (Most company executives get options on the NYSE shares, not the TSX ones.)

That has turned the Potash stock-option story on its head. Wayne Brownlee, the company's chief financial officer and one of those who had stood to make $100-million, now holds just less than a million stock options granted since 2007, nearly all of which are unusable because their exercise prices are higher than Potash Corp.'s current trading price. (To be clear, many of the stock options he held in 2010 remained profitable until their exercise, so I'm not saying that $100-million disappeared. Indeed, from 2011 to 2015 he made $96-million in options profit.)

The other executives named in the Potash proxy have no profit to be seen for any options granted since 2007, which serves as a reminder that the big numbers in the annual proxy statement may not always come to pass. Four of Potash Corp.'s top five executives received stock options from 2013 to 2015 that were valued at $9.2-million at the time. For now, they are completely unusable.

Current CEO Jochen Tilk is the only one without unprofitable stock options – because he has none to begin with. As part of his 2014 employment contract, Mr. Tilk received no options, instead getting his multiyear incentive via a deferred-share plan. It reflects a longer-term philosophical change at Potash Corp., which has been de-emphasizing plain-vanilla stock options for a number of years. First, the company attached cash-flow performance considerations to its stock options; then it shifted the mix this year even further from options toward "performance share units." All this can be seen as a response to the criticism Potash Corp. received for its past plans: Executives were getting rewarded more for the rise in the price of the commodity the company mined, rather than for any particular brilliance in running the enterprise.

However, even if the new compensation plans better align the executive with shareholders, they may also offer less incentive for company leadership to fight a deal that would see Potash Corp. acquired. At this juncture, the talk of a "merger of equals" may suggest a stock-swap combination that allows the executives to retain their stock options, but we will need to see the terms of whatever deal emerges. With so many underwater stock options, today at Potash Corp. there's just a fraction of the past wealth-building, and the path to future millions isn't so clear at all.

Which, come to think of it, applies to the common shareholders of Potash Corp. as well. That suggests there may be a lot less interest than there was in 2010 in having the company go it alone.