FFC knows bigger is better

The Faujis do not really like competitors inching close to them. Fauji Fertilizer Company - the countrys fertilizer industry giant - has finally stamped the confirmation on the month-old rumour that the company is acquiring Azgard Nines share in Agritech, a relatively small fertilizer manufacturer.
Such is FFCs reputation that the firms notice to the bourse sent Agritechs share near its upper circuit breaker yesterday, depicting the confidence the investors have in the FFCs management of the to-be-acquired entity.
How much would FFC pay for Agritech is the latest buzz in the market which would continue for some time till the dust eventually settles. Views amongst analysts are split at extreme ends with some expecting the deal to be struck at Rs20/share, while others see it being locked at Rs30/share.
There seems to be logic in the viewpoint that FFC may not be offering more than Rs 22-24/share, given Agritechs lacklustre performance at the KSE and ANLs bargaining power which seems to be on the weak side.
Bear in mind that Agritechs plant has a post-expansion production capacity of 0.49 million tons per annum - FFC, is nearly five times the size of Agritech. The balance sheet, however, is nearly as big as FFCs though, which comes as a surprise for a company one-fifth in size.
But, bigger is not always better, as the Agritech balance sheet is not the cleanest. Unlike the balance sheet of the acquirer, Agritechs balance sheet is burdened with high-leverage. Agritech is expected to be carrying a debt as high as Rs19 billion at the moment, when compared to the FFC, which has less than half of it, both long-term and short-term borrowings combined.
It naturally makes Agritechs debt-to-equity ratio quite bad at 2.2 and is all set to take FFCs debt-to-equity ratio on the higher side, irrespective of the mode of financing that the FFC adopts. How will FFC finance the transaction, is the next big question. For sure it will not be through internal cash generation as FFC does not have enough cash balance at the moment.
And it is least likely that FFC would cut down on its traditional high dividend payout as payout remains the pinnacle of the companys policy. Fauji Foundations big stake in FFC may also play a part in FFC continuing with its high dividend stream in the future - so any concerns amongst the shareholders regarding the dividend yield should lay to rest.
Market voices believe that the financing would be a mix of right issue and long-term financing, both of which should be easy for a company of FFCs repute to generate Rs6-8 billion.
Why the deal then one may ask. It is all about the pie. FFC has always had the lions share in the pie and it obviously wants to continue it as Engro has threatened to nearly match FFCs market share with its billion dollar plant expansion.
Managers at FFC probably know it best that in times of oversupply, which are as near as 2011, market size and pricing power will matter, which apparently seems the major motive behind the deal. The margins might be depressed in the initial phase, but FFC seems to have struck the right deal just at the right time.

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PRE ACQUISITION                POST ACQUISITION

             mn tons   share    mn tons   share

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FFC           2.4       35%       2.89      42%

Engro        2.28       33%       2.28      33%

FFBL         0.55       8%        0.55       8%

PFL          0.11       2%        0.11       2%

Fatima        0.5       7%         0.5       7%

Agritech     0.49       7%           0       0%

DAWH         0.48       7%        0.48       7%

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Source: NFDC, BR Research