Anatomy of a Deal’s Collapse

In a blow for one of Australian Edge’s original “Eight Income Wonders from Down Under,” late last week the Australian government decided to reject Archer Daniels Midland Co’s (NYSE: ADM) AUD3.2 billion bid to acquire GrainCorp Ltd (ASX: GNC, OTC: GRCLF). The deal had included an offer of AUD12.20 per share plus AUD1 per share in a one-time special dividend.

This outcome wasn’t entirely a surprise at this point, as it had been telegraphed a couple weeks prior in a report by The West Australian that we detailed last issue. The Coalition government has been on the receiving end of substantial lobbying from its Nationals contingent to quash the deal, so much so that Treasurer Joe Hockey had previously said he would not be “bullied” into making a decision by this cohort.

But politics clearly prevailed anyway, even if they didn’t figure into the government’s explanation of its rationale for spurning ADM. Mr. Hockey asserted that the acquisition would have been “contrary to the national interest” because it would give a foreign company control over a significant portion of eastern Australia’s bulk grains market. The treasurer noted that GrainCorp’s network handles approximately 85 percent of this trade via its ownership of 280 up-country storage sites and seven grain port terminals.

The government said that the industry is still in a transitional phase since its 2008 deregulation, and industry participants were concerned that the acquisition could impede their access to markets since GrainCorp’s network currently has few competitors.

Beyond that, Mr. Hockey was mindful that the concerns about the deal in some corners could undermine support for future foreign investment more generally should the bid have been approved. Though the government had the power to impose additional conditions on ADM to allay its concerns, it chose not to do so, as it worried it might set a bad precedent for the industry.

Interestingly, Mr. Hockey said that he would be inclined to approve any moves by ADM to increase its current stake in GrainCorp from 19.85 percent of shares outstanding to as much as 24.9 percent. The wording of this portion of the government’s statement seemed to suggest that it might not be opposed to a similar bid down the road, once the industry develops further, and ADM makes inroads among the constituencies that opposed this deal:

“This would also provide a platform for ADM to build stakeholder support for potentially greater participation in the Australian industry as it develops.”

To that end, ADM has indicated that it intends to be involved in the Australian market for the long term and is considering enlarging its stake, though it has no definitive plans to do so yet. Australia’s rules would permit ADM to purchase an additional 3 percent stake every six months up to the aforementioned threshold. ADM also said that there still might be ways for it to partner with GrainCorp in the future.

Such a partnership could prove particularly helpful, since the acquisition would have provided the financial infusion necessary for GrainCorp to upgrade key infrastructure, such as rails. Management has acknowledged that without ADM’s superior financial backing, its growth will occur at a slower pace as it deploys its own capital toward upgrades while rationalizing its storage and logistics division.

Even so, ADM’s substantial stake and influence on the board means that GrainCorp’s former suitor should still be incentivized to do what it takes to ensure its investment proves to be a profitable one. But it remains to be seen what form its support or any partnership will take.

In the meantime, GrainCorp’s executive suite was rocked by additional drama this week, as CEO Alison Watkins resigned in the wake of the deal’s collapse. She had been at the helm for the past three years and will leave the firm at the end of January to run Coca-Cola Amatil Ltd (ASX: CCL, OTC: CCLAF). Chairman Don Taylor will fulfill the executive role while the firm seeks internal and external candidates to become the next CEO.

GrainCorp’s shares are down about 34.5 percent since their trailing-year high in late April. But they’re still up 87.7 percent, including the reinvestment of dividends, since we initially recommended the stock in September 2011. The shares currently trade near AUD8.40 for a net yield of 5.4 percent.

While we would have certainly been pleased to book the gains from the acquisition’s consummation, and we’re not enjoying the sharp selloff since it unraveled, it does gives us the opportunity to continue compounding our wealth over the long term from a steady dividend payer that’s leveraged to growth in emerging Asia.