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Privatization of Pak Saudi fertilizer

Fauji offers an attractive price for Pak Saudi Fertilizer buy out

Mar 18 - 24, 2002

Finally, the suspense has come to an end regarding the divestment of 90 per cent GoP shares in Pak Saudi Fertilizer Company Limited (PSFL). Fauji Fertilizer Company ((FFC) submitted the highest bid of Rs 135.63 per share. For 54 million shares, this translates into Rs 7.334 billion. The most surprising aspect of this entire episode was the difference between the bids placed by other companies. While Engro Chemical offered Rs 66.7, per share the bid by Dawood Hercules was marginally higher at Rs 70 per share. The immediate question which haunts many analysts is, how could the various financial advisors on the buy side have such divergent views?

According to a report by IP Securities, "Pak Saudi's acquisition has been an overall positive development for FFC shareholders." In case the company had set up a new fertilizer plant, it would roughly cost US$ 400 million, which translates into Rs 24 billion. Profit generation from such a plant would have been there after a gestation period of 6 to 7 years. As compared to this, acquisition of PSFL has cost FFC only Rs 7.3 billion, with profit from 'next day'. PSFL plant is said to be a 'replica' of FFC-1 which is likely to lead to technical efficiencies.

PSFL's plant efficiency can be improved by about 25 per cent and efforts for improvement can be initiated immediately. This has the potential to enhance present annual production capacity of 557,000 tonnes to approximately 700,000 tonnes. Apart from this PSFL capacity can be doubled, in line with what FFC and Engro undertook in 1993.

The other question is, how FFC is going to square this transaction? According to a report by KASB, the company has short-term investments and cash of around Rs 5.8 billion as well as long-term investment in US Bonds, PIBs and National Saving Certificates of around Rs 2.5 billion. Therefore, FFC is not likely to raise funds through equity. It is expected to finance this transaction partly by raising debt and partly from its cash and investment. The company is expected to borrow approximately Rs 5 billion at 13 per cent per annum interest.

PSFL is expected to be merged with FFC by the end of year 2002. Another point of view is that additional debt servicing due to acquisition of PSFL will be met from the income of the purchased entity. FFC is expected to gain in year 2002 due to investment tax credit in absolute terms thus resulting in reduction in effective tax rate of the company in the following years.

Although urea sales in general are likely to be affected by the ongoing drought, FFC will be better placed as compared to other players. It is reported that water situation is much better in the Punjab, the main market for FFC. Moreover, with the acquisition of PSFL, the company will effectively control half the Pakistan urea market. It is quite possible that FFC will not only try to increase price of its popular brand but may also endeavour for urea export to regional markets, particularly Afghanistan.

According to the another report, despite the apparent expensive nature of the transaction, impact of the acquisition is likely to be only marginal in next two to three years. It is because FFC is getting almost 47 per cent of its feedstock at a fixed rate of Rs 11.25/kcf as per agreement. This agreement is likely to expire in October 2003, after which FFC is likely to get feedstock at floating rate of Rs 56.8/kcf. Thus the full impact will only be visible in year 2004. In such a scenario, FFC was previously set to experience a substantial decline in profitability. However, the acquisition of PSFL is expected to mitigate a decline in profitability going forward.

Some analysts may feel that since FFC is bound to pay Rs 10 billion and going to raise its debt, its dividend paying ability may be reduced. Whereas others believe that FFC is a strong company and acquisition of PSFL will further consolidate its financial position. The company will still be able to pay 70 to 80 per cent dividend payout.

However, a million dollar question remains, how the losses of FFC-Jordan can be minimized? FFC-Jordan has been a thorn and despite closure of DAP production unit, the legacy of incurring losses may continue. The efforts to ensure profitability of DAP unit by asking the GoP to impose regulatory duty on imported commodity has aborted, this led to closure of unit. The next probable attempt by FFC could be to monopolize DAP trade by importing the commodity from its joint venture partner.

Though, the country faces a temporary surplus supply of urea, the existing players have to expand the available capacity in the country. It will be interesting to watch how Engro and Dawood come up with their new strategy. The probability is that Engro will try to emulate what it had done in nineties, bringing in a second hand plant.