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What Chance A BHP Buyback?

Oh Canada. While sovereign takeover rejections should come as no surprise to Australians who've had to deal with a few now, it did come as some surprise to analysts that the Canadian government has quite emphatically rejected BHP Billiton's ((BHP)) bid for the Potash Corporation of Saskatchewan. BHP has a month to go back and think about it, but no details of the specific rejection criteria were released. The deal was simply deemed to be “not in Canada's benefit”. The local market, however, was much relieved. The 2.5% share price jump yesterday shows just how unpopular the Potash deal is to BHP fans who are worried the Big Australian will overstretch and over-risk an otherwise healthy balance sheet by investing in what is ostensibly for BHP a whole new market. (BHP currently owns potash assets next door in Saskatchewan at Jansen, but they are greenfield). The Potash board had already summarily rejected BHP's bid as too low, and followed the rejection up with a very strong quarterly earnings result. The risk was always going to be BHP would really have to pay up to gain control of Potash, and maybe even raise some new capital to do so. But there is a double-whammy effect as well. If BHP abandons Potash, on the assumption no amount of concessions will appease a Canadian government which is worried about local jobs and local royalties (BHP can offset its Jansen development costs against Potash earnings and thus avoid paying royalties to the state of Saskatchewan), then the market is assuming a 10% share buyback which would be about equivalently accretive for earnings per share. BHP provided a buyback hint earlier when it renewed its buyback authority at the UK AGM. However, while analysts have done the numbers on a buyback and agree that it would be a strong positive for BHP shareholders, they are not necessarily convinced that's exactly what Marius Kloppers will decide to do instead. Kloppers has clearly signaled an intention to buy rather than buy back. Firstly, analysts assume the Potash deal is far from dead, albeit we don't know whether the exact criteria of the Canadian government rejection make any sort of deal a waste of time putting forward. It's only an initial rejection nevertheless, so one assumes Canada has given BHP some specific sticking points to address and a deal may yet be given the green light. But assuming BHP ultimately gives up on either a too hard basis, or on the basis it's not prepared to pay the sort of price Potash shareholders ultimately require, then Marius will be like a kid with his pocket money in a lolly shop where the cobbers have run out. With temptation all around, what else might suffice? Analysts believe there is a very good chance that BHP will either not instigate a buyback or buy back less than 10% on the basis the excess cash on the balance sheet can be better used – at least in the board's eyes. If fertiliser is too hard, and aluminium and nickel are none too attractive, that leaves only copper and oil. There's not much point in pursuing coal and iron ore, analysts note, given BHP will always run into rejections on the basis of reduced competition. New copper projects are very thin on the ground these days, so that really just leaves oil. That's why a couple of brokers are tipping a Gulf of Mexico acquisition might replace an abandoned Potash bid rather than a straight buyback. The only risk here is that BHP baulks at getting too overweight in oil assets. Potash, after all, was all about diversification. So the jury's still out. We have to wait a month to see what BHP comes back with and wait to see what the Canadian government then does. If we assume approval, we have to then see what price BHP is prepared to jump to as its final offer for Potash and at what price Potash shareholders are tempted. Assuming final rejection, we then have to wait and see whether BHP has a Plan B acquisition already on the cards, or will regroup to consider a Plan B, or will sit on its cash and wait until another appealing target pops up, or whether it simply gives the excess cash back to shareholders by buying back stock as the market is clearly hoping. All the while, we have to consider whether or not BHP was fairly valued ahead of any Potash consideration, particularly given some uncertainty over immediate Chinese iron ore demand, general coal demand (which was quite weak last month according to the trade balance numbers), and of course the headwind of an Aussie dollar now above parity with a bullet. Of the eight FNArena database brokers, five are maintaining Buy ratings while two look at already hefty multiples and have settled on Hold. One (BA-Merrill Lynch) is restricted which means it is advising on the Potash deal. The consensus target for BHP is $49.37 which is 9.5% above the current trading price. By Greg Peel.