CSR's sugary play status

CSR's update on its proposed demerger of its sugar and building materials businesses is as significant for what it didn't announce as what it did.

When CSR originally unveiled the plan in June, one of the options – and one pursued – was to search for a cornerstone investor for the sugar business or even an outright buyer.

Instead it has opted for a relatively clean and straightforward demerger to CSR's existing shareholders, along with a $375 million underwritten entitlement issue to ensure both entities start their new lives with reasonable balance sheets.

The wrinkle in the structure adopted is that CSR is introducing a substantial shareholder into the sugar business by issuing sufficient equity in the new sugar entity to give Queensland co-operative, Mackay Sugar , an 8.77 per cent stake in exchange for Mackay's 25 per cent interest their sugar refining joint venture.

Mackay, which will have to hold the stake for at least 12 months but can't add to it during that time, probably isn't big enough to harbour predatory intentions. It is swapping a minority and illiquid interest for something it can subsequently monetise, while the sugar entity will get access to 100 per cent of the joint venture's cash flows.

It wasn't that CSR didn't attract any expressions of interest from trade buyers and prospective investors in the sugar spin-off. It did. The complication was the difficulty in valuing a strategic stake or outright sale in today's uncertain times and the uncertainty that would have been created by the need for regulatory approvals.

The neater path is to give CSR shareholders ownership of the sugar business, let the market establish a benchmark value and then, if there are predators, it will be easier to determine the business' strategic value.

The other big decision CSR made was to conduct a capital raising ahead of the demerger rather than as part of the demerger process. The market conditions, with equity readily available, made that decision relatively straightforward. CSR needed to raise new equity at some point because the demerger will, by separating two cyclical but very different groups of business, make it a much less diversified group.

The combined debt of the group will be reduced from more than $1.2 billion to about $930 million and the deal with Mackay Sugar ought to keep CSR's bankers and the credit rating agencies onside. About $300 million of the debt is earmarked for the sugar entity and the remaining $631 million for the building products group.

CSR is pursuing the demerger because it believes the market will reward it by attributing more combined value to the pure plays than to the current structure. A parting of the ways will also allow each group to pursue opportunities within their own sector – the latest flurry of consolidation and speculation within the building products and materials sector in particular creates an opportunity for CSR to either be a consolidator or to be consolidated.

The timing is also right for spinning off the sugar business, with sugar prices and the business' earnings surging.

As a low-cost producer of sugar, with a big exposure to ethanol production and renewable through the co-generation capacity of its refineries, CSR is well-positioned to take advantage of the long-term outlook for a market supported by demand from emerging economies but where the supply is constrained by the removal of export subsidies in the European Union and the diversion of production from sugar to ethanol in Brazil.

Droughts in India and floods in Brazil also support the near term outlook, although the spike in the Australian dollar and CSR's own hedging activities may blunt their impact.

More broadly, while agribusinesses are inherently volatile, the recent burst of activity in this market and elsewhere (ABB, Graincorp and Nufarm in this market) reflects global consolidation as the big agribusinesses seek global diversification of supply and position themselves for the increased demand as China, India and other rapidly emerging economies shift up the food curve.

That, and its pure play status, ought to create a strategic premium for the sugar business. The building products business, with its attached asbestos liabilities, isn't as sexy but it is one of the major players in a market where the long-term outlook is probably supported by the general consensus that there needs to be a significant increase in the rate at which new housing stock is developed to accommodate the swelling population.