Hard work going against the GrainCorp

GrainCorp's rejection of the revised takeover proposal from Archer Daniels Midland puts the ball back in its suitor's court and realistically leaves ADM with three options.

The US agri-giant could continue to try to convince GrainCorp to engage by again sweetening the proposal, it could launch a hostile offer or it could do as it has threatened since it emerged on GrainCorp's register and wait for however long it takes its target to stumble.

GrainCorp's stance wasn't unexpected. It had rejected the original $11.75 a share approach on the basis that it materially undervalued its shares and a 3.8 per cent increase in the proposed offer, to $12.20 a share, was never going to be regarded by its board as a material increase.

The only issue was the tactical one of whether engagement, which means providing ADM access to due diligence, might encourage ADM to put something on the table that was within the board's ballpark of perceived value. Obviously GrainCorp decided ADM's indicative price wasn't close enough to its own view of value to open its books.

It said today that the increase in the proposed price had not changed the board's view that ADM's proposal materially undervalued the company, whose shares have been trading above $12.30. The market, using earnings multiples drawn from comparable transactions in the sector, thinks GrainCorp's value is closer to $13 a share than $12 a share.

There are differing views between the two camps about the worth of using those comparable transactions as benchmarks.

ADM believes GrainCorp is a much more cyclical company than its northern hemisphere counterparts while GrainCorp, experiencing a bumper grain crop, believes that the growth in its processing activities to the point where they constitute about half its business will muffle any cyclicality.

There is, however, little doubt that if some of those recent offshore agribusiness deals were used as a guide to value, GrainCorp would be worth considerably more than $12.20 a share, providing a reasonable basis for GrainCorp's stance. There is also the tactical consideration that ADM would have to again bid against itself to get access to due diligence. Why give it access, and lose negotiating leverage, unless its indicative price is close to GrainCorp's own view of value?

ADM is, however, sitting on just under 20 per cent of GrainCorp and has foreshadowed an offer that would have a minimum acceptance condition of only 50.1 per cent. It could go hostile and mount an offer without a recommendation, counting on hedge fund activity to help deliver momentum and ultimately control.

Whether it would be prepared to do that and spend at least $1.5 billion and possibly $3 billion without the comfort of due diligence is a key question. It would also be aware that there are plenty of GrainCorp shareholders who share their board's conviction that GrainCorp is a lot more valuable than the prices ADM has so far indicated it would be willing to pay.

Apart its earnings prospects, GrainCorp is the last available large slab of southern hemisphere exposure to agribusiness, which is valuable for a northern hemisphere group trying to diversify its exposure to weather and gain a platform closer to the growth markets in Asia.

The ADM shareholding in GrainCorp does give it the option of waiting. It knows that it has almost certainly shut out any prospective competitor.

It also knows that while GrainCorp is expected to produce another stellar result this financial year the 2013-14 results will have to be built on a weaker contribution from its grain handling and marketing businesses and therefore its target might be more vulnerable, and perhaps cheaper, in 18 months to two years' time than it is today.

Waiting would, of course, given Alison Watkins and her team time to demonstrate that GrainCorp, which made a major expansion into edible oils this year and which also has a four-year business improvement program underway that is designed to add another $110 million of earnings over the next four years, is a different and less cyclical and volatile group today than it might have been in the past. She might even make a few more acquisitions.

GrainCorp hasn't completely slammed the door in ADM's face, saying that it would be "constructive" in any dealings in relation to proposals that had the potential to be in the best interests of shareholders.

While it might be said cynically that "they would say that" to give the appearance of being prepared to cooperate, Watkins and her board are pragmatic and if ADM shows a willingness to put a price they can't ignore on the table it is improbable the response would be anything other than receptive. If it doesn't, and isn't willing to launch a hostile offer without access to GrainCorp's books, then the stand-off could well be protracted.