The Failed Acquisition of Graincorp by ADM

Masterarbeit, 2014

89 Seiten, Note: 1,3


I. Table of Contents

II. List of Abbreviations

III. List of Tables

IV. List of Figures

V. List of Appendices

1. Introduction

2. Deal Description
2.1 Timeline of Events
2.2 Company Analysis
2.2.1 GrainCorp
2.2.2 ADM
2.3 Industry Analysis
2.3.1 Overview
2.3.2 Supply & Demand
2.3.3 Grain Handling
2.3.4 Grain Trading
2.3.5 Malting
2.3.6 Oilseed Processing
2.4 Strategic rationale

3. Multiple Valuation
3.1 Trading Multiples
3.1.1 Calculation of Multiples
3.1.2 Discussion of Results
3.2 Transaction Multiples

4. DCF Valuation
4.1 Financial Forecast
4.1.1 Segments
4.1.2 Other Income Statement and Balance Sheet Items
4.2 Weighted Average Cost of Capital
4.2.1 Cost of Equity
4.2.2 Cost of Debt
4.3 Value of Franking Credits
4.4 Synergies
4.5 Calculations and Discussion of Results

5. Event Study
5.1 Event Study Set-Up
5.2 Discussion of Results

6. Conclusion

VI. Appendix

VII. List of References

II. List of Abbreviations

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III. List of Tables

Table 1: GrainCorp Sales and EBITDA Split by Segment (GrainCorp 2012e)

Table 2: ADM Sales and EBIT Split by Segment (AMD 2013c)

Table 3: Summary of the Trading Multiples Valuation

Table 4: Summary of the Transaction Multiples Valuation

Table 5: Key Value Drivers for the S&L and Marketing Segment

Table 6: Storage & Logistics Forecast

Table 7: Marketing Forecast

Table 8: Malt Forecast

Table 9: Oils Forecast

Table 10: Valuation of Synergies

Table 11: Results DCF Valuation

Table 12: Test Statistics for the 1st Event Window (A)

Table 13: Test Statistics for the 2nd Event Window (B)

Table 14: Test Statistics for the 3rd Event Window (C)

Table 15: Test Statistics for the 4th Event Window (D)

Table 16: Test Statistics for the 5th Event Window (E)

Table 17: Test Statistics for the 6th and 7th Event Window (F)&(G)

Table 18: Test Statistics for the 8th Event Window (H)

Table 19: Wealth Effects on the Different Event Days

IV. List of Figures

Figure 1: Implied Success Probability of the Transaction

Figure 2: Industry Consolidation Map (Deutsche Bank 2011)

Figure 3: GrainCorp's Business Model (GrainCorp 2012d)

Figure 4: Food Demand Growth 2012-2050 (Alexandratos and Bruinsma 2012)

Figure 5: Eastern Australian Crop Yield and Area Harvested (ABS 2013)

Figure 6: 1-Year Forward EV/EBITDA Multiples

Figure 7: GrainCorp's Valuation Range (in AUD per Share)

Figure 8: CARs from Day -20 to Day 292

V. List of Appendices

Appendix 1: Timeline of Events

Appendix 2: Indexed Share Price and Commodity Price Development (in USD)

Appendix 3: Australian Bulk Handlers

Appendix 4: East Coast Bulk Ports

Appendix 5: Capacity and Market Share of Top 10 Maltsters

Appendix 6: Impact of Global Warming on Agricultural Output

Appendix 7: Beer Consumption Forecast - CAGR 2012-2016

Appendix 8: Oilseeds and Oilseed Products Prices

Appendix 9: Vegetable Oil Consumption Growth Rates

Appendix 10: Peer Group Characteristics

Appendix 11: 1-Year Forward EV/EBIT Multiples

Appendix 12: 1-Year Forward P/E Ratio

Appendix 13: Sensitivity Table: EV/EBITDA (With Discount)

Appendix 14: Sensitivity Table: EV/EBIT (With Discount)

Appendix 15: Sensitivity Table: P/E Ratio (With Discount)

Appendix 16: List of Historical Transactions

Appendix 17: Regression: Crop Production - Market Share

Appendix 18: Regression: Crop Production - Grain Exports

Appendix 19: Regression: Grain Production - Grain Received at Ports

Appendix 20: Regression: Throughput - Operating Costs

Appendix 21: Regression: Crop Production - Grain Traded

Appendix 22: Contribution of Earnings Growth Initiatives

Appendix 23: Regression: Grain Traded - Inventories

Appendix 24: Income Statement

Appendix 25: Balance Sheet Ratios

Appendix 26: Balance Sheet

Appendix 27: Threshold Margin

Appendix 28: GrainCorp's ROIC and WACC

Appendix 29: Sensitivity Table: Terminal Growth Rate - WACC

Appendix 30: Sensitivity Table: EV/EBITDA Exit Multiple - WACC

Appendix 31: Sensitivity Table: EBIT margin - WACC

Appendix 32: Results of Event Study with STOXX 1800 Food & Beverages as Market Index

Appendix 33: T-Test

Appendix 34: Rank-Test (Corrado 1989)

Appendix 35: Adjusted Standardized Cross-Section Test (Kolari and Pynonnen 2010)

Appendix 36: Generalized Rank Test (Kolari and Pynonnen 2011)

Appendix 37: Table of Contents for Data Archive

1. Introduction

At the top of a merger wave in the agriculture industry, Archer Daniels Midland (ADM) made an unsolicited offer to the board of GrainCorp, an Australian grain handling and processing company. The rejection of this first offer by GrainCorp’s board induced ADM to make a second bid, which also got rejected. Six months later, on 26 April 2013, the two companies entered into an implementation deed and GrainCorp’s board backed ADM’s third offer, which included a 49% premium over the last closing price before the bid announcement (ADM 2013a). However, seven months later, the Foreign Investment Revision Board (FIRB), under the leadership of Treasury Secretary Joe Hockey, rejected the takeover on national interest grounds (Hockey 2013).

This master thesis aims to give a comprehensive analysis of this rejected transaction with a focus on three research questions. The first question is whether the strategic rationale behind the takeover did make sense economically. The second question concerns the fairness of the offer price that GrainCorp shareholders would have received, while the third question examines the stock market reaction of GrainCorp, ADM, and their competitors.

To determine the strategic fit of GrainCorp for ADM, this thesis analyzes both companies and the industry in which they operate, using publicly available information provided by the companies themselves and other sources such as analyst reports.

The fairness of the offer is determined both via a multiple valuation and via a discounted cash flow (DCF) valuation. Both valuation methods are conducted from an ex ante view and the valuation date is the 19 October 2012, which is the last trading day before the offer announcement. The multiple valuation can be divided into trading multiples and transaction multiples. All required data about share prices as well as income statement and balance sheet items for the trading multiples is retrieved from Bloomberg and cross-checked with data from published annual reports. For the calculation of the forward multiples, Bloomberg’s “BEst” median consensus of broker estimates is used. The calculated multiples are all adjusted for the value of management options, operating leases, extraordinary items, and cross-holdings to ensure the comparability between firms. The data on historical transactions in the agricultural sector is taken from Thomson Reuter’s SDC Platinum database. If necessary, the multiples are adjusted to a normal crop size to increase the validity of the analysis. The forecast of cash flows for the DCF valuation is based on the industry and company analysis and focuses on the key value drivers for each of the company’s four segments.

Share price and index data for the event study is retrieved from Datastream. For the individual evaluation of abnormal returns (AR) and cumulative abnormal returns (CAR) of ADM and GrainCorp, both the standard t-test and Corrado’s (1989) rank test are used. For the group of competitors, this thesis uses the parametric test proposed by Kolari and Pynonnen (2010), which adjusts for both event induced variance increases and cross-sectional correlation due to event window clustering, as well as the generalized rank test, also proposed by Kolari and Pynonnen (2011).

This thesis is structured into six chapters, including the introduction. The second chapter contains the analysis of the takeover, starting with a description of the timeline of events. It is followed by the company and industry analysis, which serve as the foundation for the evaluation of the strategic rationale in section 2.4. The third chapter deals with a relative valuation of GrainCorp using both trading and transaction multiples, with a focus on EV/EBITDA, EV/EBIT and P/E multiples. The fourth chapter comprises the DCF valuation based on a detailed forecast of GrainCorp’s financial statements on the segment level. After the valuation is complete, the fifth chapter examines the effects of different events during the transaction process on the share prices of GrainCorp, ADM, and their competitors via an event study. Overall, eight different events are analyzed. The last chapter briefly summarizes the results of this thesis and discusses the limitations of the valuation and the event study performed in the previous chapters.

It is concluded that the rejection of the takeover was not based on economic reasoning and hence, rather was a political decision. Further, ADM had good economic reasons for the takeover of GrainCorp, as the company could operate GrainCorp’s assets more profitably. Additionally, the multiple and DCF valuation suggest that the fair value of GrainCorp lies between AUD 12.00 and AUD 13.50 per share. ADM’s first offer was AUD 11.75 and therefore slightly below this threshold. Both the second and third offer lie within this range and thus, can be considered as fair. As expected, the announcement of the first, second and third bid had significant positive effects on GrainCorp’s share price. For ADM, investor sentiment about the takeover changed during the process. While the company experienced negative abnormal returns after the first bid, there was no significant impact after the second bid, and the third bid resulted in positive ARs. This is unusual, as investor’s perception about the value of the takeover increased with the price ADM was offering. When the deal got rejected, both companies experienced large negative abnormal returns, reversing previous positive ARs. For the competitors, there was no significant and consistent reaction to the different event dates detectable.

2. Deal Description

This Chapter is divided into four sections. The first one describes the key events of the transaction. The second section examines the companies involved in the transaction while the third one analyzes the market in which these two companies operate. Based on this information, section 2.4 then evaluates whether the takeover made sense from a strategic point of view.

2.1 Timeline of Events

After a series of large acquisitions in the grain trading industry in early 2012, i.e. Glencore’s CAD 6.1 bn takeover of Viterra (FT 20.03.2012a) and Marubeni’s acquisition of Gavilon for USD 3.6 bn (WSJ Online, 29.05.2012), GrainCorp was first named as a potential takeover target by the press in March 2012 (FT 20.03.2012b). ADM started buying GrainCorp stocks in June 2012 via a cash settled total return swap until it reached an ownership stake of 4.9%, the maximum allowed without the obligation to declare itself as a substantial shareholder (Financial Review, 04.12.2012). This approach enabled it to conceal its intention to investors by bypassing the Hart-Scott-Rodino anti-trust provision of the U.S. Department of Justice (DOJ), which requires the approval to own more than USD 68.2 m worth of stock in another company (Federal Trade Commission 2012). On the night before the 19 October 2012, ADM managed to buy an additional 10% of the share capital in a private block trade with two of GrainCorp’s largest shareholders, Ellerston Capital and AMP, for AUD 11.75 per share (ADM 2012a). As a result of ADM’s disclosure of its 14.9% stake, GrainCorp requested a trading halt until 23 October 2012, which was granted by the ASX, but only for one day (GrainCorp 2012a). On Monday, 22 October, ADM approached GrainCorp’s board with an unsolicited offer of AUD 11.75 per share, which represented a 33% premium over the last closing price of AUD 8.85 (Financial Review, 29.11.2013).

ADM’s strategy to buy a toehold in the company served two major purposes. First, it reduced the free-rider problem with atomistic shareholders (Shleifer and Vishny 1986), and second, it reduced the probability of a bidding war, as other companies supposedly were also interested in GrainCorp (J.P. Morgan 2012). On 15 November, GrainCorp’s board rejected the offer, stating that it “materially undervalues GrainCorp” (GrainCorp 2012b). After an approval from the FIRB, ADM then further increased its stake in GrainCorp to 19.9% in the evening of 3 December (ADM 2012b). This stake effectively blocked the prospect of a scheme of arrangement or a full takeover from a second bidder (Financial Review 04.12.2012). On the next day, ADM made an improved non-binding offer at AUD 12.20 per share (ADM 2012b). This offer was also rejected by GrainCorp’s board on 13 December, arguing that the offer still materially undervalued the company (GrainCorp 2012c).

This rejection lead to a discussion between different shareholder groups of GrainCorp. Ashok Jacob, head of institutional investor Ellerston Capital, condemned the Board’s decision, arguing that shareholders should have the final say on the takeover. As a result, Ellerston sold its remaining stake in GrainCorp (FarmOnline 17.12.2012). On the other hand, GrainCorp’s largest individual shareholder, Don Seaton, was strictly against any takeover by a foreign entity. As former owner of Gardner Smith, he only became a shareholder after the completion of the takeover of the company by GrainCorp on 2 October 2012, stating that he would not have sold his firm to GrainCorp had he known of the transaction with ADM before (The Sydney Morning Herald 05.10.2013). The concerns about foreign control of key Australian infrastructure assets was also fiercely discussed in public, especially local east coast farmers and members of the National Party of Australia were strictly opposed to the transaction.

On 26 April 2013, GrainCorp and ADM entered into a takeover implementation deed under which ADM would make an off-market takeover offer of AUD 13.20 per share, under the condition of a successfully completed confirmatory due diligence (GrainCorp 2013a). In case the bid proceeded, all GrainCorp board members committed to recommend the offer on the condition that an independent third party determined that the offer price was fair, that all regulatory conditions had been satisfied until 31 December 2013, and that there was no superior offer. The consideration consisted of AUD 12.20 per share in cash and a special fully franked dividend by GrainCorp of AUD 1.00 to be paid before the completion of the transaction. By shifting some part of the consideration to a special fully franked dividend, ADM was able to increase the value of the bid to domestic shareholders beyond the AUD 13.20 without the need to pay more, as these domestic investors receive franking credits from the full dividend imputation tax system that they can use to offset personal income tax liabilities. The offer price represented a 49% premium over the last trading price prior to the initial proposal. Additionally, shareholders would receive an extra dividend of 3.5 cents for each month after 1 October 2013 during which the regulatory approvals would not have been achieved (GrainCorp 2013a). After successfully finishing the due diligence on 2 May 2013, ADM announced its offer of AUD 13.20 per share, subject to a minimal acceptance rate of 50.1%, all necessary regulatory approvals, and no prescribed occurrences (GrainCorp 2013b). After the fairness opinion yielded a positive result, GrainCorp’s board formally recommended ADM’s offer to its shareholders on 24 June 2013 (GrainCorp 2013c).

Three days later, the Australian Competition and Consumer Commission (ACCC) approved the transaction, stating that the takeover “was unlikely to result in a substantial lessening of competition in any market” (ACCC 2013). However, public sentiment about the transaction worsened over time and a Senate committee even recommended to the ACCC to reopen its probe (Financial Review 29.11.2013). After the victory of the center-right coalition, including the National Party that opposed the transaction, in the general election on 7 September 2013, the new Treasurer Joe Hockey, who presided over the FIRB, announced that the decision about GrainCorp would be delayed due to the size and complexity of the transaction (Financial Review 29.11.2013). In a last try to convince both farmers and the FIRB of the takeover, ADM announced a package of enhanced commitments, including additional capital expenditure of AUD 200 m, price caps on grain handling charges, guaranteed access for growers and third parties to all infrastructure, including ports, as well as the establishment of a grower and community advisory board (ADM 2013b).

However, these commitments were not enough, as three days later, on 29 November 2013, Treasurer Hockey declared that he prohibited the transaction on the basis of the Foreign Acquisitions and Takeovers Act of 1975 due to national interest reasons, but he left the door open for a 24.9% interest in GrainCorp (Hockey 2013). He stated growers’ concerns about reduced competition and the risk of undermining public support for foreign investments as his main arguments. However, by looking at the economic facts, it becomes clear that this was a pure political decision. As the ACCC (2013) stated, GrainCorp and ADM did not have significant horizontal overlaps in their operations. Hence, a merger could not have increased the market power of the combined firm and reduced competition. Furthermore, the access to GrainCorp’s port terminals had already been regulated by the ACCC, which would have continued to be the case after the transaction. Therefore, the fear of the opponents seemed to be unfounded (for a summary of the events, see Appendix 1).

Figure 1 shows the impact of the events discussed above on the implied success probability of the takeover.[1] The fact that p > 100% until mid-March of 2013 illustrates that the market expected a higher offer by ADM or a third party and therefore, the shares traded above the bid price. Moreover, the success probability is steadily decreasing as the market’s skepticism about a completion was increasing with time. However, it is surprising that until one week before the rejection of the takeover, the market still expected the transaction to be completed with a probability of approximately 80%. This optimistic view is supported by equity research analysts’ opinion that a rejection by the FIRB would be highly unlikely, as similar transactions in the past, such as the ABB Viterra and the AWB Agrium takeovers, had all been approved (J.P. Morgan 2013).

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Figure 1: Implied Success Probability of the Transaction

2.2 Company Analysis

To provide a better understanding of the proposed transaction, this section analyzes the two companies involved in the takeover. Chapter 2.2.1 gives an overview over the target, GrainCorp, and chapter 2.2.2 covers ADM, the bidder.

2.2.1 GrainCorp

GrainCorp was founded in 1916 as a statutory authority by New South Wale’s Department of Agriculture under the name Grain Elevators Board (GrainCorp 2014a). In 1989, the company incorporated under the name NSW Grain Corporation and three years later, it was privatized via a sale to Grain Growers Association for a consideration of AUD 100 m (GrainCorp 2014a). The combined company changed its name to GrainCorp Ltd. in 1993 and got listed on the ASX in 1998 (Deutsche Bank 2011). Further deregulation in the late 1990s lead to a wave of industry consolidation, after which GrainCorp emerged as one of the dominant players. A second merger wave was induced by the abolishment of the monopoly of AWB to export wheat (Figure 2). After this second consolidation wave, GrainCorp remains the only major publicly traded company that is not owned by a multinational agriculture company. As a result, GrainCorp can be characterized as an industry laggard compared to its competitors, because GrainCorp does not have access to the amount of capital required to upgrade its logistics network, which is partly not up to modern standards (Farmonline 07.10.2014). Therefore, its operating technology is less efficient than that of its competitors.

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Figure 2: Industry Consolidation Map (Deutsche Bank 2011)

In 2002, GrainCorp first moved into downstream activities by entering into a 60% joint-venture (JV) with Cargill to buy the flour miller Allied Mills (GrainCorp 2014a). The process of vertical integration was further strengthened by the acquisitions of the malt business in 2009 and the creation of GrainCorp Oils in 2012 (GrainCorp 2014a). GrainCorp follows an integrated end-to-end business strategy, focusing on three grains, i.e. wheat, barley, and canola and three activities, i.e. storage and logistics, marketing, and processing (Figure 3).

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Figure 3: GrainCorp's Business Model (GrainCorp 2012d)

The Storage & Logistics segment pools the grain it receives from farmers in its elevators. After the Marketing segment sold it to external and internal customers in Australia and overseas, the grain is either transported directly to the customers or to the port facilities for export. GrainCorp’s downstream operations of flour, malt and oil processing use these commodities to produce products for the food and livestock industry as well as for industrial applications.

GrainCorp generates 51% of its total revenues (AUD 3.4 bn in 2012) from Australia, 19% from Asia, 11% from Europe and 9% from North America, while the remaining 10% is from other countries. However, a look at GrainCorp’s fixed asset base is more representative of the geographic footprint of the company. It reveals that 69% is located in Australia, 20% in North America and 11% in Europe (GrainCorp 2012c).

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Table 1: GrainCorp Sales and EBITDA Split by Segment (GrainCorp 2012e)

Despite the recent acquisitions of downstream assets, Table 1 illustrates that half of group EBITDA is generated by the Storage and Logistics segment, although its share of sales was only 16%. This is the result of the high margins GrainCorp earns in a normal crop year in this segment, compared to the very low margins in the Marketing segment. Historically, the financial performance of GrainCorp has been very volatile, fluctuating with the size of the Eastern Australian crop production and commodity prices. Because of the high fixed costs in Storage & Logistics, this segment is hit particularly hard by a low harvest, but the volume of the Marketing segment is also impacted.

The correlation between GrainCorp’s share price and the S&P GSCI Agriculture index is 0.57, which is lower than for other companies in the same industry such as ADM or Bunge, whose correlation with commodity prices is 0.68 and 0.66 respectively (Appendix 2). To some extent, this is the result of a different business mix, but the lower correlation also stems from GrainCorp’s strategy to hedge more of its flat price risk than ADM and Bunge.

The competitive landscape for the Storage & Logistics segment in Australia is divided by regions. Cooperative Bulk Handling (CBH) dominates Western Australia, Glencore, through its subsidiary ABB, is present in Southern Australia, and Eastern Australia is dominated by GrainCorp, with Cargill and Emerald Group as minor players (Appendix 3). On the east coast, GrainCorp owns upcountry storage facilities with a capacity of 20 mt, while other bulk handlers’ and on-farm capacity each equal 10 mt (GrainCorp 2014b). Of the total export capacity of 22 mt, GrainCorp owns 15 mt. Competitors’ capacity equals 4.5 mt and the remaining 2.5 mt are attributable to container exports (Appendix 4). After the deregulation of the wheat market in 2008, competition increased significantly. Recently, several companies have opened new port terminals or will do so in the near future to benefit from further deregulation of port access in 2014 (FarmOnline 06.02.2013; Department of Agriculture, Fisheries and Forestry 2011). To summarize, GrainCorp can be characterized as a dominant player on the east coast that faces increasing competition by other bulk handlers, especially for its port terminals.

The Marketing segment acts as an intermediary between buyers and sellers of grain, both domestically and on an international level. GrainCorp operates from eight different marketing offices to reduce the distance to the customers. Three offices are located in Australia and the others are in Calgary, Hamburg, London, Singapore, and China (GrainCorp 2014b). In Eastern Australia, domestic demand makes up for approximately 50% of the total grain traded, which is above the national average due to a higher population. Because the domestic demand is satisfied first and relatively stable, grain exports fluctuate with the overall crop production. In 2012, GrainCorp’s market share was approximately 30%, compared to 27% for Cargill and 16% for Glencore (GrainCorp 2013c).

GrainCorp Malt’s operation bundles the activities of five companies, i.e. Great Western Malting Co. (USA), Canada Malting Co. Ltd. (Canada), Barret Burston Malting (Australia), Schill Malz (Germany), and Bairds Malt Ltd. (United Kingdom). Together, they operate 18 plants with a total capacity of 1.38 mt in key barley production regions (GrainCorp 2013d). It is the world’s fourth largest maltster with a market share of 6.4%, compared to a market share of 10% for each of the three largest companies, Soufflet, Malteurop, and Cargill Malt (Appendix 5). It also exceeds the average capacity utilization rate, a result of higher malt quality and a focus on the faster growing craft beer and distillery segments (GrainCorp 2013d).

GrainCorp Oils is an integrated oils business with three core activities, including oilseed crushing, packaging and refining, as well as bulk liquid terminals. Australia’s overall oilseed crushing capacity equals 1.2 mt, of which 0.32 mt belongs to GrainCorp. With a market share of 27%, the company is the second largest domestic oilseed crusher, behind Cargill with a capacity of 0.7 mt (GrainCorp 2013c). The country’s refining capacity is approximately 0.6 mt and GrainCorp is the largest refiner with a capacity of 0.28 mt and a production market share of around 40%, before Peerless Foods with 0.17 mt and Cargill with 0.15 mt. With its 13 bulk liquid terminals, GrainCorp Oil manages approximately 50% of Australia’s and New Zealand’s edible oil imports and exports. Its major competitors are Terminals Pty Ltd, Stolthaven Australia Pty Ltd, and Vopak Terminals Australia, which are all subsidiaries of international edible oil storage companies (GrainCorp 2013c).

GrainCorp’s joint venture Allied Mills is one of the country’s largest producers of flour and semi-finished bakery products (GrainCorp 2013d). It operates seven flour milling facilities, four mixing plants, two frozen food manufacturing facilities and one food ingredient plant with an annual production of approximately 0.65 mt (Allied Mills 2014).

2.2.2 ADM

ADM was created after the merger of Archer-Daniels Linseed Company and Midland Linseed Products Company in 1923. With sales of approximately USD 90 bn in 2013, it is the second largest integrated agriculture company in the world (ADM 2013c). The company’s activities can be categorized into two main areas, i.e. the processing of agricultural commodities, and the integrated merchandizing and handling of these commodities. Currently, ADM focuses on corn, oilseeds, wheat, and cocoa, but the company’s strategy is to expand both its product offering and its geographical reach. To achieve this goal, the firm invests in a significant network of joint ventures. The most important investment is its 16.4% stake in Singaporean company Wilmar, which it acquired in 1994 (ADM 2013c). Wilmar has a particularly strong market position in oilseed and sugar cultivation and processing, with revenues of SGD 45 bn in 2012. The company serves as ADM’s bridgehead into the Chinese market.

ADM generates roughly 50% of its revenues in the US, with Germany and Switzerland being the second and third most important markets with 11% each (ADM 2013c). But as for GrainCorp, the location of fixed assets is more relevant in evaluating the geographical footprint of the company. 67% of its processing capacity and 70% of its storage capacity are located in North America. The remainder is located in South America and Europe, Asia does not play any role (ADM 2013c). Compared to its largest competitors, Cargill and Bunge, ADM’s operations are less geographically diverse and more U.S. focused.

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Table 2: ADM Sales and EBIT Split by Segment (AMD 2013c)

ADM operates in the four business segments Oilseed Processing, Corn Processing, Agricultural Services and Other, which bundles its insurance and financial operations. In 2013, Oilseeds Processing contributed 39% to group revenues and 54% to group EBIT (Table 2). The higher share of EBIT is a result of higher margins compared to the other segments. While Agricultural Services generated 46% of overall sales, its share of EBIT was only 14%. Although this is partly the result of a below average harvest in the Midwest of the U.S., most of it can be explained by the lower margins in grain merchandising. In recent years, Corn Processing also has been generating above average margins, mainly driven by the growth in the ethanol business (ADM 2013c).

Generally, the performance of ADM is highly dependent on prices for agricultural commodities (Appendix 2). As has already been discussed, the correlation between ADM’s share price and the S&P GSCI Agriculture Index was 0.68, indicating that ADM is less active in hedging compared to GrainCorp.

The Oilseeds Processing Segment’s diverse activities are divided into the four sub-segments Crushing & Origination, Refining, Packaging, Biodiesel & Other, Cocoa & Other and Asia. The Asia segment mainly consists of the Wilmar investment. More than half of both revenues and operating profits are generated by the crushing and origination activities (ADM 2013c). Furthermore, the company recently sold its chocolate business, including its factory in Mannheim, Germany, to Cargill for a consideration of USD 440 m to redeploy capital to higher return investments (WSJ 02.09.2014). ADM’s product offering includes ingredients for the food, feed, energy and industrial products industry. As a supplier of agricultural raw materials, Wilmar, Stratas Food LLC and Edible Oils Ltd are among its biggest customers.

ADM is the largest corn processor in the U.S., using wet-milling and dry-milling procedures to convert corn into a variety of sweeteners, starch, lysine, ethanol and other products, with an overall capacity of 72 kt per day (ADM 2013c). The activities are divided into the two sub-divisions Sweeteners & Starches and Bioproducts. The target market for Sweeteners & Starches is the food and beverages industry, whereas the Bioproducts sub-segment produces alcohol and amino acids for the livestock industry and industrial applications.

The Agricultural Services segment bundles the company’s merchandising and handling, transportation, and milling activities. A substantial portion of the merchandising and handling business involves the marketing of Oilseed Processing and Corn Processing products, while also servicing external clients. It owns 16.1 mt of storage capacity, 72% of which is located in the U.S., 20% in South America and 8% in Europe (ADM 2013c). The transportation unit links the company’s extensive network of storage and processing facilities with a fleet of oceangoing vessels, barges, trucks and trains. Milling & Other primarily processes wheat to flour and other ancillary products used in the livestock industry.

2.3 Industry Analysis

To get a better understanding of the underlying economics, this chapter analyzes the industry in which the two companies operate. Combined with the company analysis, it will also serve as the foundation of the financial statement forecast for the valuation in chapter 4. The chapter starts with an overview of the agricultural industry, followed by an examination of the key supply and demand drivers. As the dynamics of each part of the agricultural supply chain differ along several dimensions such as the competitive environment, each segment of the industry in which GrainCorp operates, i.e. grain handling, marketing, malting and oilseed processing, is analyzed separately.

2.3.1 Overview

Since the 1970s, the global agriculture industry has seen a trend towards consolidation and vertical integration as a result of deregulation and growing productivity levels. This development had several advantages for the companies involved. The higher level of industry consolidation has greatly increased the cost efficiency of companies, mainly a result of economies of scale in operating larger logistics networks. The vertical integration resulted in a better control over the supply chain, reducing transaction costs via the elimination of the hold-up problem. This problem is particularly severe for grain trading firms due to a high degree of temporal specificity (Pirrong 1993). Temporal specificity means that only a short delay in receiving or delivering the commodity may result in large losses for the trader, giving the owner of the storage asset the bargaining power to extract additional economic rents. Furthermore, the operation of both trading and storage facilities provides the owner with increased flexibility to react to volatile commodity prices. This flexibility has characteristics of a real option and is therefore valuable to the owner. Although there exists growing literature on the valuation approach of such a storage real option using calendar spreads (Seok et al. 2013; Manoliu 2004; Secomandi 2009), this thesis refrains from valuing this real option in chapter 4 due to a lack of public information about the input parameters and the impossibility to test the validity of the suggested approaches with real market data.

However, Australia lagged behind these global industry trends, as privatization of state owned companies and deregulation started in the late 1980s (Deutsche Bank 2011). The single-desk for wheat exports was only abolished in 2008, leading to a merger wave where main companies were bought by international grain traders such as Viterra and Cargill. In fact, the Australian market has not been fully deregulated until 2014 (Department of Agriculture, Fisheries and Forestry 2011).

In general, the global agriculture industry is also highly dependent on the political environment, as food security is a very important issue and the market is highly regulated, especially in developing countries. Besides adverse weather effects, the global crop production can also be impacted by political uproars in cultivation regions, as was highlighted by the Ukraine crisis, which threatened the food supply in the Middle East (Food Navigator 28.04.2014) and also distorted global trade flows. Other examples include export bans of governments in times of low crop yields such as in India in 2011 (Reuters 13.01.2011) or changes in subsidies for bio-fuels or agriculture in general. For instance, the subsidies for bio-ethanol and bio-diesel in the 2000s led to an increase in demand for crops, resulting in higher and more volatile commodity prices due to supply shortages.

2.3.2 Supply & Demand

The world food demand is driven by two main factors, i.e. population growth and growth in per capita food consumption, which is the result of rising living standards due to economic growth in developing countries. While the average population growth is expected to be 0.8% p.a. until 2050, per capita food consumption will increase by 0.3% p.a., resulting in an overall world food demand growth rate of approximately 1.1% (Alexandratos and Bruinsma 2012).

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Figure 4: Food Demand Growth 2012-2050 (Alexandratos and Bruinsma 2012)

However, Figure 4 illustrates that this growth is distributed very unevenly among the different world regions, with Sub-Sahara Africa, South East Asia, and the Middle East all growing at rates above 1.5%. As these high growth countries are no significant grain producers, this shift in demand will lead to an increase in trading volumes and exports. Through its freight cost advantage to these high growth regions, Australia could profit disproportionately from these developments.

The two determinants of the crop supply are area harvested and yield. While the area harvested is chosen by farmers once per year on the basis of relative price differentials, the yield is impacted by weather conditions in the respective cultivation regions and is therefore highly volatile. Figure 5 shows that the volatility of the yield over the last 20 years has increased compared to previous periods, with more extreme contractions due to severe droughts. The compound annual growth rate (CAGR) of the yield from 1901-2011 was 0.76%. This increase is mainly the result of technological advancements in the form of fertilizers and genetically modified plants. The yield is expected to continue to increase, however, due to the impact of global warming, at a much lower rate of 0.2% p.a. (Cline 2008; Appendix 6). While the area harvested on average increased by 1.7% p.a. over the last 50 years, further growth is not expected, as basically all of the suitable land is already cultivated and artificial irrigation of marginal land is not profitable at current market prices (Alexandratos and Bruinsma 2012).

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Figure 5: Eastern Australian Crop Yield and Area Harvested (ABS 2013)

2.3.3 Grain Handling

Grain handling comprises all activities to deliver grain from the farm to the market, including storage in elevators, transport of grain from elevators to domestic customers or to port terminals for export, and loading of vessels at port terminals. As the fees that the grain handlers charge are all on a per tonne basis, revenue is a function of throughput and varies with the crop harvest. To offer their customers end-to-end solutions, bulk handlers need to operate an extensive network of grain elevators, transportation facilities and port terminals. These networks are characterized by a high operating leverage, as marginal costs of an additional tonne of throughput are low compared to the high fixed cost base. As a result, not only revenues but also margins are dependent on the volume of grain handled.

The grain handling industry also exhibits significant barriers to entry that limit the level of competition. First, the business is highly capital intensive with large up-front investments and high fixed costs. Second, on the regional level, the industry has traits of a natural monopoly, as economies of scale, high fixed costs and dependency on throughput with a limited supply make it economically inefficient to run several parallel logistics networks in one region.

As a result, the industry is dominated by a few large players. The term “ABCD” was coined for the four largest players ADM, Bunge, Cargill, and Louis Dreyfus, but more recently, Asia based Noble, Olam, Wilmar, Marubeni and Sumitomo as well as Swiss Glencore Xstrata also emerged as key competitors.

2.3.4 Grain Trading

There are three different activities that grain traders engage in to generate revenues. The first one is to manage grain pools for farmers, in which case the traders receive a fixed fee and the price risk stays with the farmers. The second alternative is to trade grain on behalf of customers, in which case the company earns a commission on the transaction volume. The third activity is proprietary trading, buying and selling grain for its own books. In that case, the trader usually tries to profit from price differences across time and or space (Pirrong 2014). The flat price risk is hedged via derivative contracts, i.e. futures, forwards, swaps, and options, so that the trader only has to bear basis risk, the difference between the price of the physical commodity and the price of the derivative used to hedge the price risk. As this basis risk can still be very substantial, risk management plays a pivotal role in any trading operation.

All these trading activities require large up-front investments, thus, the trading firms usually rely on short-term credit facilities, which are often secured by the commodity inventory, to finance their operations. This dependence on short-term financing favors larger players, as they have easier access to bank credit.

International commodity markets are very competitive, and the homogeneity of the product leaves no room for product differentiation. Therefore, the average operating margins in grain trading are relatively low, fluctuating between 2-5% (KPMG 2013).

2.3.5 Malting

Malt demand depends to 95% on beer consumption and to 5% on whiskey consumption (Deutsche Bank 2011). As beer consumption per capita has been declining in developed countries, overall industry growth has been driven by emerging markets. However, emerging market growth is also expected to slow down, resulting in a growth forecast of 2.4% until 2016, while the CAGR from 1998 to 2013 equaled 2.8% (Appendix 7; Statista 2014). However, the craft beer segment is growing faster than the overall beer consumption. The whiskey demand is expected to grow by 4%, but as it only accounts for 5% of malt demand, the impact of this higher growth is very small. Because a number of trends such as a shift in consumer preferences towards less malt and efficiency gains have reduced the amount of malt needed in the brewing process, malt demand growth is expected to be lower than beer demand growth, at approximately 1-2% (Macquarie 2012).

The supply of malt is influenced by the size of the global barley harvest and the proportion of the harvest that is suitable for the malting process (Macquarie 2012). The overall malting capacity for 2013 is expected to be 27 mt, while the expected production equals 21.5 mt (First Key 2013). This represents an overcapacity of 25.6% within the industry. In the absence of an industry consolidation to take out part of this excess capacity, this gap will remain large, as growth rates are not high enough to quickly increase demand.

This excess supply has led to the deterioration of malt prices and margins in recent years, as producers try to increase their capacity utilization by giving discounts to customers. Furthermore, the brewing industry is highly concentrated, with the five largest breweries capturing a market share of more than 50% (Business Insider 14.02.2014). The high bargaining power of these large companies puts further pressure on malt margins.

2.3.6 Oilseed Processing

The demand for oilseed processing derives from two major applications, i.e. the use of vegetable oils as food and industrial applications such as biofuels. As world oilseed production is expected to slow down considerably after years of excessive growth, the prices for oilseed products are expected to remain at elevated levels until 2020, high above the historical average (OECD/FAO 2011; Appendix 8).

Demand growth is also expected to slow down to approximately 2% p.a. until 2020. Two thirds of this growth will occur in developing countries (Appendix 9). While emerging market growth is primarily driven by food demand, growth in developed countries mostly originates from non-food uses such as biofuels (OECD/FAO 2011).

2.4 Strategic rationale

This chapter will evaluate the strategic rationale behind the transaction and determine if the reasons ADM communicated to investors are economically sound or if the takeover was not sensible from a strategic point of view and rather constituted a case of empire building.

According to ADM (2013d), the main reason for the takeover was gaining better access to the fast growing markets of Asia and the Middle East. Australia is strategically situated to serve the growing demand from these markets, as it has a freight cost advantage compared to other major grain growing regions (ADM 2013d). Australia also produces higher quality grains with respect to moisture and proteins. Because these higher quality grains are far less abundant, they achieve higher prices at world markets (J.P. Morgan 2012). Another strategic advantage of Australia is the harvest period at the opposite end of the year. This can be utilized by ADM to smoothen inventory levels and thereby enhance operating efficiency. Some research analysts also mention a reduction of risk through the diversification of sourcing regions as a key benefit from the takeover (Deutsche Bank 2012). However, this does not constitute a valid reason to merge for several reasons. First, the risk of bad harvests is unrelated to the overall market risk and therefore, investors do not factor in this idiosyncratic risk when valuing the company, as it is completely diversifiable. Second, even in case investors would factor in the risk of bad harvest for their valuations, the reduction of this risk would still not add any value, as investors could always achieve the same diversification effect more cheaply by buying GrainCorp shares in the market. This way, they would not have to pay any control premium.

After ABB’s acquisition by Viterra and AWB’s takeover by Cargill, GrainCorp was the only company that allowed ADM to gain a sizable share of this attractive market. By acquiring GrainCorp, ADM could also block further access to the Australian market for its competitors. Furthermore, ADM planned to expand GrainCorp’s revenues by giving it access to its existing global customer network, including its own downstream operations (ADM 2013d). Particularly ADM’s oilseed crushing facilities in Eastern Europe would generate demand for Australian canola. GrainCorp’s vertically integrated infrastructure assets also contained private information about the quality and quantity of the Eastern Australian crop. This information was more valuable to a globally operating company that sources grain from many different regions, as it could better leverage this information to profit from trading in the grain market. ADM also planned to increase the operational efficiency of the infrastructure network by additional capital investments and the implementation of best practices from its other networks (ADM 2013d).

Because of all the reasons discussed above, it becomes apparent that GrainCorp is not the best owner of its assets and thus, this thesis concludes that ADM’s offer made sense economically, as it would have increased the efficiency of the overall economy by a better capital allocation.


Ende der Leseprobe aus 89 Seiten


The Failed Acquisition of Graincorp by ADM
Universität Mannheim
ISBN (eBook)
ISBN (Buch)
1730 KB
M&A, Valuation, Event Study, DCF, Multiple Valuation, Industry Analysis, WACC, ADM, Graincorp, Grain Trading, Food Processing
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Matthias Störk (Autor), 2014, The Failed Acquisition of Graincorp by ADM, München, GRIN Verlag,


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