FFBL and FFC Amalgamation; SWAP Ratio Estimation

Staff Report : Fauji Fertilizer Bin Qasim (FFBL) board has granted in-principle approval to evaluate and prepare a proposal for the amalgamation of FFBL with and into Fauji Fertilizer Company (FFC) by way of a Scheme of Arrangement (SoA).

For background, both fertilizer companies are part of the Fauji Foundation group, and FFC currently holds a 49.9% stake in FFBL. With this merger activity, FFBL business operations will be merged into FFC, and shareholders of the FFBL will receive shares of FFC, in our view.

To highlight, Fauji Group has been undertaking restructuring and consolidation activities for the last few years. In the past, Askari Cement Limited (ACL) was merged into Fauji Cement (FCCL).

According to SECP regulations, the fair value of shares shall be determined by averaging the fair value arrived at through any three of the suggested four methods: (1) Net Worth Method (or break-up value method), (2) Market Value Method, (3) Discounted Cash Flow, and (4) Comparable Transaction Method.

The valuation and subsequently the swap ratio of the ACL and FCCL was determined by EY Ford Rhodes using an average of the income approach (DCF), the cost approach (Adjusted Net Asset Value), and the market approach. This resulted in 5 shares of FCCL against 1 share of ACL.

The SWAP ratio of FCCL and ACL was determined within 22 days of the board announcement, as per the timeline of the notices shared with the exchange. However, the overall process took around 7 months as this transaction needed approval from the competition commission and was required to be sanctioned by the high court.

In our view, once approved by the board and shareholders, the FFBL and FFC amalgamation will be vetted by the competition commission as this would be a horizontal merger (operating in the same industry) like ACL and FCCL.

End Results of Surviving Entity: If all approvals are accorded, the surviving entity post-amalgamation would be FFC with a combined market share of 52% in Urea based on 6M2024 sales data and 71% in DAP. The capacity-based market share of Urea would be 41%.

Furthermore, the merged entity, if approved by the regulator/board, will hold a 65% market share in Askari Bank (AKBL), a 37.5% stake in Pakistan Maroc Phosphore, S.A. (PMP), and an 82% stake in Fauji Foods (FFL), among others.

We have used three approaches: (1) Market Approach (Forward P/E Multiples), (2) Income Approach (DCF), and (3) Breakup Value Method (Book Value) to arrive at a likely SWAP ratio for this transaction. The probable range based on our calculation is ~3.2-3.6 shares of FFBL against 1 share of FFC. The average of these methods comes to around 3.39. This suggests a long approach on FFBL to eliminate any arbitrage opportunity. However, the quantum of dividends announced by FFC may limit the arbitrage opportunity.

Nonetheless, the actual SWAP ratio will be determined by external/independent valuators and will be simultaneously approved by the board.

In the recent past, Dawood Hercules (DAWH) demerger into two legal entities “DH Corp” and “DH Partner” was a different case, and shareholders of Engro will receive 2.24 shares of DH Corp (against 1 share of Engro) to maintain proportionate shareholding in Engro Corp indirectly through DH Corp.

Market Approach of Valuation: Based on our back-of-the-envelope working, the Sum of The Parts (SoTP) value of FFC is estimated at Rs253, with the core fertilizer business valued at 61% of the total and portfolio companies at 39%. The SoTP value of the FFBL is estimated at Rs75/share with the core fertilizer business constituting 62% of the total value, while the rest comes from portfolio companies. In this approach, we have used the market approach in valuing the fertilizer business of both companies with a multiple of 6.2x, the last 10 years forward multiple of the fertilizer sector. This translates into a likely SWAP ratio of 3.36x, suggesting a long approach on FFBL.

Income Approach of Valuation: Similarly, if we value the core fertilizer business using the income approach (DCF) for FFC, we arrive at a SoTP value of Rs271/share with the core fertilizer business contributing 63%. For FFBL, using DCF for the core fertilizer business, we arrive at a SoTP value of Rs74.5/share, suggesting a SWAP ratio of 3.59x.

Breakup Value Method: FFC’s book value as of Mar 2024 is Rs121 and FFBL’s book value is Rs37. This suggests a SWAP ratio of 3.26 shares of FFBL against 1 share of FFC.

SWAP ratio below 4 is favorable for FFBL investors: We believe if the SWAP ratio arrives below 4x, it will be favorable for FFBL investors, while a ratio above 4x will be favorable for FFC investors.