An article from the Chinese Daily by Jodi XuOne rule of thumb in...

An article from the Chinese Daily by Jodi Xu
One rule of thumb in investing is to buy stocks when a company is seen as a potential acquisition target. The math is pretty straightforward: company + expected takeover premium = profit.

Then there is Nufarm Ltd. A rally in shares of Australia’s leading chemical company ran out of steam shortly after Nufarm announced the receipt of bidding interest from Sinochem, a state-owned Chinese chemical company. After jumping 10% on Thursday and another 13% to 11.12 Australian dollars a share on Friday, the day the market received word of Sinochem’s interest, the Australian company had a market value of A$1.8 billion.

But on Monday, the stock fell 5%. What killed the short-lived rally? The company’s own gloomy fundamentals.

In June, the company warned that its operating profit would be down about 15% from a previous projection due to “a decline in demand for glyphosate and increased price competition for fewer sales opportunities in key markets,” according to Nufarm’s financial statement.

Friday, Credit Suisse downgraded Nufarm’s performance from neutral to underperform, according to this Dow Jones Newswires article. “While strategically the merits of a takeover add up, we would consider the timing curious given the constant earnings downgrades and poor quality cash earnings. Corporate appeal seemingly once again coincides with lower potential earnings,” Credit Suisse told Dow Jones. “Based on the share price appreciation and weaker fundamentals, we argue any takeover premium is seemingly already implicit in the share price at A$11.12 (Friday closing price).”

J.P. Morgan analysts, upon news of Sinochem’s possible bid, also cautioned its investors. “Considering we think the current share price is factoring in a takeover premium for a bid that has not been formalized yet, we will take a wait and see approach,” the analysts said.

Analysts at Standard & Poor’s were less critical, saying the worse-than-expected earnings didn’t immediately affect the company’s ratings. S&P’s ratings of Nufarm remain at BBB, the lowest investment grade. They also recognized the potential positive impact it would have on Nufarm if Sinochem really proposes an offer.

Still, the J.P. Morgan analysts, concerned about Nufarm’s weak performance, said “there are still significant risks around this deal being formalized such as agreement on price and due diligence.”

Then there is Nufarm’s history. On Nov. 2, 2007, China National Chemical Corp., or ChemChina, bid A$3 billion for Nufarm, only to pull the plug at the last minute without giving substantial reasons. That bid offered a 35% premium to Nufarm’s volume weighted average share price for the previous 12 months.

Another question J.P. Morgan analysts had is whether China would be prepared to pay a significant premium again. The 2007 bid was roughly 12.5 times Nufarm’s earnings before tax, which would imply an offer of A$21.67 a share this time around. J.P. Morgan analysts said they “do not think so, as it is roughly double where Nufarm is trading.”