Talk of Potash Corp. of Saskatchewan Inc. (POT), the world's largest potash producer, looking to buy German rival K+S AG (SDF.XE) will come as a surprise to many who follow the industry. It would be better off paying for smaller potash assets and has no need to rush into a big deal.

If it goes ahead, the purchase would reverse a decade-long organic growth strategy steadfastly followed by the Canadian-based company. Also, Potash already controls nearly a quarter of the world's potash supply, raising the question of how easy it would be to gain European antitrust approval if it bid for K+S.

Undoubtedly, Potash is one of the most successful in the business, reflected in its solid 46% margin on the last 12 months' earnings before interest, taxes, depreciation and amortization.

Potash's investment-grade balance sheet has a A-1 credit rating from Standard & Poor's but that would be badly stretched if it pursued the deal. Talk surrounded Potash Corp paying EUR50 per share for K+S Aktiengesellschaft which would stamp an enterprise value of $12 billion on it.

Potash Corp's current net debt to Ebitda stands at 4.1x, 10 times what it was last year. It has only $371 million of cash. But K+S's debt is low at only 1.2x Ebitda, which means the combined net debt to Ebitda would stand at 3.7X.

Potash's intent is understandable. K+S would give it a European footprint that would be attractive to a company which is strong in Canada, the U.S., Brazil and the Middle East. K+S also has a presence in Chile.

While the EUR50 share price is at a 37% premium over K+S Friday's closing price of EUR36.50, one still has to doubt the willingness of K+S to sell out just yet.

K+S shares were trading at EUR95 levels just about a year ago before falling on reduced demand for potash. Meanwhile, its management has been pursuing a strong independent strategy of its own. In April it paid $1.68 billion to buy the Morton Salt unit from Dow Chemical Co. (DOW), becoming the world's largest supplier of salt.

 
 Competitors On The Move

That said, the fertilizer landscape is changing. Potash would be worried about its competitive position if either Agrium Inc. (AGU) merged with CF Industries Holdings Inc. (CF) or CF merged with Terra Industries Inc. (TRA). Both deals are under discussion among the three companies.

Potash has not been involved in any deals since it beat out Freeport-McMoRan for the $1.4 billion takeover of Arcadian back in 1996.

But given its existing leadership position, Potash Corp. would be better off paying for smaller potash assets. It should wait at least until Agrium, CF Industries and Terra Industries sort out who partners with whom. One of the three will be left out and could be an ideal Potash partner.

Of the three, Agrium, valued at $8.4 billion, is the best fit given its complimentary operations in North East Asia and Argentina. CF and Terra have mostly North American footprints.

Even Uralkali (URKA.RS), Russia's second-largest potash producer would be cheaper, and it would give Potash Corp access to the rich mines of Russia and an export distribution network to China. 40% of Uralkali's potash exports went to China in 2007.

There's another reason for Potash to watch and wait: the uncertainty of fertilizer prices.

Agrium Chief Executive Mike Wilson believes we are at an inflection point and the sector is on the verge of a big turnaround. Demand is also seen rising later this year. The International Fertilizer Association has forecast consumption growth of 3.6% by the end of this year. Fertilizer consumption fell 14% in the first six months of the current year.

Yet the IFA also hinted at a possible potash surplus in the long term and K+S was forced to cut prices in June to respond to sagging demand. Both K+S and Potash Corp have cut production to help dispel supply demand imbalances.

Potash has achieved its ambition to become the global leader in production by growing organically, and it does not have to rush into a deal yet.

(Kevin M. Nichols is a columnist for Dow Jones Newswires on the energy, industrial and auto sectors. He has more than seven years experience as an analyst and trader on Wall Street and was formerly an executive in the proprietary trading unit at an investment bank. He can be reached at +1 (212) 416-2104 or by email: kevin.nichols@dowjones.com. Dow Jones Newswires is enhancing its news, commentary and analysis for the investment banking community, and is providing it on this service temporarily. To ensure continued access to the best of Dow Jones news and opinion on companies, sectors and deals for bankers and research analysts, please contact investmentbanker@dowjones.com.)