By MATEUSZ PERKOWSKI

Capital Press

A global farm machinery company is diversifying its business model by taking over a manufacturer of grain storage systems and livestock equipment.

AGCO, which makes several brands of tractors, combines and other machinery, has agreed to pay $940 million for GSI Group, a producer of grain bins for farmers and processors, as well as equipment for the automated feeding and care of livestock.

"This acquisition is consistent with our long-term strategy of providing improved productivity for professional farmers," said Martin Richenhagen, AGCO's president and CEO, during a conference call with analysts.

Though the GSI takeover is a departure from AGCO's core business, Richenhagen said the company wants to capitalize on the growing need for grain storage in the U.S. and in emerging markets like South America, Asia and Eastern Europe.

"More grain is being exported today, and that provides for more need for storage at every step of its journey," he said.

The difference in the two companies' manufacturing operations has raised questions about the savings that will result from the merger, said Adam Fleck, a farm machinery analyst at the Morningstar investment research firm.

"We're a little concerned these cost synergies will not be as material as the company expects," he said, noting that factories geared toward farm machinery can't quickly switch to making grain bins, or vice versa.

Richenhagen said AGCO expects the merger will endow the company with more buying power for electrical components and raw materials, like steel.

Fleck said AGCO may benefit incrementally from this dynamic, though the takeover won't give the company as much buying power as a behemoth like Caterpillar.

"It's not a negative, but the materiality is still something we're trying to wrap our head around," he said.

AGCO believes a big advantage of the merger will be GSI's ability to more rapidly penetrate markets with a large potential market but where it's not currently a major presence, said Richenhagen.

That's because AGCO machinery dealerships are already well established in those countries, he said. "They are rather small in emerging markets where we are rather big. With our distribution, we can do much better, much faster, and support them a lot."

The sales advantages of the merger are more likely to occur overseas, with existing AGCO dealers expanding into grain storage equipment, said Fleck.

It's less realistic that GSI grain dealerships in the U.S. will move significant volumes of AGCO brands like Challenger, Fendt, Massey Ferguson and Valtra, which have had a hard time gaining ground in North America against larger competitors like John Deere, he said.

AGCO executives also touted the value of GSI's popularity in the pork and poultry industries, where automated equipment is common.

Food companies in these livestock sectors are very vertically integrated, so large packers provide farmers with specific requirements for which equipment to buy, said Andy Beck, AGCO's chief financial officer.

The acquisition of GSI also helps AGCO balance economic fluctuations in the agriculture industry, since the grain and livestock sectors are financially counter-cyclical, he said.

"If grain prices are high, that bodes really well for the grain storage side," Beck said. "If grain prices come down a little, that helps the profitability of protein producers and allows them to feel comfortable about investing and modernizing their equipment."

GSI doesn't have heavy fixed costs and has able to maintain consistent profit margins despite shifts in the economy, even during the depths of the recession in 2009, he said. "It has a flexible cost structure that allows it to move up and down with volumes quite nimbly."

AGCO's acquisition of GSI is certainly expected to help the company's profits, said Fleck.

GSI has an operating income of about 15 percent of revenues, before taxes and interest, while AGCO's operating income hovers at about 5 to 6 percent of revenues, he said.

The $940 million purchase price will increase AGCO's total debt from about $700 million to $1.6 billion, but the company still has healthy cash reserves of about $700 million to offset that added leverage, Fleck said.

"In this case, it seems like they didn't overpay for it," he said, noting that interest rates are also low. "We think they have the flexibility to take that on. It's pretty cheap debt for the most part."

AGCO probably decided to buy a company outside its core business due to a dearth of options in the machinery market, Fleck said.

Buying a smaller competitor, like Kubota, may not pencil out because a merger could result in overlapping distribution systems, he said. That would be a hindrance to efficiency, rather than a benefit.

On the other hand, acquiring a larger manufacturer like Case IH -- a subsidiary of CNH global that AGCO has had its eyes on -- could result in antitrust problems, Fleck said.

During the conference call, Richenhagen hinted that the GSI purchase may help the company grow in different directions, such as acquisitions in the irrigation, milking equipment and wind energy sectors.

Such diversification requires careful balance, said Fleck.

Companies want to avoid spreading themselves too thin, but offering multiple products can give manufacturers more contact with end customers, he said.