Mining: To buy or to build?
Large mining companies are generating so much cash that a new round of consolidation would, by the standards of the industry’s pre-2008 cycle, seem likely. But the past six months have told a different story. The largest miners have preferred small, targeted deals, such as the buyout of affiliates or the acquisition of exploration companies that round out their exposure to one commodity.
The old chestnuts of mining mergers and acquisitions are still kept warm in bankers’ offices. These include a merger of Glencore, the world’s largest commodities trader, with Xstrata; a break-up of Anglo American, focused on a spin-off of the South Africa assets; the merger of Anglo and Xstrata; and the combination of Rio Tinto and BHP Billiton.
None of these game-changing, blockbuster deals appear to be on the horizon. In the year since BHP’s failed $40bn bid for PotashCorp, the Canadian fertiliser producer, an expected second tier of takeovers has mostly failed to materialise, with one exception: the takeover of Australia’s Macarthur Coal by Peabody Energy, the US coal group, and ArcelorMittal, the steelmaker.
The reason is caution. While balance sheets are healthier than they were in the 2004-08 round of consolidation, the outlook for commodities demand has become less certain, deteriorating markedly in the past three months.
The biggest miners are playing a conservative, wait-and-see game. They are channelling cash into mine-building programmes, whose multibillion-dollar capital expenditure rivals the price tag of sector deals. When they have ventured into the markets to buy – rather than build – growth, they have used their firepower cautiously on assets they already know, or new assets that look compelling, but will not break the bank.
A representative deal is Anglo’s agreement to take over De Beers. Anglo already owns 45 per cent of the diamond miner. As the quasi-parent of De Beers, Anglo knows the diamond market and expects no surprises in the company’s books.
Although Anglo bought the Oppenheimer family’s 40 per cent stake in De Beers for a headline $5.1bn, its outlay could fall to $3.8bn depending on the exercising of pre-emption rights. The purchase price looked attractive for Anglo, with analysts at Deutsche Bank saying the deal implied a valuation of De Beers that is beneath its estimate of the diamond miner’s net asset value.
Anglo bought growth without the risks that attend takeovers of an unfamiliar asset. The idea seems attractive. Rio Tinto has moved to squeeze out minorities in Coal and Allied, its majority-owned Australian coalminer. And Glencore plans to raise its stake in Kazakhstan’s Kazzinc, a base metals producer, from 51 per cent to 93 per cent by the end of the year. This buy up of its subsidiary would cost Glencore an estimated $3.2bn.
Two of Rio Tinto’s recent deals are also noteworthy. The first is its A$4bn ($4bn) acquisition of Riversdale Mining, owner of a coking coal deposit in Mozambique. The deposit pads out Rio’s exposure to coking coal, a commodity that the company thinks is worth fighting for. But it could have afforded to buy a bigger, more productive asset in this commodity class.
In this way, the transaction was similar to BHP’s $15.1bn acquisition of Petrohawk, a US shale gas developer, that improves BHP’s long-term positioning in gas, one of its relatively minor commodities. In the case of both Rio and BHP the purchase prices are large but they are a fraction of these cash-rich companies’ firepower.
While the Riversdale deal grabbed the headlines, Rio was taking incremental steps towards another $4bn deal. The miner has spent $4.1bn buying a 49 per cent stake in Ivanhoe Mines, a Canadian miner that owns the Oyu Tolgoi copper project in Mongolia.
In the past six months, Rio rapidly bought tranches of Ivanhoe shares, building a near-majority position. It also struck a financing deal with Ivanhoe that gives Rio operational control of Oyu Tolgoi despite its minority interest. Like Anglo’s takeover of De Beers, Rio’s creeping interest in Ivanhoe is a targeted, relatively low-cost move on an asset that it both knows and likes.
A comparison of cash flows to dealmaking activity might suggest that the big miners are hoarding cash. That is not always the case. Deal volumes must be seen alongside capital expenditure, which is booming. Miners always face the choice of buy or build to replace their wasting assets. Build – a safer choice with more factors under the company’s control – has been preferred this year. BHP plans to spend $80bn building and expanding mines in the five years to 2015.
Yet the preference may be changing. Christopher LaFemina, mining analyst at Jefferies, the US investment bank, says rising project construction costs are helping to make acquisitions a more attractive way to achieve growth. “The math has clearly shifted toward ‘buy’,” he says. “There is cost inflation amid equity devaluation.”
So many multinationals are spending so many billions of dollars to build mines that the price of labour, raw materials and equipment continues to rise. Meanwhile, mining companies de-rated sharply in August and have not recovered from the level to which they fell. This has made the average takeover target less expensive.
“We are beginning to come into the zone where companies might pull the trigger on deals,” says Michael Rawlinson, head of natural resources at Liberum Capital, the broker. “The corporates need three months to come to a decision. We are coming to the time when they have processed what has happened since August, when they have seen their board, seen their advisers, seen their cash flows.”
He adds: “There are huge opportunities in pre-production assets where the capital markets are not available for funding.”
Cash-rich multinationals are already beginning to move on cash-strapped junior companies. Rio has won a bidding war with Cameco, the world’s biggest uranium producer, for Hathor Exploration, a small Canadian uranium developer. BHP bought Petrohawk at a time when shale gas explorers faced funding difficulties in the US.
In August, Marius Kloppers, chief executive of BHP, said the market volatility had “already impacted funding” for smaller projects.
“If you are a promoter of, say, an incipient iron ore producer in Brazil and you need $5bn, it is not to be had,” Mr Kloppers said. His remarks came two months before unconfirmed speculation of BHP’s interest in Ferrous Resources, an emerging iron ore producer in Brazil.
While takeover activity may pick up, few experts are expecting another round of the massive takeovers that characterised the last period when the big miners were this cash rich. While Rio once spent $38bn on Alcan, the aluminium producer, its finance director now says their preferred deals are in the “low-single-digit-billions” territory, as was Riversdale.
“The next wave of M&A is in the $3bn-$7bn range,” says Mr LaFemina of Jefferies.
“There is not a lot out there in that range. But those are the types of companies that the industry can easily afford.”
He adds: “I would be surprised if you do not see an acceleration of acquisitions over the next six months, unless equity valuations come back.”
The old chestnuts of mining mergers and acquisitions are still kept warm in bankers’ offices. These include a merger of Glencore, the world’s largest commodities trader, with Xstrata; a break-up of Anglo American, focused on a spin-off of the South Africa assets; the merger of Anglo and Xstrata; and the combination of Rio Tinto and BHP Billiton.
None of these game-changing, blockbuster deals appear to be on the horizon. In the year since BHP’s failed $40bn bid for PotashCorp, the Canadian fertiliser producer, an expected second tier of takeovers has mostly failed to materialise, with one exception: the takeover of Australia’s Macarthur Coal by Peabody Energy, the US coal group, and ArcelorMittal, the steelmaker.
The reason is caution. While balance sheets are healthier than they were in the 2004-08 round of consolidation, the outlook for commodities demand has become less certain, deteriorating markedly in the past three months.
The biggest miners are playing a conservative, wait-and-see game. They are channelling cash into mine-building programmes, whose multibillion-dollar capital expenditure rivals the price tag of sector deals. When they have ventured into the markets to buy – rather than build – growth, they have used their firepower cautiously on assets they already know, or new assets that look compelling, but will not break the bank.
A representative deal is Anglo’s agreement to take over De Beers. Anglo already owns 45 per cent of the diamond miner. As the quasi-parent of De Beers, Anglo knows the diamond market and expects no surprises in the company’s books.
Although Anglo bought the Oppenheimer family’s 40 per cent stake in De Beers for a headline $5.1bn, its outlay could fall to $3.8bn depending on the exercising of pre-emption rights. The purchase price looked attractive for Anglo, with analysts at Deutsche Bank saying the deal implied a valuation of De Beers that is beneath its estimate of the diamond miner’s net asset value.
Anglo bought growth without the risks that attend takeovers of an unfamiliar asset. The idea seems attractive. Rio Tinto has moved to squeeze out minorities in Coal and Allied, its majority-owned Australian coalminer. And Glencore plans to raise its stake in Kazakhstan’s Kazzinc, a base metals producer, from 51 per cent to 93 per cent by the end of the year. This buy up of its subsidiary would cost Glencore an estimated $3.2bn.
Two of Rio Tinto’s recent deals are also noteworthy. The first is its A$4bn ($4bn) acquisition of Riversdale Mining, owner of a coking coal deposit in Mozambique. The deposit pads out Rio’s exposure to coking coal, a commodity that the company thinks is worth fighting for. But it could have afforded to buy a bigger, more productive asset in this commodity class.
In this way, the transaction was similar to BHP’s $15.1bn acquisition of Petrohawk, a US shale gas developer, that improves BHP’s long-term positioning in gas, one of its relatively minor commodities. In the case of both Rio and BHP the purchase prices are large but they are a fraction of these cash-rich companies’ firepower.
While the Riversdale deal grabbed the headlines, Rio was taking incremental steps towards another $4bn deal. The miner has spent $4.1bn buying a 49 per cent stake in Ivanhoe Mines, a Canadian miner that owns the Oyu Tolgoi copper project in Mongolia.
In the past six months, Rio rapidly bought tranches of Ivanhoe shares, building a near-majority position. It also struck a financing deal with Ivanhoe that gives Rio operational control of Oyu Tolgoi despite its minority interest. Like Anglo’s takeover of De Beers, Rio’s creeping interest in Ivanhoe is a targeted, relatively low-cost move on an asset that it both knows and likes.
A comparison of cash flows to dealmaking activity might suggest that the big miners are hoarding cash. That is not always the case. Deal volumes must be seen alongside capital expenditure, which is booming. Miners always face the choice of buy or build to replace their wasting assets. Build – a safer choice with more factors under the company’s control – has been preferred this year. BHP plans to spend $80bn building and expanding mines in the five years to 2015.
Yet the preference may be changing. Christopher LaFemina, mining analyst at Jefferies, the US investment bank, says rising project construction costs are helping to make acquisitions a more attractive way to achieve growth. “The math has clearly shifted toward ‘buy’,” he says. “There is cost inflation amid equity devaluation.”
So many multinationals are spending so many billions of dollars to build mines that the price of labour, raw materials and equipment continues to rise. Meanwhile, mining companies de-rated sharply in August and have not recovered from the level to which they fell. This has made the average takeover target less expensive.
“We are beginning to come into the zone where companies might pull the trigger on deals,” says Michael Rawlinson, head of natural resources at Liberum Capital, the broker. “The corporates need three months to come to a decision. We are coming to the time when they have processed what has happened since August, when they have seen their board, seen their advisers, seen their cash flows.”
He adds: “There are huge opportunities in pre-production assets where the capital markets are not available for funding.”
Cash-rich multinationals are already beginning to move on cash-strapped junior companies. Rio has won a bidding war with Cameco, the world’s biggest uranium producer, for Hathor Exploration, a small Canadian uranium developer. BHP bought Petrohawk at a time when shale gas explorers faced funding difficulties in the US.
In August, Marius Kloppers, chief executive of BHP, said the market volatility had “already impacted funding” for smaller projects.
“If you are a promoter of, say, an incipient iron ore producer in Brazil and you need $5bn, it is not to be had,” Mr Kloppers said. His remarks came two months before unconfirmed speculation of BHP’s interest in Ferrous Resources, an emerging iron ore producer in Brazil.
While takeover activity may pick up, few experts are expecting another round of the massive takeovers that characterised the last period when the big miners were this cash rich. While Rio once spent $38bn on Alcan, the aluminium producer, its finance director now says their preferred deals are in the “low-single-digit-billions” territory, as was Riversdale.
“The next wave of M&A is in the $3bn-$7bn range,” says Mr LaFemina of Jefferies.
“There is not a lot out there in that range. But those are the types of companies that the industry can easily afford.”
He adds: “I would be surprised if you do not see an acceleration of acquisitions over the next six months, unless equity valuations come back.”
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