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risk rises for mine mega mergers...

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    Source: www.theaustralian.news.com.au

    Risk rises for mine mega-mergers
    Soaring metal prices and ravenous privateers make BHP and Rio Tinto targets, writes Andrew Trounson

    June 28, 2007

    THE global mining sector is abuzz with expectations of mega-mergers, with the likes of Alcan, Alcoa and Anglo American all said to be on the block.

    Even giants such as Rio and BHP aren't immune, amid expectations that cashed-up private equity buccaneers are set to turn their sights on mining, perhaps convinced that the Chinese and Indian growth phenomenon is here to stay.

    But with metal and mineral prices arguably near their peaks, the acquisition game is set to get harder, as the risks of overpaying increase.

    Rather than banking on rising commodity prices, acquirers now need to make long-term calls on the effects of Chinese and Indian economic growth.

    They need to bet that current market valuations of targets, which are based on falling commodity prices, are underestimating the potential of developing countries' growth to sustain the strong prices.

    Australia's biggest mining takeovers - Xstrata's purchase of MIM and BHP's acquisition of WMC - proved to be steals, courtesy of soaring metal prices.

    If US aluminium giant Alcoa is taken out in a competitive auction between the world's mining giants, how will that deal be judged in five years time?

    "In the past five years just about every acquisition has turned into a winner because commodity prices have gone up, but I suspect that if we aren't at the top of the market we aren't going to be far away from it, and that means every deal that goes ahead from these loftier starting points will have more risk in it," PricewaterhouseCoopers Asia-Pacific mining expert Tim Goldsmith said.

    Certainly the global mining giants are cashed up like never before, with plenty of firepower to pursue acquisitions.

    As the cost of new developments soars on the back of rising costs for materials, labour shortages and heightening political risk in new mining frontiers such as Africa, the incentive is clearly there for the big miners to get bigger by buying production, rather than developing it themselves.

    According to PwC's global survey of the industry, the combined profit of the world's 40 biggest miners, representing 80 per cent of the industry by market capitalisation, jumped a staggering 64 per cent last year to $67 billion, with the net profit margin improving from 23 per cent to 27 per cent. That was despite operating costs rising by 23 per cent.

    The industry's net debt jumped 73 per cent last year to $42.5 billion in the wake of last year's takeover binge, as Brazil's CVRD and Xstrata acquired Canadian nickel giants Inco and Falconbridge, respectively.

    That debt is dwarfed by the sector's market capitalisation, which rose 22 per cent to $962 billion. As a result the industry's gearing ratio remained low, rising from 12.5 per cent to 15.2 per cent.

    Of the majors, Anglo American and Rio Tinto are the most under-geared, with gearing ratios of 11 per cent and 13 per cent, respectively.

    Mr Goldsmith said the outlook for the industry remained strong, with supply struggling to catch up with the demand, driven mainly by China's rapid industrialisation.

    But with the big price gains in metals and minerals now probably behind the industry, Mr Goldsmith expects profitability this year to be little changed from last year.

    The main uncertainty is longer term: will analyst expectations of a significant fall in metal prices in coming years will prove accurate, or will demand from China and India sustain prices - the so-called "stronger for longer" theory. It is this uncertainty that presents the big miners with the opportunity to be aggressive on acquisitions, but it also highlights the risks if they get it wrong.

    For his part, Mr Goldsmith backs the "stronger for longer" scenario and sees no reason why the current tight supply and demand equation in commodity markets will change soon.

    "I don't see any good reason why you wouldn't use longer-term commodity prices that are more akin to where prices are now - and therein lies a possible market re-rating for these companies, which may mean that the big rises (in stock prices) may not have yet come."

    But it is not just the mining companies that are assessing whether they can bank on the stronger-for-longer scenario.

    Private equity funds are also circling the industry, and will be encouraged to become major players if they believe that sustained demand from China and India reduces the volatility of the pricing cycles that have traditionally scared them away from investing in mining.

    Speculation that private equity is becoming increasingly interested in the sector was stoked earlier this year when Xstrata sold its aluminium assets to private equity players Apollo for $1.15 billion.

    And with private equity deals in other sectors now topping $40 billion, analysts have been running the rulers over even the biggest miners, including BHP and Rio, and suggesting that their lack of debt could make them targets.

    Already some $500 billion a year is being invested in private equity funds. According to Mr Goldsmith, it is inevitable that some of this money will find its way into mining.


    Cheers, Pie
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