The great mining predators are on the prowl again, says Judi Bevan. The Chinese are on a spending spree in Africa. And there’s plenty of room for canny investors to make money by following the deals closely
For those worried they have missed the move in mining shares – the FT mining index has nearly doubled since the market hit bottom in March – consider this. As of late November, the index was still around 40 per cent down from its peak in June 2008 and a renewed outbreak of bid speculation – along with Xstrata’s so far unsuccessful approach to Anglo American – indicates that those who are actually running mining houses believe there is plenty more value to be unleashed.
The surge in share prices has given predators such as Xstrata the paper power to go prowling once again. Before the stock market meltdown of last autumn, several deals had been in the air. China’s biggest aluminium group, the state-owned Chinalco, had been seeking to buy an 18 per cent stake in Rio Tinto, while the former Brazilian state miner Vale had enjoyed informal talks about bidding for Xstrata.
Last autumn, as stocks and commodity prices sky-dived, with the exception of gold which moves on a separate axis, all big deals were put on ice. Now, as animal spirits resurface, the game is on again.
For some, it is a case of eat or be eaten. Mick Davis, who left BHP Billiton seven years ago to build Xstrata from a small Swiss group worth around £500 million into the world’s fifth biggest mining group today, is back on the acquisition trail with his not-so-friendly approach to Anglo American in September.
Yet Xstrata itself needs to keep moving as it is not yet a big enough shark to be immune from predators. The Brazilian Vale could well come back in more aggressive mode while Chinalco might enter the bidding for Anglo using hard cash to compete against Xstrata’s paper.
So why all this frenzied activity? Miners have simply woken up to the urgent need to find new sources of minerals to meet the demand. According to Thras Moraitis, the head of strategy at Xstrata, the industrialisation of China and India is creating demand for coal, copper and other metals on a par with what happened during the building boom in America at the turn of the last century or the reconstruction of Europe after the second world war, but on an even greater scale. ‘We have been in a general positive trend since 2001, although cycles can be superimposed on that,’ he says.
Besides industrialisation, there is still a long way to go in the urbanisation of China. Per capita incomes are still only 13 per cent of those in the US and there are just 33 cars per 1,000 people, compared to 800 in the US. If development continues at the current rate, 50,000 new skyscrapers will be built in China by 2025. All this requires vast quantities of metals and aggregates.
Some of the big mining houses which had spent the 1990s cutting back production, anticipating modest world growth, were slow to recognise the signs from the East and even those such as BHP that did spot it (hence its merger with Billiton in 2002) could not crank up production quickly enough. The result is an impending shortage of supply of most metals and coal that cannot be rectified quickly. New minerals have to be found and once found, developed – a new mine takes between five and ten years to bring to full production. In a world where most of the major mineral deposits in developed countries have already been identified and developed, the miners need a renewed spirit of derring-do to find new resources.
For the past decade, most of the big mining houses have relied on the more junior speculative companies to go forth and explore. The successful ones would then be snapped up by the giants; but for the past year the credit crunch has deprived most of these smaller explorers of capital, making the shortage of new deposits for development ever more acute. So the big mining houses are faced with rethinking their exploration policies, either by beefing up their exploration teams or by taking stakes in smaller companies.
God, as Rudolph Agnew said when he was chairman of Consolidated Gold Fields, did not put mineral wealth in politically stable countries. Huge undeveloped mineral wealth has been identified in lawless and war-torn lands in Africa from the Democratic Republic of Congo to Equatorial Guinea. The prizes may be huge, but a tetchy dictator can withdraw a licence or nationalise the assets on a whim. Even in relatively stable countries such as Argentina, the government can slap on a punitive new tax, as it did recently with copper.
Nevertheless, ways will be found. Last year, while the credit markets were frozen in terror, the Chinese went on a spending spree for both licensing deals and smaller companies. Analysts estimate that the Chinese spent roughly $20 billion buying up smaller mining companies in Africa last year and as much as $70 billion worldwide. (Chris Wright explores the huge potential spending power of China Investment Corporation in this sector on page 31.)
But to handle such risks and to afford the increasing development costs of operating in such complex areas takes muscle and expertise, which is why it is important not only to be big but to be globally diversified.
The synergy of a takeover by Xstrata for Anglo is clear. Xstrata is a major copper and zinc producer and the world’s largest producer of coal, all of which feed early stage urbanisation. Anglo’s main assets are diamonds and platinum – it produces 40 per cent of the world’s platinum – both of which are used in later stage consumer goods. One of the reasons platinum has been so weak recently is due to the sickly car industry where it is used in catalytic converters for diesel engines, but if and when the US and European economies pick up, it will come into its own.
But Xstrata reckoned without the seasoned hand of Sir John Parker, who was drafted in as chairman in July, shortly after the approach. Parker is an ace turnaround merchant of the old school and his experience in shipbuilding and coal mining gives him a rare understanding of both mining and basic industries. Parker skilfully boxed Xstrata into a corner with a ‘put up or shut up’ demand and Davis opted to shut up, putting the deal on ice. So Parker has six months’ grace to knock the staid Anglo into a more nimble, modern corporation – or at least to make a good start on the process.
Long-term followers of Anglo expect its hallowed Johannesburg headquarters, where the tick of the Victorian grandfather clock still dominates the reception lounge, to be slimmed down and modernised. The board will be ‘refreshed’ by the arrival of some heavyweight non-executive directors – RBS chairman Sir Philip Hampton was their first appointment – and doubtless the departure of some passengers. Anglo has already announced some divestments and the removal of a global layer of management.
For investors who love to speculate, the lure of junior miners on the exploration trail will always be strong, but they are only to be touched with a small fraction of a portfolio. Gold, meanwhile, appears to be reaching the top of this particular cycle. The bogeyman of inflation is still a long way off and talk of gold replacing the dollar as a world currency is somewhat overdone. The current flurry of gold conferences and advertisements for gold coins normally heralds the top of the market.
The best bets on worldwide economic recovery are the diversified mining groups. From the chart it is clear that Xstrata outperforms on the way up and underperforms on the way down. With its high proportion of earnings coming from copper and coal, it is the most geared to the Chinese recovery. A consensus of analysts believe that on a multiple of just over ten on forecast 2010 earnings, Xstrata looks the cheapest of the big groups. The management intend to use paper for acquisitio ns and history shows that the share price is also the most volatile.
Better all-round value is to be had from Rio Tinto on 11 times 2010 earnings. Rio is possibly the best diversified of all the groups, having exposure to most metals from iron ore to gold, with the extra kicker of aluminium which is also used in infrastructure projects. It has a long track record of sound management and solid returns.
BHP Billiton has an oil division as well as a broad spread of minerals and with low debt and high cash flows is more likely to be a bidder than a target. Finally, there is Anglo American which is already on a multiple of 16 on next year’s predicted earnings. If any rival bidder emerges, Xstrata will have to pay a significant premium to the current price. Shareholders can expect a flow of bullish news.
Judi Bevan is the author of The Rise and fall of Marks & Spencer and Trolley Wars: The Battle of the Supermarkets
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