Glencore and Xstrata to seek merger approval in Brussels
Despite earlier statements that Xstrata and Glencore would not need to seek approval from the European Commission the parties have now decided to submit their case for approval in Brussels.
The companies argue that there is no significant increase in market domination because of the strong ties the companies already had prior to the merger.
The European Commission will now have to decide on the potential restrictions to the new company, such as the obligation to sell certain elements of the business. A market density index calculation is used to see whether or not the new company would have a too dominant position. The big uncertainty in this calculation is how the Commission will scope the market or markets the companies are active in.
Vedanta merges Indian assets to create Indian mining giant: Sesa Sterlite
Vedanta has decided to merge all its Indian assets, including Sesa, Sterlite, and Cairns India, into one big Indian company. This new Entity will be named Sesa Sterlite and will have a market capitalization of around $22bln. Vedanta will hold just under 60% of the shares.
The Mongolian government plans to list a significant part of Tavan Tolgoi, a large coking coal project in the south of the country, in both London and Hong Kong this summer. Regulatory issues threaten to delay the HKEx listing.
The government plans to eventually hold 51% of the shares, give 20% to the population, sell some 10% to local business at a discount, and make the rest available to international investors. A significant part of the 20% given to the population might find its way to international investors.
The creation of Sesa Sterlite builds both a second diversified miner with a significant oil & gas business (next to BHP Billiton) and a second diversified miner with a significant interest in zinc (next to Glencore/Xstrata).
If Vedanta manages to both make the merger integration of the 7 or more individual companies a success and to manage its investments in other developing countries successfully, it creates the primary candidate to become the stable Indian mining giant. Growth of the Indian industry is phenomenal but faces many challenges. The mixture of a very strong Indian foothold with high growth assets in many other developing countries could prove to be a good basis for risk diversification.
Conflict arose in the board of Bumi, the Indonesian coal miner with the investor Nathan Rothschild as a large investor after a reverse takeover of the Vallar investment vehicle. After initial conflicts the Indonesian board members planned to remove mr. Rothschild from the board, but he now only appears to have to give up his co-chairmanship. Share price of the company dropped significantly after the news of the conflict.
(Higher prices + higher costs) x lower volumes = lower profits. That was the story of the results releases of the world’s largest miners this week. The impairment taken by Rio Tinto on the Alcan acquisition costs probably was the most significant item, together with the relatively positive outlook given after the negative and uncertain signals given about global demand in the past months.
BHP (58%) and Rio (30%) expand Escondida at $4.5bln cost
BHP Billiton and Rio Tinto announced investments of $4.5bln to replace the plant at Escondida, the world’s largest copper mine in output, increasing capacity and enabling mining restricted by the current facilities.
February is the month in which most of the world’s largest diversified miners present their annual results (only BHP Billiton runs a different fiscal year). The investor presentations provide interesting reading and give a good idea of the vision for the future of the industry. Below a peak preview with the most insightful slides from the presentations:
Anglo American – Price benefit achieved mainly in first half of year
Rio Tinto – 2011 in Summary: high prices are the only good news
BHP Billiton – Cost pressure is high, but not structural
Rio Tinto – Borrowing to pay out next to all investments
Anglo American – restarting the diversification discussion
Xstrata – Supply constraints lead to the Glencore merger
For several years Xstrata and Glencore, with over 30% its largest shareholder, have been linked in rumors of mergers. This week both companies released statements to announce that Glencore has now officially started the merger procedure. As a result Glencore is required to come up with an official proposal by early March. However, analysts expect an agreement to be reached much faster.
Glencore is the world’s largest commodity trader and also owns operating assets for several commodities, most notably copper, zinc, and coal.
Xstrata is the world’s 4th-largest diversified miner, grown rapidly in the past decade by a series of acquisitions.
Last year Glencore became a public company, putting an official market value on the company. This step was seen as a requirement to convince Xstrata’s other shareholders to discuss a merger.
Why does a merger make sense?
Although the mining industry only very slowly moves in this direction it makes sense to combine raw material production and marketing and processed goods production and marketing in one company. The vertical control over the value chain provides flexibility to react to sudden opportunities in the global marketplace. The 3 pictures below illustrate Glencore’s view of these arbitrage opportunities: geographical, product, and timing arbitrage. The larger the company is and the more overlap between marketing and production, the larger the rationale for merging. Estimated synergies of the Glencore-Xstrata merger are close to $1bln annually, mainly due to increased revenues (whereas most mining related M&A is driven by cost reducing synergies).
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What could go wrong?
Two important things could make the merger fail. The first could even prevent it from happening at all:
1. Antitrust - Glencore is the absolute market leader in trading of various commodities. Any increase of power in these areas would trigger action by antitrust regulators around the world. To get approved, the deal will have to be structured in a way that ensures both supply substitution and demand substitution; i.e. all market parties should be able to get around Glencore-Xstrata as customer or as supplier.
2. Corporate culture - Glencore is a company built on the two-thousand marketeers & traders, while Xstrata is run like a typical conservative mining company. Traders are typically very smart, aggressive, impatient, rational, office-workers. Miners are ‘roll up your sleeves’, ‘move the dirt’, operational guys with only very few of the highly schooled trading-types among them. To make these two groups of people not only work together smoothly, but to integrate the companies so that departmental interests and emotions are fully aligned with the larger companies objectives is going to be a major challenge, in which many employees from both sides might choose to leave the company to find a place where they are more comfortable.
Vale announced its plans to appeal to the governments intent to charge $5.6bln worth of taxes on foreign earnings. The clash with the government promises to be the first real test for the new CEO Murilo Ferreira.
Mr. Ferreira took over the leadership of the company from Roger Agnelli, who was not reelected partly based on a disagreement with the government (which is control Vale via state-controlled shareholders) over $2bln taxation.
Rio Tinto increased its ownership of Ivanhoe from 49% to 51%, giving it full control over the flagship Oyu Tolgoi copper project in Mongolia, the world’s premier copper development project.
Vale estimates the impact of a review of the tax code on the company’s earnings to be approx. 4-5% of earnings. Taxation regimes around the world for specifically iron ore and copper mining are reviewed to make the countries benefit more from ‘extreme’ profits, which could be seen as a temporary phenomenon. However, the key issue in Vale is facing now is a debate about double taxation; paying taxes over profits after taxes realized in countries where the company is operating.
Rio Tinto’s control over Ivanhoe will help the company to put in place its management structure and have the project managed by some of its top project developers. Gaining full control of the project in this stage will help Rio Tinto to build the project according to the company’s standards, preventing costly and above all time-consuming future transitions in the operating structure. The global standards that enable effective project management more and more set the world’s largest miners apart from the ‘small’ mining firms with only a few operating assets. Very much like GE has become known as a great ‘project management company’, the world’s largest miners are more and more developing into ‘mine development’ companies in which development speed is the key success factor and navigating politics in developing countries is a key skill.
BHP Billiton and Rio Tinto deliver record production in Pilbara
This was another record-breaking year in the Pilbara with both quarterly and full year iron ore production. Record global iron ore shipments of 239 million tonnes in 2011 were below production due to extreme weather conditions experienced in the first half of the year. Despite this, Rio Tinto’s Pilbara ports operated at above annualised capacity rates and shipped record volumes of 61 million tonnes in the fourth quarter and 225 million tonnes for the full year.
While scheduled maintenance, tie-in activities and the wet season in the Pilbara are expected to affect Western Australia Iron Ore production in the second half of the 2012 financial year, full year production is now forecast to marginally exceed prior guidance of 159 million tonnes per annum.
Vale proposed a minimum dividend of $6bln for the year, an increase of over 50% versus the previous year’s minimum payment and in line with the actual dividend payment over 2011.
Rio Tinto and BHP Billiton continue to build capacity in the Pibara iron ore district. With relatively low mining costs and close proximity to the Asian/Chinese market this iron ore region is the most competitive (and largest) producer in the world. As the output in Pilbara is exceeding expectations and Chinese growth is slowing, exporters in other regions face an uncertain future. The global iron ore market is slowly evolving to a scenario where Brazil and Western Africa supply ore for the European market and the Latin American growth market, and Australia supplies iron ore for Asia.
Vale’s increase of dividends fits in the trend of recent dividend increases in the industry and is a clear sign of uncertainty in the boardrooms of many companies: organic investment opportunities and development capacity are limited, share buybacks and cash takeovers would increase leverage and vulnerability, and with the uncertainty about future economic developments many companies decide to give the cash to shareholders in an attempt to keep share price high.
ENRC agreed to pay $1.25bln to First Quantum to settle the dispute over the Kolwezi Tailings project, the Frontier and Lonshi mines and related exploration interests in DRC. First Quantum was stripped of the rights to these projects by the government, after which ENRC came in and agreed to buy the rights from the government in a move widely criticized in the industry.
Coal India, by far the largest miner of energy coal in the country, has agree to a 25% permanent increase of wages. In august of last year the unions demanded a 100% increase to offset increased cost of living and reduce the increasing income gap between management and workers. Investment bankers at the time expected the company to agree to a 15-20% increase. The salary hike results in an increase of operating cost for the company by approx. 10%.
Weather in Australia and Brazil drives iron ore price up
The closure of the export facilities in Port Hedland because of cyclone Heidi and the cancellation of shipments from Brazil because of heavy rains results in supply pressure in the iron ore market. Heavy rains are expected to continue in the Pilbara region, which supplies close to 40% of seaborne iron ore in the world, in the short term.
Extreme weather conditions have a big influence on bulk material supply chains in the short term, because stockpiling these materials in amounts large enough to last for several weeks is very costly and thus not a normal practice. Especially the steel industry is hit hard with both iron ore and metallurgical coal having to be shipped in from locations that are often hit by storms. Although the impact on spot prices in the short term can be large, the longer term impact on the miners is quite small. Most contracts allow for some flexibility in when exactly the ore is delivered. As long as the mining operations don’t have to stop, the ore will get to the steel manufacturers as some point.
The wage increase expected for Coal India is a good example of the very high cost inflation of mining in developing countries. Whereas the cost increase of contracted services and equipment leasing can be seen as (at least partly) a temporary phenomenon caused by high commodity prices, the cost increase because of increased labor and consumable costs in developing countries causes a more permanent shift of the global cost curves.
Alcoa cuts aluminium production in fear of lower demand
Alcoa announced shutdown of 532,000 tonnes of smelting capacity at the top of the cost curve to lower production costs and improve competitiveness. The 12% reduction of capacity mainly hits operations in the USA.
Potashcorp temporarily closes a third mine because of low demand
After recently temporarily closing down Lanigan and Rocanville mines, PotashCorp now decided to temporarily close Allan mine to because of lack of demand for fertilizer. The combined shutdown of the three mines results in approx. 1 million tonnes of potash, or some 10% of the company’s annual production.
Unions in Canada and Zambia make their case for wage increases
A union representing copper mine workers in Zambia signaled the foreign miners will have to agree to higher salary increases than the average offer of 11% to prevent widespread strikes. At the same time Rio Tinto Alcan and Caterpillar are taking a strong position against unions in Canada by locking out union workers after expiry of the negotiation periods.
The mining industry for the last 2 years has been and continues to be gripped by 2 paradoxical fears:
The fear for slowing demand due to the lack of recovery after the financial crisis – With the financial crisis over 4 years old already the typical macro-economic cycle of 6-9 years has clearly been disrupted. Governments and companies are still operating in ‘crisis fighting’-mode because demand does not pick up like after a regular economic downturn. Large investments are still undertaken because the belief in the long term demand driven by population growth and growth of average GDP/capita is unchanged, but at the same time companies are trying to manage short term lack of demand by scaling down or temporarily closing operations.
The fear for strikes and civil unrest resulting from struggling individuals facing mining companies that continue to realize high profits – Despite the financial volatility the commodity prices generally have remained high, making mining companies among the few companies in the world that continue to generate high profits. With people around the world facing the economic crisis and feeling its impact, friction develops between the rich companies and the less well off workers and neighbours.
Australia solicits Chinese infrastructure investment
The government of Western Australia is trying to speed up the development of port and rail facilities of the Mid West region’s Oakajee port by stripping the Mitsubishi/Murchison combination of exclusive development rights and inviting Chinese parties to step in. 8 of the 14 projects in development in the region have Chinese investors.
Yanzhou’s Australian coal company Yancoal will merge with Gloucester coal, 64.5% owned by Singapore-based Noble group. As a result Yancoal obtains a listing on the Australian stock exchange, a condition put on the 2009 acquisition of Felix Resources
Anglo American launched a range of claims in Chilean court trying to prevent Codelco from being awarded the right to buy a full 49% of the Minas Sur assets. The scope of the option for Codelco to buy 49% has been unclear since Anglo sold a 24.5% stake to Mitsubishi. In response to Anglo’s claims Codelco restated its intention to acquire 49% of the full project.
As expected Chinese investments have proven to be a key driver of M&A activity in the mining industry in 2011. It is noteworthy that many Chinese firms are using a foreign based subsidiary or team up with a Western firm to do foreign investments. This structure holds 2 main benefits for the Chinese investors: they obtain an experienced western staff with knowledge of the way of doing business in the target countries; and they are viewed much more favorably by regulators when trying to execute deals.
The fight of Anglo American and Codelco over Minas Sur appears to become a long term court fight. The longer this court fight stretches, the more inclined Anglo American will be to find a compromising deal, as the uncertainty about the ownership structure will delay all investment decisions for the company in the mining region.
Freeport reached a two year extension of the collective labor agreement at its Indonesian Grasberg mine after a 3-month strike. The new agreement holds a 40% wage increase over 2 years, improved benefits, and the promise to base wage future negotiations on cost of living and competitor benchmarks.
Only days after the announcement of the agreement a helicopter transporting Freeport’s workers was shot at close to the mine, wounding one person.
Less than a year after being put up for sale and then declining all offers made Whitehaven teamed up with Aston Resources to create the largest listed coal mining company in Australia with $5.1bln market value. The deal is structured as a shares only acquisition of Aston by Whitehaven.
The South African court ruled that the department of mines had no right to grant the mining rights of Sishen iron ore mine in the country to a junior mining company with strong ties to some influential politicians, but that instead the Kumba Iron Ore holds the rights to the mine. Kumba is majority owned by Anglo American.
The coal mining industry in Australia is still relatively fragmented, with both the diversified supermajors and many domestic listed and unlisted companies active in the industry. Because the mining districts are much less concentrated than the iron ore or gold districts of the country it is harder to achieve economies of scale that would justify many mergers. The deals taken place are mainly based on transportation and sales negotiation synergies.
The Wall Street Journal published a good, readable, article this week describing the developments in the mining industry, signaling the combination of two key drivers this year: declining prices, and increasing costs. The resulting low margins will move the focus of many mining companies in the coming years to cost control. However, the winners of this cycle will be the companies that manage to invest during this period with lower profits to build capacity that will make them benefit from the structural increase in prices that will be caused by the structural price increases in the industry. Clearly not all cost increases are structural: equipment and contractor scarcity is mainly a temporary result of an overheated industry; but cost increases resulting from the move to harder forms of mining will stick.
After 5 years as CFO of the world’s largest miner Alex Vanselow (Brazilian national) announced he will step down and look for a CEO position in the industry. Mr. Vanselow managed to get BHP through the economic downturn in great financial shape (helped by high commodity prices). His recent experience in acquisitions of Chesapeake assets and Petrohawk and the failed acquisitions of Rio Tinto, Potashcorp, and the failed Pilbara JV with Rio Tinto, make him an interesting candidate for any resources company looking to grow by M&A.
In a legal fight over the rights to the Anglo American Sur project Anglo’s lawyers blame Codelco and the Chilean government to act unfairly. Codelco holds an option to buy 49% of the project, but it is unclear whether that is only of Anglo’s stake or of the total project.
BHP Billiton announced it will review its options around its only diamond project: Ekati diamond mine in arctic Canada. Rio Tinto, which owns the nearby Diavik diamond mine, is the most likely buyer because of the synergistic potential and the lack of funds and abundance of capital spending needs of other large diamond miners.
Mr. Vanselow will be an interesting candidate for global companies looking for a change of CEO. As Brazil’s Vale recently changed CEO and Petrobras’ Gabrielli de Azevedo is widely recognized as a strong CEO with work to do he will most likely look to head up a foreign player. The ideal period for a CEO is typically seen as 6-8 years: after that a new point of view and a new alignment with the personality needed for the phase of a company is often helpful. Taking a look at the top positions of the world’s largest miners at this moment, several CEO position changes can be expected over the coming years.
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