De-spinning the Anglo American/Xstrata myths

Whatever happens, investment bankers and their sidekicks are going to make hundreds of millions of dollars from spinning this festival; here's the bottom line, for free.

JOHANNESBURG  - 

Whatever the outcome of Xstrata's "merger of equals" with Anglo American, a proposal that's at "a very preliminary stage", says Anglo American, investors can rest assured that investment bankers and their sidekicks, not least tardy lawyers, are going to pocket hundreds of millions of dollars from the festival. A good deal of the effort is going to go into spinning stories aimed at winning over influential investors. Given that Xstrata is ranked the potential predator, here are the some of the salient facts. 

Cash flows

Since its London IPO in 2002, when it raised USD 3bn in cash, Xstrata has spent USD 38.5bn on acquisitions; more than 90% of that in the form of cash. Over the same time period, Anglo American has spent a net USD 4.9bn on acquisitions. Unlike Xstrata, which started out in 2001 with a bunch of coal assets from still-controlling shareholder Glencore, Anglo American has long had assets earmarked for selling, a position that holds to this day. Anglo American has, for example, banked billions of dollars in cash selling down it stake in AngloGold Ashanti. The net acquisitions figure here of USD 4.9bn for Anglo American excludes the USD 3.7bn unbundling of Mondi, a dividend in specie, to the benefit of Anglo American's shareholders. 

Debt

A merged Anglo American-Xstrata would create the world's most indebted mining company, with net debt of close to USD 21bn, at this stage, based on disclosures by the companies. Erstwhile net debt leader Rio Tinto is now rapidly reining in its situation, with USD 15bn in cash on the way from a rights issue, and a further USD 5.8bn likely from a joint venture iron ore equalisation payment from BHP Billiton, the world's biggest diversified resources company. Xstrata would be contributing the biggest chunk of debt in any proposed Anglo American-Xstrata business combination. 

Cost of capital

Given that Xstrata has spent USD 38.5bn on acquisitions since 2001, after raising USD 3bn cash upon its IPO, and has received a further equivalent of USD 6.8bn in cash from a rights issue earlier this year, investors may want to ask what Xstrata's real cost of capital is on nearly USD 50bn in cash. In the same vein, while Anglo American passed its 2008 final dividend, apparently for the first time in 70 years, Xstrata also passed its 2008 final dividend. Xstrata took nearly 60 years less to equal Anglo American on that one. 

Cash handling and market value

For the way it has handled cash of close to USD 50bn since 2001, investors award Xstrata a current market value (capitalisation) of USD 31bn. For net acquisitions of roughly zero over the period, and an annual dividend of around USD 1.6bn, more than twice that paid by Xstrata, Anglo American is valued by investors at USD 37bn. 

Control of cash flows

Coal and base metals are the two biggest divisions in Xstrata, by far. In its coal division, the single biggest mine tonnage for Xstrata comes from Cerrejón Coal, in which Xstrata holds 33%; Anglo American and BHP Billiton also own a third each. Across the rest of its coal division, Xstrata always holds more than 50% of a mine, but in only a few cases, 100%.  

In its base metals division, the biggest mine by tonnage, Collahuasi, a copper mine in Chile, is 44% held by Xstrata; Anglo American also holds 44%. The second biggest base metals mine in the Xstrata stable, Argentina's Alumbera, is 50% held by Xstrata; the other two key shareholders are global Tier I gold stocks Goldcorp and Yamana. 

The third biggest base metals mine in the Xstrata stable, Antamina, is held 33.75% by Xstrata, 33.75% by BHP Billiton, 22.5% by Teck, and 10% by Mitsubishi Materials. Anglo American also is impacted by a number of important investments where it does not hold at least 50% of the asset, and thus exert a material influence over cash flows.  

A paucity of overlapping interests

Beyond base metals and coal, Anglo American and Xstrata overlap only in the area of platinum, where Anglo American is totally dominant, with its 80% stake in the world's No 1 player in platinum group metals, Anglo Platinum. That leaves ferroalloys, which Anglo American exited in 2005, when Samancor Chrome (60% BHP Billiton and 40% Anglo American) was sold. Most of Xstrata's ferrochrome capacity, also located in South Africa, is currently idled. 

As to assets on the ground, there are but few, as mentioned, where Anglo American and Xstrata overlap. 

Project pipeline

Anglo American has a substantial pipeline of long term projects, where Xstrata appears to compare unfavourably, as shown by any independent comparison of recent presentations by Anglo American CEO Cynthia Carroll and Xstrata CEO Mick Davis. The differing profiles of the two groups are consistent with Anglo American's history that stretches back nearly a century, and Xstrata's, which is yet to be around for a decade.  

Anglo American continues to make significant moves into the ferrous area; at USD 6.2bn, Brazil's Minas-Rio comprises the group's biggest acquisition for years, since the USD 1.3bn spent on Minera sur Andes in 2002. Minas-Rio will take years and billions of dollars to mature even at Phase I level, but it is clearly headed to ranking as a world class player in seaborne iron ore, for years now ranking as the world's most lucrative mining franchise. The development of this theme is consistent with Anglo American's longer term bid to enter this space, including USD 536m spent to acquire control of Kumba Iron Ore in 2003. 

Over the past decades, Anglo American has had disappointments in the field, pulling out of the bidding for Australia's North, which went to Rio Tinto, and also out of the initial privatisation of Brazil's CVRD. The latter would shortly mature into the world's No 2 miner by value, Vale. Three of four of the world's biggest miners, by value, rank as holders of 70% of the global seaborne iron ore market: Vale, Rio Tinto, and BHP Billiton.  

Given the ebb and flow in global cycles, Rio Tinto was financially crippled by its USD 38bn acquisition of Alcan in 2007. It seems that with Rio Tinto safe enough for now, in announcing a supported rights issue to raise the equivalent of USD 15bn, and agreeing a joint venture with BHP Billiton over the two companies' West Australian iron ore assets, valued at USD 116bn, Xstrata and Anglo American are going to have to feed the modest fee accounts of investment bankers and their cohorts. 

Anglo American has a number of other projects available in the forward kitchen. The 50% held Pebble project, with Northern Dynasty, is just one of a number of giant possible metals projects for Anglo American in the years ahead. For Xstrata, the focus is clearly on focusing on existing operations; Xstrata's capacity for further acquisitions is severely hampered, leaving it to make a last ditch attempt to wrest control of the bigger Anglo American.  

The bottom line: no deal

There may be a few operations where Anglo American and Xstrata could extract some "optimization" costs, such as Collahuasi, and, less likely, Cerrejón, but, based on the overall metrics, a no deal between the two groups appears to be a no brainer. Less than a year ago, Davis bought 1.28m Xstrata shares at GBP 41.70 per share, for his only account, after dispatching a GPB 45.00 per share approach from supergroup Vale. 

While the Xstrata stock price would fall to as little as GBP 2.89 a share, and later recover to current levels around GBP 6.40 a share, Davis clearly has reasons to do a deal, reasons that apparently did not apply when Vale was around. So far as is known, Vale has not been back for a second sniff, despite an Xstrata stock price that was to fall by more than 90%.  

The costs stink

In a 2005 filing with the SEC in Washington, Gold Fields, a global Tier I gold digger, disclosed USD 50.8m under the classification "Harmony hostile bid costs". This referred, of course, to an earlier hostile bid by peer group Harmony, a bid that was to fall apart amid acrimony and controversy. While both companies have since been restructured under new CEOs, Harmony, the hostile bidder in the story, today carries a market value of USD 4.4bn, and Gold Fields, one of USD 8.1bn.

Anyone familiar with that story will tell you that Harmony needed to upgrade the overall quality of its assets, needed another deal, as its income statement came increasingly into focus, and was inspired into a hostile bid that had the chance of a snowball, albeit a big one, in hell. It never needed investment bankers, and their motley attendant crews, to work that one out, and they will not been needed here either. But still, they will earn hundreds of millions of dollars, about double the costs of the Gold Fields-Harmony debacle nearly five years ago, and then involving entities with far smaller market values. 

Disclaimer

MINEWEB is an interactive publication, with rolling deadlines through each day, commencing in the Sydney morning,  and concluding, 24 hours later,  in the Vancouver evening.  If you believe your side of an issue deserves inclusion, but has failed to meet one of our deadlines, you are invited to notify the Editor in Chief in Johannesburg, and we will include you in our editing and expanding on our stories. Email him at alechogg@gmail.com

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