Smoke, mirrors, and financial returns

Differences between financial metrics at Anglo American and Xstrata are akin to the somewhat slight variations between cheese and chalk.

JOHANNESBURG - 

By now thousands of words have been written, and even more spoken, about diversified transnational miner Xstrata's charm offensive, of Wednesday last week, when it published a detailed "merger of equals" discussion document over its unofficial bid for  Anglo American, after the initial proposal was completely rejected by Anglo American seven days ago, arguing that "the terms proposed by Xstrata were totally unacceptable".

Beyond the documents that have been publicly aired, there is strenuous lobbying going on behind the scenes; the more the story develops, the more confusing it seems to become. Along with BHP Billiton and Rio Tinto, the two parties engaged in verbal conflict comprise the Big Four London diversified mining stocks. While Anglo American traces its roots back to 1917, Xstrata was unfurled in 2001 when a bunch of Latin American mining interests were re-launched, and a batch of coal assets were injected by Glencore, mainly a commodities trader, and, like Xstrata, based in Switzerland.

Xstrata was unleashed on the wider world in 2002, with its initial public offer (IPO). Xstrata's one-time raison d'être was summed up in its 2002 annual report: "One of the key investment propositions set out at the time of the IPO was that there existed a niche in our industry for a fourth, London-listed, diversified metals and mining company, with headroom to grow. 

"It was our strong conviction that if Xstrata were to leverage the advantages of its size, momentum and financial structure to grow its portfolio, through steps that were in themselves value creating, then the market, in time, would reward the subsequent diversification of commodity, currency and earnings risk, by re-rating upwards the multiples on which we trade". 

Given its unofficial bid for Anglo American, Xstrata has clearly abandoned its idea of being a niche player.  Why this should be so has not been explained, but clearly, Xstrata has no intention of unbundling itself and quitting on targeted achievements which have now apparently been abandoned. 

Xstrata's 2002 London IPO raised some USD 2.9bn in cash, with shares sold at GBP 8.70 each. The stock price would eventually peak out during 2008 around GPB 42.00 a share, before crashing down more than 90% to less than GBP 3.00 a share in March this year, before, in turn, then recovering to around GBP 6.65 today. This is less than the IPO price.

Between 2001 and today, Xstrata has raised USD 16bn in cash from investors; more to the point, perhaps, is that there has been an expansion of more than ten fold in its issued shares, from 251m upon IPO to just short of 3bn today. At the other diversifieds, there has been an intense focus on driving issued share numbers down by mounting share buy back programmes; objectives achieved over the period, on a net basis, by BHP Billiton and Anglo American. 

Between 2001 and today, Xstrata has spent nearly USD 40bn, most of it in the form of cash, on acquisitions. The strategy, or "culture", at the other three diversifieds has been very different. Over the period 2002 to date, the four diversifieds have paid an aggregate USD 32.8bn in cash dividends to shareholders (with 5% of that number contributed by Xstrata). Buy-backs of stock, also a form of returning value to shareholders, have aggregated USD 30.1bn (with 5.5% of that accounted for by Xstrata). 

Apart from Xstrata, only Rio Tinto has also raised capital through a rights issue, one that's currently underway. Rio Tinto recently abandoned its posed near-USD 20bn capital injection from smaller rival Chinalco, replaced instead by the announcement of a general rights issue to raise the equivalent of USD 15.2bn, and agreement of a monster joint venture with BHP Billiton over the two companies' West Australian iron ore assets, involving 18 mines, two railroads of more than 1,000km each, rolling stock, port handling facilities, and ports.

Most of the period between 2001 and now fell within the so-called commodities supercycle, which commenced early in 2002 and eventually terminated, for most traded commodity prices, with a vengeance, in mid-2008. The era inspired some significant merger and acquisition (M&A) transactions, including the zealous USD 38bn cash takeover of Alcan by Rio Tinto in 2007. 

The incident, allied with Rio Tinto's current rights issue, severely undermined Rio Tinto's measured returns from 2002 to date, when accounting for dividends paid, share buy backs, and rights issues, among London's Big Four diversifieds. On this metric, however, Xstrata remains far behind its competitors. BHP Billiton has returned a net USD 25bn over the period, Anglo American a net USD 20bn, while Rio Tinto has absorbed a net USD 1bn; Xstrata, the smallest, has absorbed more than USD 12bn. 

Given the broader allocation of capital by investors, it may be useful to observe that between 2002 and the present, more than USD 40bn in cash returned by BHP Billiton and Anglo American to investors has been used, in part, to the tune of more than USD 13bn, to finance the adventures of Xstrata and Rio Tinto.

Like its Big Three London competitors, Xstrata maintained a policy of paying dividends and staging buy backs over the period. Buy backs by any company are, of course, premised on the notion that long term shareholders will hold ever-increasing percentage stakes in corporate profits and dividends.

Thus, in year one, a 10% stake in a company would be allocated dividends equal to 10% of the overall dividend pie. A decade later, given net stock buy backs, the initial 10%  stake would be an enlarged percentage, and would receive not only a bigger percentage of the overall dividend, but also possibly benefit from an overall bigger dividend.

In Xstrata's case, however, a 10% stake in the group in 2002 would today amount to a stake of just 0.89%, assuming that the shareholder did not follow any rights issues. In financial parlance, this is sometimes described as dilutitive. 

Xstrata's acquisitions frenzy was only partly fuelled by cash that could have been returned - at least in part - to investors; it was also supported further by rights issues, but also lots of - growing - debt. While far bigger Rio Tinto ended 2008 as the world's most indebted mining company, its rights issue means that Rio Tinto's issued shares will increase above the levels that prevailed in 2002. At BHP Billiton and Anglo American, shares now in issue are below the numbers seen in 2002. 

Xstrata ended 2008 as the world's No 2 most indebted mining company, with USD 16.50bn in net debt, followed by the likes of unlisted Rusal (USD 14.00bn), Teck (USD 11.65bn), Anglo American (USD 11.00bn), and Evraz (USD 9.28bn). 

For reasons that remain unclear, Xstrata chose not to address its debt challenges by issuing paper into either the corporate bonds market (a debt market), or the convertibles market, a hybrid instrument classified as debt, but which can later normally be converted to equity by holders. 

Instead, Xstrata found itself earlier this year in a hugely dilutive rights issue, issuing 1960m new shares, tripling its shares in issue, to raise the equivalent of USD 6.7bn. A number of big miners have this year issued corporate bonds, where creditworthiness is essential. 

Anglo American also issued convertibles, and, as mentioned, Rio Tinto has embarked on a rights issue. A number of companies have this year raised substantial billions of dollars by selling earmarked legacy assets; Rio Tinto, for example, sold its potash assets to Vale, the world's No 2 miner by value, for USD 850m, and Anglo American sold its final tranche of its shares in AngloGold Ashanti for USD 1.2bn. 

Xstrata, apparently unable to access further bank debt, or the corporate bond and/or convertibles market, bucked the trend by making yet another acquisition; it spent USD 2bn of cash it raised from its 2009 rights issue to buy Prodeco, a Colombian coal asset, from Glencore, which supported Xstrata's rights issue. If Anglo American and Xstrata were to merge today, consolidated debt of the new entity would likely comprise the world's most indebted mining company. 

While a merger between Anglo American and Xstrata would no doubt have a number of positive spin offs for Xstrata's applicable debt covenants, both companies, along with practically all mining companies outside gold specialists, have to continue facing the margin compression that set in for most commodities around mid-2008. Most prices have been recovering this year, but from a low base. 

Company reporting so far this year shows that while established gold miners continue to make reasonable to good profits, seaborne iron ore is the only area where solid profits are still being made. That is one area that Xstrata did not venture into, and one area when Anglo American has been making inroads, but that is another story. 

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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Related Links ARTILCES:  Billions of dollars down the tubes  Carroll in peril as Anglo tries to ward off Xstrata  Anglo American seeking China deal to ward off Xstrata - reports  Miners bruised, but standing firm  OTHER PAGES:  MINING FINANCE / INVESTMENT AFRICA

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responses to this article

Strategy Come on Barry, don't you see that Mick has a PLAN. He will get Dave King in to oversee production, and then will surely be invited to list on the NY big board, and all will be fine. by ST on June 29 2009, 10:12 Find this comment inappropriate? Report it

AAC- Xstrata The vultures are gathering and the sharks sniff blood in the water- Cynthia is viewed as weak, and a gap has opened. Someone will take it unless it is closed soon...... by Vaalseun on June 30 2009, 00:56 Find this comment inappropriate? Report it

Xstrata If it comes off, Glencore will have converted a bunch of ordinary assets into cashable shares in less than 10 years. by Bill Melville on June 30 2009, 19:34 Find this comment inappropriate? Report it

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