New world order

Competing takeover bids for base metal producer Rio Algom can’t have come as a surprise to too many industry-watchers. For three years now, the seers have been predicting consolidation in both the base metal and gold sectors.

Trend-spotters love to think they are the first to see the revolution coming. The mining industry was due for a wholesale shakeup, and would end up with just a handful of behemoths running the show. Nothing would ever be the same.

The minuet danced by Phelps Dodge, Grupo Mexico, Cyprus Amax and Asarco last year reinforced the view that the bigger fish would be eating the smaller ones. But it is perhaps significant that Asarco ultimately went to Grupo Mexico, rather than join Cyprus in Phelps Dodge. The lesson may be that takeovers will happen only when the buyer can afford them, and that wholesale consolidation may be too rich a meal for even the biggest companies.

The merger of Franco-Nevada Mining and Gold Fields was the loudest shoe to drop in the troubled gold industry, and it found a nearly instant echo when Newmont Mining and Battle Mountain Gold announced their merger. Unlike their counterparts in the base metals business, gold producers face an uncertain future for their commodity, and that knowledge has led many producers to look for low-cost production. Acquisition is easier than exploration and development, provided you have the money, and the pace of mergers in the gold industry has reflected that.

Coupled with that urgency, the unbundling of the South African mining houses (and the emergence of new, large gold producers, such as Durban Deeps and Harmony) has made deal-making (and sometimes deal-breaking) a matter of course over the past couple of years.

There has been a generally accepted notion that consolidation is both inevitable and good for the industry. The argument has been made that, as market capitalizations in other industries ballooned, mining companies would have to get bigger to show up on institutional investors’ radar screens.

That notion, though, seems to be one of those abstractions that neatly explain the superficial, especially in the case of the Rio Algom battle. The reality may be different. Noranda made its offer largely because its downstream assets had begun to outweigh its upstream ones, and taking over Rio offered a chance to buy some badly needed copper reserves that would provide dedicated feed, particularly to the Altonorte smelter. Codelco joined Noranda out of a recognized need to diversify out of purely Chilean assets — it should not be forgotten that Codelco is looking at acquisitions in the Zambian copper belt in a conscious effort to “internationalize.”

Billiton, similarly, sees a takeover of Rio as addressing specific corporate interests. Billiton’s base metal business unit is the smallest one in the company, dwarfed by its much larger aluminum, ferroalloys and coal businesses. Commodity diversification is a healthy move for Billiton, considering the experience of those companies that embraced the idea of being a pure-commodity “play” in recent years — a look at share prices in the gold sector should be a convincing enough argument.

In short, the takeover players are all in the game for reasons readily distinguishable from the pull of the stock market and the compulsion to make a deal.

Perhaps most of all, merger mania reflects just how cheap mining companies have become, particularly in relation to their net assets. Rio Algom was trading at $18 a share when Noranda made its bid — about two-thirds of the company’s book value. In the circumstances, a takeover bid was very nearly a no-lose proposition.

However the fight for Rio Algom turns out, we can probably expect more fireworks in the base metal and gold industry over the next year or two. Other companies are underpriced and widely held, and offer attractive value for a cash-rich rival.

Big companies need big mineral deposits to mine. Development thresholds get higher, and profitable projects are passed over because they are too small. That spells opportunity, invariably. Consolidation in any industry generally means one thing: smaller and nimbler competitors will appear, and the mammals will dart between the feet of the dinosaurs.

We know how that one turned out.