Analysts ponder fate of copper companies

The battle for control of Rio Algom (rom-t) is keeping mining analysts busy in what would otherwise be a quiet Canadian summer. Talk on the street is that Noranda (nor-t) will boost its $24.50-per-share bid now that rival Billiton has offered $27 per share, or $1.7 billion, to acquire control of the Toronto-based miner of base metals.

Canaccord analyst Mark Horn notes that Billiton’s friendly bid represents a 10% premium to Noranda’s hostile offer, yet he does not appear to find the deal particularly attractive for Billiton. “The strategic rationale for the deal appears simply to be to increase geographic and product diversification. There are no synergies of any significance to be extracted from the combination of the two groups. We are of the view that this deal dilutes Billiton’s position in the value-chain ladder.”

What Horn means is that through exposure to aluminum, titanium and ferrochrome, Billiton is near the upper rungs of the commodity value-chain ladder and has close relationships with its end-user customers. Copper producers tend to have little or no connection to their end-users.

What’s more, he points out that Rio Algom will have a copper cost of US70 per lb., including acquisition and project debt-financing costs, whereas the long-term copper price forecast is about US75 per lb. “As such, there is a very slim margin from which to cover the cost of the acquisition and to make the deal earnings-enhancing,” Horn writes.

Accordingly, the analyst has issued a “take profits/sell” recommendation for Billiton, which trades at about 2.93 on the London Stock Exchange.

Horn’s colleague, Greg Barnes, has meanwhile issued a “sell” recommendation for Rio Algom, the target of the takeover activity. “The market strength that has greeted Billiton’s higher bid, we believe, is a good opportunity to realize a strong gain in what has been a poor investment climate for mining stocks, and we continue to recommend selling into the strength,” Barnes writes.

Rio Algom is currently Canada’s second-largest copper producer, with most of its new growth projects based in Peru and Chile. The company has 60.6 million shares outstanding, and its stock trades at about $28.

If it is successful in its bid, Noranda will sell half of Rio to the world’s largest copper miner, stated-owned Codelco (Corporacion Nacional Del Cobre de Chile). Unlike Billiton, Noranda stands to benefit from operating synergies with Rio Algom. The two are already one-third partners at the developing Antamina copper-zinc project in Peru.

The prospect of Rio Algom disappearing from the Canadian market has promoted Canaccord’s Greg Barnes to issue a “strong buy” recommendation for Aur Resources (aur-t), which he describes as potentially “the only one pure copper producer on the Canadian scene.

“With the pending acquisition of a 76.5% share interest in the Quebrada Blanca copper mine in Chile,” Barnes adds, “Aur will have transformed itself from a junior metals producer to an intermediate mining company with solid and growing copper production.”

The US$134-million acquisition is expected to triple Aur’s annual copper production to more than 220 million lbs. from 70 million lbs. Copper reserves would quadruple to more than 2 billion lbs.

“An acquisition of this size does not come without risk,” Barnes concludes. “The level of debt Aur is taking on means that the next two years will be primarily focused on debt reduction.”

Barnes has set a target price of $4.25. Aur currently trades at about $2.30 per share and has 75.7 million shares outstanding.