UPDATE:Xstrata wants Lonmin’s platinum

Xstrata (XSRAF-O, XTA-L) wants to widen its reach in its efforts to become the world’s pre-eminent diversified miner.

On the heels of announcing third quarter results, which it says were saved by diversification it credited strong copper and coal prices with counter-balancing falling nickel and zinc prices it announced a hostile bid, that if successful, would catapult it into the upper echelon of global platinum producers.

The offer is for the world’s current number three producer, London-based Lonmin (LMI-L), and amounts to a $10 billion offer.

That breaks down to 33 a share — a 42% premium on Lonmin’s closing price on Aug. 5 but news of the hostile attempt rallied Lonmin shares up to 34.26 on a volume of roughly 15 million shares.

Lonmin is not impressed.

Especially since the offer came at a time when its shares were trading for just 22.17 compared with their 35.96 close in the middle of May.

“This is an opportunistic move by Xstrata which attempts to capitalize on the current volatility in financial and metal markets,” Sir John Craven, Lonmin’s chairman said in a statement. “Lonmin will contest this approach vigorously. It undervalues Lonmin’s unique business and fails to deliver appropriate value for Lonmin’s shareholders.”

Those words contrast starkly with Xstrata’s, which sought to paint itself as the one company that could save Lonmin from itself. Lonmin has consistently missed its own production targets, frustrating investors and leaving it vulnerable.

“I believe strongly that Lonmin can be returned to its former production levels and growth trajectory but this will require a fresh approach to the operational and organizational strategy to realize that value over time,” Xstrata’s chief executive Mick Davis said at a conference.

Alison Stent, a London-based analyst with Blueoar Securities, expects shareholders to be favourable to Xstrata’s position.

“Lonmin’s third quarter results don’t help it in manning a defence,” Stent says. “They’ve missed production targets once again and they’ve given no guidance on production going forwardMy personal view is that Lonmin investors may take this.”

Additionally, Lonmin may have few other options.

Any list of possible white knights would include the usual suspects: BHP Biliton (BHP-N, BLT-L), Rio Tinto (RTP-N, RIO-L), Norilsk Nickel (NILSY-O, MNOD-L) and Vale (RIO-N). But BHP and Rio are entangled in their own possible merger, Norilsk is suffering under political issues in its homeland of Russia and Vale — after a failed attempt to acquire Xstrata — has said it is concentrating on smaller takeovers and internal growth.

“Rumours have been going around for some time that Xstrata was looking at Lonmin, and with the price of platinum and the share price falling Xstrata’s been quite clever with their timing,” Stent says.

If Xstrata can complete the takeover it would put itself on the fast track to achieve its stated platinum growth strategy.

The company has a goal of hitting 1 million oz. of platinum production within 10 years through organic growth alone.

With Lonmin’s assets, however, it could reach that number by the end of next year provided it can meet the challenges that have kept Lonmin off target.

While all platinum miners in South Africa took hits from recent power shortages a chief culprit in the run-up in the metal’s price earlier in the year — Lonmin has hit snags unique unto itself.

There has been inconsistency with ore feed, maintenance problems with the smelter, labour issues and difficulties in ushering a new era of mechanized mining a transition that analysts says is sorely needed in South Africa.

Those factors have forced Lonmin to consistently shave back its production targets.

It had originality anticipated producing 900,000 oz. of platinum for 2008 but reduced that forecast to 770,000 oz. only to reduce it yet again on the day of Xstrata’s bid no less — to 725,000 oz.

What’s more, Xstrata contends, the company’s management structure is large and complex and its head offices in London are out of touch with operations in South Africa.

“(Lonmin’s) centralized organization strategy is at odds with Xstrata’s approach to devolving authority and accountability to the operation level and integrating activities such as safety into operational responsibilities,” Mick Davis said.

While not known as a significant platinum producer, Xstrata is touting its technical expertise and experience within South Africa as keys to its ability to turn things around.

“Xstrata do have the right kind of people to make a difference,” says Charles Cooper an analyst with London-based Evolution Securities. “Not just on the operational side but also in terms of understand how to utilize other areas within Bushveld Igneous Complex.”

Lonmin’s flagship project in the Bushveld — Marikana — sits just 10 km from Xstrata Alloys’ Wonderkop complex and its ferrochrome smelters. So while Marikana leaves chrome in its tailings, Xstrata would be able to make that chrome economic.

“It’s not big numbers,” Cooper says of the potential chrome revenues, “but little bits and pieces here and there combined with their technical expertise and the financial muscle of Xstrata with help of Glencore, all of it would help.”

Xstrata signaled how serious it was about platinum last year when it acquired South African platinum producer Eland Platinum for US$1 billion. It has expansion plans for the Elandsfontein PGM mine and concentrator it acquired that aim at increasing production to 600,000 oz. of platinum group metals by 2013.

Beyond the Eland acquisition Xstrata also has platinum experience through its Mototolo joint venture with Anglo Platinum (AMS-J).

And on the same day it announced the Lonmin bid, Xstrata solidified its exploration position in the Bushveld through a joint venture with Nkwe Platinum (NKP-A). The deal gives Xstrata a 50% option over five prospective properties in the Eastern Limb of Bushveld.

And to bulk up its position in Lonmin regardless of how its bid goes, Xstrata announced it had upped its stake in the company from 8% to 10.7% in after market trading on Aug. 5 the evening before the bid was announced.

All of Lonmin’s project are situated in South Africa and have a combined mine life of 30 years. South Africa alone is responsible for 77% of global platinum production.

News of the bid was seen as driving force behind platinum’s rally on Aug.6 it gained 4% to finish the day at US$1,613.50 per oz. That reversed a three day trend that had shaved 10% off the metals price.

Powerhouse metals dealer Glencore is the largest shareholder in Xstrata with roughly 35% of the company, hence the deal is being read by some as a positive indicator for where platinum prices could be heading.

Xstrata says it believes platinum demand will outpace supply by 500,000 oz in 2008 despite a weaker car market in the U.S. and Europe. Autocatalyst demand is expected to come largely from China where stricter environmental regulations will necessitate the use of platinum.

But Stent is sceptical.

She believes a combination of sluggish western auto sales and declining jewellery demand which is known to be price sensitive will exhibit downward pressure in the coming months.

Blueoar’s forecast for platinum for 2009 is US$1,600 oz. and long term prices are forecasted at US$1,300 oz.

Cooper’s view is more inline with Xstrata.

He agrees that Chinese and eventually Indian auto demand will compensate for the downward trend in west and, he says, platinum enjoys a favoured status in the jewellery world that can protect it from global economic slumps.

As an indicator of that status he points out that while demand for lower quality diamonds has dropped with the recent economic downturn, high quality diamonds have remained at lofty price points.

Most importantly for Cooper, however, is the supply situation.

“Fundamentally in the platinum market there is a large deficiency up into the early part of the next decade,” he says. “We’d have
to see a 35% drop in demand to erase that deficit. So while we’re not as big of bulls as Xstrata, we’re certainly bullish.”

Xstrata says the offer would be funded through cash at hand and bank debt but chief financial officer, Trevor Reid, insisted that any addition of debt would not affect the company’s credit rating.

The takeover bid came as Xstrata reported profit of $2.75-billion, or $2.87 per share, in the first half of the year — an 8% loss compared to the same period last year.