Xstrata eyes 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 that it says were saved by diversification — with strong copper and coal prices counter-balancing falling nickel and zinc prices — Xstrata has announced a US$10-billion hostile bid, which 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).

The offer is for 33 per share, or a 42% premium on Lonmin’s closing price on Aug. 5 — though news of the hostile attempt quickly rallied Lonmin shares to 34.26 on a volume of roughly 15 million shares.

Lonmin’s management says it’s 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,” 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.”

Xstrata, meanwhile, is seeking to paint itself as the one company that can save Lonmin from itself. Lonmin has consistently missed its own production targets, frustrating investors and leaving it vulnerable.

“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 of the bid.

Alison Stent, a London-based analyst with Blueoar Securities, expects Lonmin 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 forward. My personal view is that Lonmin investors may take this.”

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’s goal is to hit 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 its smelter, labour issues, and difficulties introducing mechanized mining at its operations — a transition that analysts say is sorely needed in South Africa.

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

It had originally anticipated producing 900,000 oz. of platinum in 2008 but reduced that forecast to 770,000 oz., and then 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 office in London is out of touch with operations in South Africa.

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

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

“Xstrata does 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 understanding how to utilize other areas within the 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.

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

Xstrata signalled 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, aiming at increasing production to 600,000 oz. of platinum group metals by 2013.

Beyond the Eland acquisition, Xstrata 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 the Bushveld.

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 projects 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 metal’s price.

With roughly 35% of the company, powerhouse metals dealer Glencore is Xstrata’s largest shareholder, 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 more platinum.

But Stent is skeptical. She believes a combination of sluggish Western auto sales and declining jewellery demand — which is known to be price sensitive — will exert downward pressure in the coming months.

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

Cooper’s view is more in line with Xstrata. He agrees that Chinese and eventually Indian auto demand will compensate for the downward trend in the West. 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 ones have remained at lofty price points.

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

“Fundamentally in the platinum market there is a large de
ficiency 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 a platinum bull as Xstrata, we’re certainly bullish.”

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

The takeover bid comes as Xstrata reports a profit of US$2.75 billion, or US$2.87 per share, in the first half of the year — an 8% decrease compared to the same period last year.