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Alcoa Bid Fires Up Alcan

Simon Constable

Updated from 11:41 a.m. EDT

Alcan (AL Quote) soared 33% Monday after aluminum rival Alcoa (AA Quote) unveiled a $27 billion unsolicited merger proposal.

Alcoa's deal would give shareholders of Montreal-based Alcan $58.60 in cash and 0.4108 Alcoa shares for each Alcan share held. Alcoa said the deal is worth $73.25 a share at Friday's prices -- a 20% premium to Alcan's trading price.

Alcan said its board would look into the matter.

"Consistent with its obligations and focus on delivering value to shareholders, Alcan's Board of Directors will consider the proposal and how it could impact the interests of Alcan's shareholders and other stakeholders," it said in a midmorning announcement.

"Alcan's Board of Directors and management remain committed to building and delivering value for shareholders and other stakeholders, and believe that Alcan's strategy and recent performance and accomplishments clearly demonstrate this commitment."

With the end of trading near, Alcan was climbing $19.99 to $81.02, and Alcoa rose $2.91, or 8.2%, to $38.57.

Alcoa said it made the bid after "almost two years of discussions between our companies regarding a variety of potential business combination transactions, including unsuccessful board-level discussions of a merger transaction last fall."

Alcoa said it hopes to cut costs by $1 billion annually after closing the deal. It sees completing the transaction by the end of the year.

By appealing directly to investors and going around management, Alcoa is making what is normally referred to as a hostile takeover bid. The company said its offer for shares of Alcan will begin Tuesday.

The move comes as something of a surprise, as few on Wall Street would have foreseen Alcan being bought out at these levels. Plus, some market observers had believed Alcoa itself might potentially be acquired at some point.

Both companies have a shared history and were once part of the same organization. The company that is now Alcoa chartered its Canadian unit as Northern Aluminum in 1902. The company became known as Aluminum Company of Canada in 1925.

Three years later, when Alcoa divested most of its non-U.S. assets, a business called Aluminium Ltd. was established to run the majority of the interests and became the parent of Aluminum Company of Canada. The Aluminum Company of Canada changed its name to Alcan Aluminum in 1987 after the acquisition of British Aluminium and various other assets.

Alcoa said the combined company would be "a stronger, more diverse global competitor with the scale and cost structure to be competitive over the long term within a rapidly changing industry landscape."

The new company would have dual head offices in Montreal and New York, with management functions located in each city. Montreal would be the headquarters for the global primary products business, which entails bauxite, energy, alumina and aluminum.

Had Alcan and Alcoa been one in 2006, the joined company would have had revenue of $54 billion. Alumina capacity would have been roughly 21.5 million metric tons, and aluminum capacity would have totaled around 7.8 million metric tons. Together, the company would employ 188,000 workers in 67 countries.

The transaction is subject to review by antitrust authorities in the U.S., Canada, the European Union, Australia and Brazil. It also requires foreign investment clearance in Canada, France and Australia.

Even though the market's reaction to the deal was positive for both stocks, that doesn't necessarily mean it's a good time for investors to buy shares of either smelter, because analysts say the aluminum market is set soften over the coming months.

"This year we are expecting a fair amount of capacity to come on stream in China and Iceland and Russia," says Catherine Virga, a metals analyst at New York-based specialty consulting firm CPM Group.

She says China alone will see aluminum output capacity jump 25%, with an overall global increase of 8%. That compares with projected growth in global demand of only 6.7% in 2007.

Virga says that although the surplus will likely be relatively small by historic standards, speculators have already bid up the benchmark price for aluminum for delivery in three months time "beyond a level reflected by the fundamentals."

At the end of last week, the three-month London Metal Exchange price was around $2,830 a metric ton. Virga believes that will decline to an average of $2,615 this year and further in 2008. Inventories on the LME are edging higher compared to where they were at the beginning of February, but prices have remained steady, in sharp contrast to copper prices, which have rallied from around $5,300 a ton to more than $8,000.

The aluminum industry has only a handful of major players, meaning the market leader can create dominance by achieving economies of scale, thus shaking out the smaller producers over time, explains Bob Bruner, dean of the University of Virginia's Darden Graduate School of Business Administration.

Or put another way, the combined Alcoa and Alcan could have the power to discipline higher-cost producers, which are typically smaller in size, by from time to time flooding the market with additional metal output, he says.

It's a strategy that, Bruner adds, is technically illegal under U.S. and European Union law, but one which has been hard to prove historically, especially against producers of commodities. Bruner is also the author of the merger and acquisition tome Deals from Hell.

Still, he acknowledges that driving aluminum prices down to hurt modest-sized smelters would also weigh on Alcoa-Alcan in the short term. If such tactics were employed, investors should expect margins to get squeezed and the stock to stagnate, at best, he cautions.

Another problem for the combined entity will be escalating power costs, which have risen faster than metal prices, says Brian Hicks, co-manager of the (PSPFX Quote)Global Resources Fund at San Antonio-based U.S. Global Investors. Energy constitutes a major part of the expense of converting bauxite ore into aluminum.

"The companies are looking for ways to cut costs," he says. However, even with the projected $1 billion in savings, he's not tempted to add stock in Alcoa to his portfolio. With Alcoa trading at around 12 times next year's consensus earnings estimate of $3.11 a share, he thinks the stock is fairly valued, especially given that the company is at the top of the cycle.

Alcan fetches about 14.5 times next year's projected earnings of $5.56 and is also fairly valued, he says.

Hicks says there's the possibility that one of the large diversified miners, such as Rio Tinto (RTP Quote) or BHP (BHP Quote), could make a bigger bid for Alcan.