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Alcoa Deal Not Certain

An acquisition may not be right for BHP or Rio Tinto.

A report that diversified mining giants

Rio Tinto




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may both want to buy aluminum smelter


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for up to $40 billion may be little more than a banker's fantasy.

The story, from the London-based


newspaper, would be the latest transaction in string of recent monster deals across the metals sector, should it actually go through.

Late last year,

Freeport-McMoRan Copper & Gold

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struck a $26 billion acquisition plan for

Phelps Dodge

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, and before that there was a bidding frenzy in which a bevy of firms, including Anglo-Swiss concern


, Canada's

Teck Cominco


, Phelps and Brazil's

Companhia Vale do Rio Doce

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, went after Canada-based nickel miners




. Eventually Xstrata won Falconbridge, while CVRD took Inco.

That recent history may have some investors thinking that it's only a matter of time before the aluminum basin catches fire also. However, such a view would be ill-conceived, because the acquisition of Alcoa makes little sense for either BHP or Rio Tinto.

For starters, the market for aluminum isn't the same as for nickel, or even copper, the underlying metals for the other transactions mentioned above.

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It's true that aluminum prices have lagged while other metals have spiked. Aluminum currently sells for around $1.25 a pound, double where it was five years ago, but during the same period copper prices have more than quadrupled from 60 to 70 cents a pound to $2.55 recently. Last year, copper surged close to $4 a pound.

Meanwhile, nickel, which last year sold for around $15,000 a metric ton, now commands prices approaching $40,000.

Such performances may have some ill-advised speculators thinking aluminum is due to catch up and eventually be pulled higher by the generally rising tide.

But that's a hard-sell, because growth in aluminum demand is being met with solid increases in supply. Stocks in London Metal Exchange warehouses now total more than 750,000 metric tons, (1.7 billion pounds) -- plenty to avert any near-term tightness that might send prices shooting skyward.

"Aluminum market fundamentals are less compelling than they were last year," says Gayle Berry, research manager at Metal Bulletin Research in London, who notes that modestly higher prices have prompted increased production of the metal and alumina, the main raw material. She sees demand growing steadily as China's economy expands.

Other observers seem to agree.

"Supply and demand for aluminum will grow roughly in line with each other," says Neil Buxton, managing director at GFMS Metals Consulting in London. "We're not really looking for massive swings."

In simple terms, he's saying the market will remain balanced. And unlike with other metals, there are few supply or technology worries likely to interrupt production.

To make aluminum, all that is required is alumina, a supply of electricity and a smelter. They call this a basic industry for a reason.

By contrast, nickel is impossibly tricky to produce in volume, and alumina is more common than copper ore.

Those underlying fundamentals leave some analysts predicting a broad softening. "Aluminum prices are past their peak," says Jeff Christian, managing director at New York-based specialty consulting firm CPM Group. He sees a 15% dip over the next 24 months or so.

Now let's presume that the folks at BHP and Rio Tinto, who already know all of this, decide to go ahead and jump further into aluminum anyway. The next question becomes, why Alcoa?

"It's not particularly cheap," says Brian Hicks, co-portfolio manager of

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U.S. Global Investors Global Resources Fund. The stock is currently trading at about 11 times consensus profit estimates of $3.09 a share for next year's earnings. While that might sound inexpensive relative to other industries, it's not when compared to the sector.

Freeport-McMoRan trades at a similar multiple, as does


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Hicks points to

Century Aluminum

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, which is selling for less than eight times next year's earnings, as a better value in the space.

Shares of Alcoa rose 6.4% to $35, Rio Tinto gained 3.1% to $216.94, and BHP advanced 2.3% to $45.02.

Then there is the question of what such an acquisition would do to the balance sheet of either acquirer.

Depending on how the deal is structured, it could put pressure on the debt ratings of the potential buyers, says Tom Watters, credit analyst at rating agency Standard & Poor's in New York. Currently, both the possible acquirers hold stable A+ ratings, while Alcoa was recently dinged down to a BBB+, he says.

He also points out that Rio Tinto and BHP are classic "rock crushers," whereas Alcoa has downstream operations where products are semifabricated.

On the off chance that the deal is further along than fundamentals suggest it should be, one long time deal-watcher sounds a note of caution.

"Managers, directors and investors should view this

type of possible transaction cautiously," says Bob Bruner, dean of the University of Virginia's Darden Graduate School of Business Administration and author of the book

Deals From Hell

. "We know that the worst deals are hatched near the peak of the M&A cycle."

The big question is whether we're closing in on such a peak now. In part, that would be determined by how long the flow of cheap capital keeps running.

BHP and Rio Tinto are remaining predictably tight-lipped. Alcoa wasn't saying much either.