The base metals patch looks more than ever like a rugby scrum gone wild.
Friday's $15 billion all-cash bid by Brazilian iron ore producer
Companhia Vale do Rio Doce
to acquire Canadian nickel miner
is only the latest marriage proposal in a sector determined to get hitched.
Other players in the frenzied war for nickel include Swiss miner
, Canadian nickel producer
, Canada's zinc mammoth
and U.S. copper giant
. Both Teck and Phelps have offers outstanding for Inco, while Xstrata is finalizing its acquisition of Falconbridge.
The whole crazed bidding battle raises the question: When will the madness end?
Some investors, such as hedge fund Atticus Capital, no doubt hope it will be soon. The firm, which recently
upped its stake in Phelps Dodge, has consistently opposed the Inco deal, preferring management would buy back stock or put the company on the block.
It's as if Atticus views Phelps Dodge's acquisition strategy as some sort of economic crime being perpetrated by out-of-control management, which, in turn, says Atticus is too focused on short-term strategies.
Thursday's late-session rallies in Teck and Phelps, despite a day of red ink in the metals patch, suggest that some investors may have had advanced warning of the Companhia proposal and were elated with the possibility that the proposed acquisitions of Inco (which also jumped just before the close) may fall through.
On Friday, Inco and Teck Cominco shares were recently up 3% each, while Phelps Dodge was up 2.4% and Falconbridge by 0.3%. CVRD shares were recently down 1.8%.
Means, Motive and Opportunity
Stockholders of takeover targets such as Inco and Falconbridge will certainly want the bidding wars to continue, with future bids extending already good gains. Share prices for both miners have almost doubled since the beginning of January, fueled in part by the bidding war and partly by supercharged metals prices.
It seems that those hoping for more M&A activity will get their wish, as metals-mining chieftains have the means, motive and opportunity to continue the shopping spree.
The means is an abundance of cash in the base-metals business. Despite recent reports of a possible future dip in prices of key industrial materials, such as copper (used for electrical wiring) and nickel (vital for production of stainless steel), no one is predicting a meltdown of the sort seen around the turn of the millennium, when, for instance, copper prices hit record lows of 60 cents a pound. Instead, Asian economies look likely to keep buying shiploads full of metal.
"China has the power to continually surprise on the upside
with regard to demand," says Kona Haque, a senior commodities economist at the Economist Intelligence Unit in London. "Then there is the possibility that supply will not come on line as quickly as expected."
Haque sees prices dipping to $2.53 a pound in 2008 vs. $3.465 in recent Comex trading Friday, and she's not alone in seeing softness. London-based specialty consulting firm Bloomsbury Minerals Economics sees prices averaging $2.64 a pound in 2008.
But with production costs averaging $1 a pound, according to Metal Bulletin Research's metals analyst Andy Cole, that will mean that base-metals miners will continue to fill their saddlebags with gobs of cash for some time to come. And that bullish story isn't limited to copper, with nickel and zinc looking strong also.
Of course, management isn't restricted to acquiring other entities with the green stuff. They now have a highly valued currency in the form of stock. For instance, Phelps stock is now trading around $90 vs. the mid-teens in late 2002. Although CVRD is proposing to use cash to nab Inco, its stock is up big time too: shares closed at $22.89 Thursday vs. trading between $3 and $4 for most of 2002. Both the Teck and Phelps offers involve stock.
So why would managers determined to tie the knot with other firms, such as those at Phelps, Teck and CVRD, remain deaf to some investor concerns? The answer, it would seem, comes down to compensation.
"Larger organizations are more complex and that would lead to larger job value and therefore higher pay," says Irv Becker, regional head of executive compensation at global human-resources consulting house Hay Group. "Executives understand that job size and complexity can be driven by the size of the organization."
Or more simply put: if an executive can grow the firm into a sprawling conglomerate of mind-boggling, complexity they stand to gain with bigger pay checks. Even a casual observer of recent corporate history understands executive greed is a powerful motive.
"Boards of directors have been slow to catch on that it's not book value that matters, but rather returns," says Bob Bruner, Dean of the Darden graduate school of business administration.
Hence, managers have the opportunity to run hog wild.
"The buoyant parts of a market cycle tend to draw into the action investors that are less sophisticated and perhaps more motivated by the frenzy of action than those who are more disciplined," he says. And sometimes executives know what the right thing to do is, but do the wrong thing anyway, Bruner adds; other times they simply "delude" themselves.
"CEOs outlined in my
Deals From Hell
book are commonly given to the most optimistic about benefits from a deal, when in fact, prudence would be better," he says.
For those that can spot future takeover targets, there are good profits to be had. One company curiously absent from this summer's merger talks has been $10 billion market cap
Freeport-McMoRan Copper & Gold
Despite monster earnings last quarter, which almost doubled vs. a year before, the company continues to be dogged by a lousy BB- credit rating on its approximately $1 billion of debt, which puts it deep in junk territory.
This issue is partly the location of Freeport's mine in Indonesia. Credit rating agency Standard & Poor's, which upgraded Indonesia's currency at the end of July, didn't shift the company's credit rating, calling it "constrained by Indonesia's unpredictable judicial system," in a press release.
Freeport's lower credit rating may make it an attractive proposition for more diversified miners better able to absorb the company onto a much larger balance sheet. Such obvious candidates would include behemoths
both rated A+, and perhaps even CVRD, which holds a BBB+ rating. All of those companies are big enough to easily absorb Freeport, should they choose to do so.
But whether Freeport's a target or not, it's clear the mining merger mania isn't going to abate anytime soon.