Mining and metals: All that glitters

As cited in the recent Part One of this survey, M&A activity in the mining and metals space was mostly noticeable by its absence last year. And the private equity portion within that was miniscule. But the consensus among the 1,200 industry delegates and investors that attended last week’s BMO Capital Markets Global Mining & Metals Conference in Hollywood, Florida last week – the world’s biggest – is that the sector may be in the midst of a major inflection point, more or less across the board.

Still, there is a catch lurking under this:  that the fulcrum around which these hopes are centered is ongoing and expanding demand from China.

BMO research concludes that industrial commodities will perform very well into 2011, and over the longer term as well. The main driver is double-digit growth in China which, while comparatively poor at 8.2% last year, is now forecast to expand to 10.3% in 2010 and perhaps further to 10.5% in 2011.

There are others, however. Another is synchronized global growth. This shrank by 1% in 2009; but BMO’s call is 3.7%+ in 2010. Also, in the US specifically, where growth plummeted by 10% in 2009, it’s now projected to grow by 3.5% this year.

The inventory factor

“Currently, the commodity market is pretty robust, despite the recent market correction,” says BMO Capital Markets global commodities strategist Bart Melek.

As well, (commodities) inventories around the world fell substantially as a consequence of the most marked decline in global economic activity since the 1930s.

“For that reason, we’re not only anticipating an increase in actual bids for commodities, but also a robust re-stocking scenario,” Melek explains. “Inventory-to-consumption ratios are very low, and as demand moves higher it will become necessary, if for no other reason than logistics, to beef these inventories up. That further boosts the consumption story, and in fact is driving the very strong import activity into China that we’re seeing as regards most commodities.”

Other spurs are the supply constraints – varying by metal and mineral – that are scattered across the segment.

Perhaps the best example is copper, which mining expertt Robert Friedland has characterized as “the thinking man’s metal,” because of its breadth of use and therefore demand.

Although the immediate impact on production of the recent devastating earthquake in Chile – perhaps the prime source of supply worldwide – was small, it will still have a hefty impact on the prevailing copper shortage, which explains the concomitant price spike above already high levels.

“Even though the Chilean production downturn will likely be less than 50,000 tonnes over the year (which isn’t much relative to the global total of 15.7 million tonnes mined annually), we reckon there’s only a surplus of about 110,000 tonnes worldwide in 2010; so the Chilean quake will cut this in half, meaning you can make markets quite tight,” Melek explains.

That’s why BMO has picked copper as its Number One commodity. But there are also concerns about the availability of platinum and silver in particular, among the precious metals, plus the ubiquitous iron, metallurgical coal, gold and, of course, oil.

Multiple drivers are in play on the demand side as well, from worries re: sovereign debt (led by Greece) and longer-term global economic prospects (gold being the ultimate hedge), to the massive stimuli applied in the US, Europe and China, which is fuelling infrastructure and industrial activity increases. BMO projects iron ore prices rising by a whopping 40% in 2010-11 as an example.

But again, it has to be noted that “…the primary driver in all these commodities is China, and that will remain true for the next several years.”

Intersect with Asia-linked M&A

As to what all this means for Asia-linked deal activity, the answer is a lot, particularly in an M&A context.

Sharad Apte, a Singapore-based Bain & Company partner and head of the firm’s energy practice in Asia, and Alan Bird, a London-based Bain partner and global head of their mining practice, offered this perspective as regards regional mining and metals M&A potential:

“There are two main drivers,” they told AVCJ. At the global level, this means that “…size (often) matters to existing mining companies, particularly at a local level. Such companies generally see value in scale as it allows them to handle the volatility around pricing, and diversifies their portfolio across multiple geographies.”

Natural resources companies tend to operate in some of the world’s riskier political environments, and therefore value such diversification. As a result, Bain sees further consolidation, and therefore M&A, in the mining and metals space generally in the coming years as the large players like BHPB, Vale, Rio, Anglo, Xstrata, and the like, seek to bulk up, and the mid-sized and smaller players either get acquired or merge with each other to build scale.

Secondly, they note that “…China is looking to strategically aggregate or acquire the natural resources that it believes are critical for its long-term growth and pace of industrialization.”

This is a long-established theme by now, of course. But it has picked up a sharp new edge with the PRC’s huge trove of trillions of US dollars that it believes may be declining in value.

“Using that USD currency to acquire needed national resources, which will undoubtedly be in short supply in the future, is one mechanism to help China hedge their USD exposure,” Apte and Bird believe.

Consolidation – top to bottom

Andrew Dale, head of mining and metals research in Asia with Macquarie, concurs, and adds a close focus view on China in particular:

“I’d say there’s a lot of potential for M&A. But it’s a bit tricky with Chinese companies because they tend to be SOEs, so there’s a lot more in play than simply market-driven activity. They’re also driven by regulatory and governmental factors.”

He’s seeing numbers of transactions already, though they’re primarily small-scale and in the domestic segment, and so mostly unreported. The point, however, is that it’s the same big-buying-small scenario seen at the mega-international level, the driver in both cases being the quest for scale.

“There are thousands of small operators in mining, as there are in nearly all industries in China. The government’s got a push on the consolidation, and an easy way to do that is to encourage M&A,” he told AVCJ.

This is especially clear in China’s steel industry, though deals are complicated by backroom plays due to such companies’ importance to provincial governments, so there is always drama around who will run the merged entity, where the tax money will flow, how many people will be laid off, and so on.

A similar situation exists in the PRC cement industry, and coal – with government pressure to clean up being another imperative that the latter has to contend with.

In other mining subsectors, such as aluminum, copper, gold and so on, the focus has been to look offshore for targets; and the coal industry fits into this paradigm as well.

Offshore obstacles

Not surprisingly, however, the theme of Chinese miners moving offshore implies a number of obstacles, and it’s believed that these will likely act as a retardant in this theme.

Inexperience is one. Modes of operation that are effective in China don’t really play abroad, and so a number of the deals that have already been done have proven problematic thereafter. Political risk – in Africa for example – is another.

“This isn’t to say that Chinese outbound is losing steam, however. It’s more like staying slow and steady, operating as quietly as possible. There are some obvious areas of interest, like Australia, for instance. But it’s really commodity-specific,” Dale explains. “Iron ore is topical. But most assets have been crawled over; meaning there are not that many obvious opportunities. Coal is also complicated. But mostly it relates to areas that are in close proximity to China, e.g. Australia and Indonesia. And it will be opportunistic.”

The funding imperative

Consolidation on these various levels is not the only industry driver, however. From the collective viewpoint of international miners, the long lead times now needed to get a mine up and running, plus increased currency exchange costs, capex costs and the like, have made them ravenous for funding – at a time when their conventional sources, from stock markets to international banks, have been unable to provide it (though there are signs this is changing).

As the Bain partners put it:

“Given the GFC, and the resulting difficulty that some mid-size and smaller players have had accessing capital, a number of them are looking to other capital providers to help them fund their growth. This will provide sovereign wealth funds (SWFs) and private equity with a new opportunity to invest in this space.”

And most industry players are well aware that where Chinese stock markets raised an aggregate of some $50 billion+ last year, US stock markets corralled only $30 billion+. So eyes are moving east, and the sentiment heard more than once out of the recent BMO conference was: “…there is just tons of money over there.”

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• Industrials
• Greater China