Xstrata Courts Anglo American, Does This Merger Make Sense?

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One can’t help feeling much of the enthusiasm for the proposed merger between Xstrata and Anglo American is coming from investment bankers and lawyers looking at the fees. Savings are projected at $700-875m according to estimates made by Citigroup, Merrill and Nomura reported in the Telegraph this week. In terms of rankings by market capitalization the two firms are among the top ten and combined would place them above Rio. But it is their rankings in terms of debt that is more interesting. Following what in hindsight have proved disastrous acquisitions (at least in terms of price paid) over the last 5-6 years both companies have grown significantly but at the expense of building huge debt mountains. While companies like Freeport-McMoran purchased assets and promptly reduced debt by rights issues and reduced dividends during the boom times such that now the firm sits with just over $6bn in net debt, Xstrata purchased Eland Platinum and Falconbridge Nickel at or just before the height of the market. They now have over $16bn of net debt while Anglo has an additional $11bn. After Rio has completed its rights issue and taken the balancing payments from BHP for the merged iron assets, a combined Xstrata/Anglo will probably top the net debt league amongst miners. $700-800m of savings, though welcome, is hardly a panacea for the companies’ ills. Particularly as the management team at Anglo is said to be far from cooperative in their dealings with Xstrata following previous hostile takeover attempts. This may prove to be the biggest block to achieving a successful merger, management enthusiasm and commitment.

Xstrata is said to be the world’s largest coal exporter according to MineWeb and Anglo is no slouch either. Combined they would become a very significant player in the coal market with earnings in excess of $5.5bn from coal alone. Anglo has the largest platinum holdings by way of its 80% share in Anglo Platinum but Xstrata is also a player via their acquisition of Eland and 25% holding in Lonmin following an abortive bid to buy the whole firm last year just as the markets crashed. Although PGM’s are very depressed at the moment, at some stage when demand returns, that dominance in the sector could create significant leverage opportunities. Both companies have iron ore production facilities and combined may earn themselves negotiating rights, if not with the big three then at least as a credible alternative with Asian buyers desperate to diversify supplies to significant others. Last but not least the two firms are significant copper producers and combined they may rival Freeport-McMoran in terms of scale. We haven’t seen a valuation on their copper assets but according to Timesonline, Xstrata is particularly bullish on the potential savings achievable by merging the two companies copper operations and their coal operations. Unfortunately, Xstrata’s shareholders did not agree, the share price dropped 7% on the news!

–Stuart Burns

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