2007 was a record year for transactions in the mining and metals sector, with the pace of industry consolidation showing no sign of abating. The key drivers for mergers and acquisitions (M&A) in the sector have been high commodity prices, resource security, delays in bringing on new projects, achieving greater marketing muscle and risk diversification. China and India, in particular, lack sufficient natural resources to maintain their current growth rates and are seeking greater access to raw materials. Deals made by Brazil, Russia, India and China (the BRIC countries) between 2000 and 2007 have increased by over 1,200%. This trend is likely to continue. Countries with resource security concerns have been perceived by the market to be buying assets ‘at any price’. The reality is that these countries are prepared to pay a strategic premium to secure assets.
Ernst & Young research has shown that mining stocks have been, and continue to be, undervalued. Analysts’ predictions since the beginning of 2005 have lagged metal prices and this has created a valuation gap. As a consequence, the market has assumed premiums have been paid, whereas it may be that companies are simply paying fair value for the assets. Clearly, consolidation also creates greater marketing muscle, with many of the deals in the past three years resulting in the emergence of a new number one or number two producer. This has reduced the fragmentation of supply and is most evident in the iron ore sector. Between 2000 and 2007, the value of deals increased by 444%, despite the number of deals increasing by only 130%. While the $1b-plus deals command the headlines, the strength of the sector is evident in the rise in the number of deals across all industry segments. Junior explorers have been acquired by other juniors or by mid-caps, mid-caps by other mid-caps or by majors, and the majors are merging with each other. Australia, Canada and the US were the most acquisitive countries in 2007 and were also the most targeted for acquisition. All three countries were net losers of mid-caps to the UK-listed acquirers in 2007 and Canada was also a net loser in the $1b-plus deals, despite being the largest acquirer in this area.
While mining and metals companies have been entering new territories in their quest to replace reserves or increase production, they also recognize the need to distribute their risk as they invest in politically riskier environments. By carefully structuring their cross border investments, companies are attempting to avoid the problems that a concentration of investment may bring. As a result, investment flows are tending to spread across regions rather than just one or two countries. In the past two years cross border deals have out-accelerated domestic deals. Companies from developing countries have been responsible for the rise in high-value initial public offerings (IPOs), seeking to unlock the wealth of their shareholders or diversify their capital base. In 2007, over $20b was raised via IPOs. The UK, China, Canada and Australia continue to be the most attractive countries for raising capital. In the short to medium term, it is possible to foresee a continuation and perhaps an acceleration of the consolidation trend. In 2008, there could be something like three major transactions valued at $50b or more. It is likely that there will be a continuation of major capital raising by emerging market players onto the London Stock Exchange by way of both global depository receipts and full primary listings. It is also possible that sovereign wealth funds will increase their stake in the sector in 2008. In the longer term we look to the dominance of four or five diversified majors with strong geographic representation in Russia and China. There is also a possibility of forced disposals or break-ups resulting from competition authority rulings to restrain the rising market power of certain mining and metals companies. 2008 will be a year of increased divestment activity as a result of actions by competition authorities, the exiting of non-core assets, the need to pay down acquisition debt and the sale of highcost mines.
The question now is whether the pace of consolidation can and will continue within the sector with some commodity prices softening and the global economy slowing. It is our view that current metal prices actually represent a return to sustainable price levels following an extended period of artificially depressed prices. This is opposed to the conventional belief that the industry is near the top of the cycle. The fundamentals of the Chinese and Indian domestic economies remain strong. Therefore, the potential for significant demand growth also remains strong. There are two areas that must eventually return to equilibrium. Firstly, it cannot continue to cost less to acquire reserves than to discover and develop them. Secondly, mining and metals companies cannot continue to acquire peers in an undervalued market.
Mergers and acquisitions
Ernst & Young research has shown that mining stocks have been, and continue to be, undervalued. Analysts’ predictions since the beginning of 2005 have lagged metal prices and this has created a valuation gap. As a consequence, the market has assumed premiums have been paid, whereas it may be that companies are simply paying fair value for the assets. Clearly, consolidation also creates greater marketing muscle, with many of the deals in the past three years resulting in the emergence of a new number one or number two producer. This has reduced the fragmentation of supply and is most evident in the iron ore sector. Between 2000 and 2007, the value of deals increased by 444%, despite the number of deals increasing by only 130%. While the $1b-plus deals command the headlines, the strength of the sector is evident in the rise in the number of deals across all industry segments. Junior explorers have been acquired by other juniors or by mid-caps, mid-caps by other mid-caps or by majors, and the majors are merging with each other. Australia, Canada and the US were the most acquisitive countries in 2007 and were also the most targeted for acquisition. All three countries were net losers of mid-caps to the UK-listed acquirers in 2007 and Canada was also a net loser in the $1b-plus deals, despite being the largest acquirer in this area.
While mining and metals companies have been entering new territories in their quest to replace reserves or increase production, they also recognize the need to distribute their risk as they invest in politically riskier environments. By carefully structuring their cross border investments, companies are attempting to avoid the problems that a concentration of investment may bring. As a result, investment flows are tending to spread across regions rather than just one or two countries. In the past two years cross border deals have out-accelerated domestic deals. Companies from developing countries have been responsible for the rise in high-value initial public offerings (IPOs), seeking to unlock the wealth of their shareholders or diversify their capital base. In 2007, over $20b was raised via IPOs. The UK, China, Canada and Australia continue to be the most attractive countries for raising capital. In the short to medium term, it is possible to foresee a continuation and perhaps an acceleration of the consolidation trend. In 2008, there could be something like three major transactions valued at $50b or more. It is likely that there will be a continuation of major capital raising by emerging market players onto the London Stock Exchange by way of both global depository receipts and full primary listings. It is also possible that sovereign wealth funds will increase their stake in the sector in 2008. In the longer term we look to the dominance of four or five diversified majors with strong geographic representation in Russia and China. There is also a possibility of forced disposals or break-ups resulting from competition authority rulings to restrain the rising market power of certain mining and metals companies. 2008 will be a year of increased divestment activity as a result of actions by competition authorities, the exiting of non-core assets, the need to pay down acquisition debt and the sale of highcost mines.
The question now is whether the pace of consolidation can and will continue within the sector with some commodity prices softening and the global economy slowing. It is our view that current metal prices actually represent a return to sustainable price levels following an extended period of artificially depressed prices. This is opposed to the conventional belief that the industry is near the top of the cycle. The fundamentals of the Chinese and Indian domestic economies remain strong. Therefore, the potential for significant demand growth also remains strong. There are two areas that must eventually return to equilibrium. Firstly, it cannot continue to cost less to acquire reserves than to discover and develop them. Secondly, mining and metals companies cannot continue to acquire peers in an undervalued market.
Mergers and acquisitions
- In 2007, 89% of deals were less than $200m in value. These deals represented 7% by value of 2007 deals. One-third of these deals involved targets based in Australia, followed by Canada and the US, and over 50% of these deals were undertaken in the US, Canada and Australia. The median value of these deals was $5m, which shows the volume of property and entity transactions.
- Seven percent of deals were between $200m and $1b in value. These deals represented 14% by value of 2007 deals. Twenty-four percent of these deals involved targets based in Australia, followed by the US and Canada, and over 50% of deals were undertaken in the US, Canada and Australia. Despite the level of activity, the US, Canada and Australia are still net losers of mid-caps to the UK.
- Only 4% of deals in 2007 were over $1b in value, but they represent a staggering 79% by value of 2007 deals. Targets were once again predominantly based in the US and Canada; however, Canada was still a net loser.
- he deal of the year was also the largest mining and metals deal to date — Rio Tinto’s purchase of Alcan for $43.9b.
- In 2003, cross border deals were worth $17.5b and accounted for 38% of all transactions in the mining and metals sector. By 2007, cross border transactions had accelerated to reach $122.7b and accounted for 58% of all deals.
- JPMorgan and UBS dominated the league tables both in the value and number of M&A transactions.
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