 "Mining, Iron ore")
A series of earnings collapse suffered by the world's major mining companies last year and in the first half of 2015 has reopened the debate as to whether many of them would have done better by not acquiring assets, paying what now look fancy prices at the high point of the commodity cycle preceding the financial crisis of 2008. Had they not further compounded their miseries by committing billions of dollars in capital and exploration expenditure for rapid capacity expansion?
More than anything else, the unprecedented Chinese demand for metals and minerals that lasted for two decades was the reason for the "insanely" high prices that companies of the stature of Rio Tinto and Anglo American paid to broaden their asset portfolios.
Some Indian groups too made premium deals at the last cyclical peak. Thus, in January 2007, Tata Steel would engage in an eight-hour bidding fight with Brazilian Siderurgica Nacional to acquire Corus for about $8 billion. The acquisition in one shot made Tata Steel the world's fifth biggest steelmaker, but there is no end to its pain in running a steel business in Europe in the present environment.
Ian McVeigh of Jupiter Asset Management of the United Kingdom has coined the expression "top stinkers" for the "deals in the mining sector we believe should never have happened." Top stinkers, according to McVeigh, make a long list. But the worst offender till date remains Rio Tinto, which in November 2007, throwing all caution to the wind, engaged in a bidding contest with Alcoa of the United States and Vale of Brazil for Canadian aluminium maker Alcan. Rio won the Alcan trophy in what till now is the biggest deal in the history of metals by paying $38.1 billion.
Earlier, in June 2006, Lakshmi Niwas Mittal paid $33.84 billion for Arcelor. The price in this case too was high. The acquisition cost rocketed as Mittal had to put up with the Arcelor management's bare-knuckled defence strategy and Severstal of Russia which appeared as the white knight. But he stuck to the target as in Arcelor he saw a technology treasure trove as also a route to global leadership in tonnage.
Post the Arcelor buy, Mittal could, therefore, move into pole position of fending off substitution threat from aluminium and composites, particularly in automobiles. Even then, Mittal has not been spared the pain of servicing a mountain of debt, still well over the targeted $15 billion, and write down.
Misreading China and warning bells about the country falling till recently on deaf ears of mining groups - read their CEOs' statements till a year ago defending their massive capital investments to principally meet future Chinese demand - have left them with such large capacity that they are now doomed to sell their production at continuously falling prices.
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Going all out
The person who got it all wrong about China was the former CEO of Rio Tinto, Tom Albanese, who, in the belief that China would need to import growing quantities of aluminium to support its infrastructure development and manufacturing industries, didn't think twice while paying a share price premium of 65 per cent to acquire Alcan. Albanese must have believed like many others that for China, not rich in bauxite, aluminium imports would always be the right choice.
Much to the disappointment of Albanese, China went on a smelting capacity building spree to become a net exporter of the metal, changing the market dynamics of heavily traded aluminium. For the first seven months of 2015 up to July, the country exported a record quantity of 2.87 million tonnes of aluminium.
Undaunted by its large-scale dependence on bauxite imports, China raised its aluminium production by 14 per cent in 2014 to 28.3 million tonnes. In the current year, the country's aluminium production is running at an annualised rate of over 30 million tonnes- more than half of the world output.
What is further causing anxiety to the globally surplus aluminium industry is the 6 million tonne smelting capacity in the Chinese pipeline. No wonder, Rio's Alcan-related write downs have reached $25 billion. In a cruel repartee, Dick Evans, who in his capacity as Alcan chief had lured Rio into the deal, described the Anglo-Australian group's acquisition as "one of the worst corporate decisions ever".
Any number of mining groups who, enticed by China, decided to extract as much minerals as possible out of the ground through takeovers and capacity expansion have now been found guilty of large write offs. The lasting slump in commodity prices has forced Anglo American, which in 2008 bought Minas Rio iron ore project in Brazil and then suffered major cost overruns in completing it, also to go for major write down.
A recently-released study by The Boston Consulting Group shows that of 101 mining companies with market values of more than $3 billion at 2014 end, all but 11 had lost investors' money on a total shareholder return basis. BHP Billiton, Rio and other big miners are out to reassure their shareholders that by progressively reducing capital and exploration expenditure, raising production through stretching productivity and cutting costs all around, they will ride out the slump in commodity prices with minimum possible injury.
The long commodities slump will leave many assets sick, making them ripe for takeover. But will the mining groups, having already written off billions of dollars and angering investors in the process, still have the appetite to buy these assets?
Prospects for value addition trigger the hunt for assets. In the current environment, that trigger is missing. Rio Tinto's chief executive of copper and coal, Jean-Sebastien Jacques, said in a conference presentation: "We will not see significant consolidation. This is because there is now greater scrutiny of the real value creation of big bang merger and acquisition and the potential value-destructive premium needed to secure tier-one assets."
What is likely to happen is the emergence of partnerships among miners and trading houses to acquire assets and share the risks.
