Metal Merger ManiaPublished by MAC on 2007-02-14
Source: Forbes magazine ()
Metal Merger Mania
Paul Maidment, Forbes magazine
14th February 2007
Whether or not BHP Billiton or Rio Tinto buys Alcoa for $40 billion as the stock-market rumor machine has it, a deal of that scale in the metals industry is a question of when, not if.
The same forces of consolidation that drove the oil industry's megamergers in the late 1990s are at work today. The $73.7 billion merger of Exxon and Mobil, announced in 1998, which created the world's largest public company, was the apogee of that wave of M&A, creating the world's first truly global oil company. Metals and mining will have their match.
It looked for a while as if the marriage between Mittal and Arcelor to create the world's largest steelmaker would be the one, even if the courtship was stormy and prolonged. It has been the steel industry leading the way in this round of metals industry mergers, which has been running since at least 2004.
The steel business is highly fragmented. But industrialization in eastern and central Europe, Latin America and the Asia-Pacific region, and especially China, has driven this wave of acquisitions aimed at building vertically integrated companies, as the oil industry did before them.
Steelmakers want to gain market scale so they can have a stronger hand when negotiating with customers such as the automotive industry. They also have been buying coal and iron ore mines to control raw materials costs. (The mining companies, too, have been consolidating to strengthen their countervailing pricing power.)
While Europe, the U.S. and Asia have all seen domestic and regional consolidation, the Mittal-Arcelor deal had a global span and vertical integration unmatched in previous deals.
How much further this has to go in the steel industry in this round is a moot point. The gap between low stock valuations and high earnings from a four-year bull run in commodities markets that has financed the merger binge is starting to narrow. The valuations of steel companies are catching up again with those of their industrial peers, and the bloom is starting to come off the commodities boon.
The closing of that gap is lagging in the mining industry, if not by far. Both BHP Billiton and Rio Tinto have had the strong earnings in recent years to keep their M&A war chests well filled. Like the steel industry, natural resources giants want to control supplies to offset price fluctuations and strengthen their vertical integration.
A tie up with either BHP Billiton or Rio Tinto would give Alcoa access to millions of tons of bauxite and alumina, the mineral used in making aluminum. The benefit in the opposite direction is that 70% of Alcoa's revenue comes from its downstream business, rather than from basic production of the metal and mining-- just as oil companies have found it cheaper to buy reserves, other companies have found [it better] rather to explore for it, especially when it is in cheap-to-extract places.
It is the same rationale that drove the Rusal-Sual-Glencore merger last year: Rusal has access to cheap hydropower (a third of the cost of aluminum is accounted for by the electricity used to smelt it), Sual has bauxite, and the Swiss company downstreams operations.
A similar strategy lies behind the proposed $5.9 billion merger between India's largest aluminum producer, Hindalco Industries, and Canada's Novelis, the biggest producer of flat-rolled aluminum products, whose customers include Coca-Cola, Anheuser-Busch and General Motors .
With its own cheap supplies of bauxite and coal, the purchase of a downstream producer like Novelis, which was spunoff from Alcan after its former U.S. parent bought Pechiney of France in 2004, would make Hindalco the same sort of integrated producer that many oil companies strove to be in the 1990s.
Each deal puts pressure on competitors to grow bigger in response. The Mittal-Arcelor merger was followed by Tata Steel buying the Anglo-Dutch steelmaker Corus, itself the product of a 1990s merger of former state-owned British Steel and Dutch steelmaker Hoogvens in an earlier round of European consolidation. The Exxon Mobil tie-up followed a merger between BP and Amoco and was followed by one between Texaco and Chevron .
For its part, Alcoa was relegated from first- to second-largest aluminum producer by the Rusal-Sual-Glencore merger. * A deal with either BHP Billiton or Rio Tinto would be needed restore it to first place.
And as Exxon Mobil's recent record-breaking profits attest, first place is a good place to be.
* Forbes has jumped the gun here: the merger has not yet taken place