A HOT WIND ruffles the stunted trees that dot the red hills round the West
Angelas iron-ore mine. It’s 45C, about normal for a January afternoon in the
Pilbara in Western Australia.
At the mine – a mini Grand Canyon 6km long, 2km wide and 250 metres deep –
workers ignore the heat and toil 24 hours a day. Driving trucks the size of
houses and diggers the size of churches, they prise out the iron-ore that is
fuelling China’s industrialisation and urbanisation.
They work flat out and sell all they produce, and still the Chinese want more
– and so do the Koreans and the Japanese.
At the far end of the terraced hole there is a muffled thud, and a plume of
red and black dust shoots into the air. Then the diggers and trucks race in
to gather the exploded rock. Another Beijing apartment block has begun its
journey skyward.
Until two months ago, few people in London had heard of the Pilbara. Now it is
at the centre of the second-largest takeover deal of all time, the audacious
£70 billion grab by BHP Billiton, the world’s biggest mining company, for
its rival Rio Tinto.
Rio’s Pilbara operations are its crown jewels, their profit margins and
potential for growth making them a modern-day Klondyke. If BHP, the
second-ranked player in Australian iron-ore, succeeds in taking over Rio, it
will control 40% of China’s imports of iron ore, and 60% of Japan’s. The
combined company will also have formidable global positions in aluminium,
copper, uranium, silver, coal and nickel.
This takeover battle is being closely watched not only by shareholders and
bankers, but by world leaders.
Which way the tide is running will become clear over the next few weeks. So
far, BHP has made only an indicative offer to Rio. It has not offered cash,
but its own shares, telling Rio investors it will give them three for every
one in Rio they hold.
Rio’s directors, led by chairman Paul Skinner and chief executive Tom
Albanese, have rejected the approach, and have refused to talk to BHP, led
by chairman Don Argus and chief executive Marius Kloppers. The Takeover
Panel, a City watchdog, has given BHP until February 6 to make a formal bid.
The battle is all about value – whether Rio investors believe the price
being offered is sufficient, or whether they will be better off remaining
independent.
Argus, who this weekend speaks exclusively to The Sunday Times (see report
below), reckons BHP has raced past Rio in the past five years, both in
earnings growth and share-price performance. “Since 2001 a gap has opened up
between BHP and Rio – and that is the core of our argument about
relative value. This is not a cash transaction, it’s paper, so people have
to understand that point on relative value – our performance compared
with Rio’s.”
That’s nonsense, according to Albanese. “They have done a bit better in the
past five years because they were coming from a very low base. People forget
BHP had a rocky period in the late 1990s, and the shares have done well only
because they have turned that round. Their offer is not even close on value –
they are two ball parks away,” he said.
Argus retorts: “People talk about ball parks or football fields – I
don’t know what that means.”
To understand why BHP is so keen on Rio, it is worth looking at some of the
facts and figures behind the Pilbara iron-ore operations. Until recently, it
was regarded as a low-margin, low-growth business, with mining companies
fighting for supply contracts and loath to invest in extra production.
Annual price negotiations with the big steelmakers were dispiriting. “You
would wait in your hotel room until someone from Nippon Steel pushed an
envelope under your door with a figure on it, and that was the price for the
coming year,” said one mining veteran.
China has changed all that. A decade ago it made 100m tonnes of steel each
year, 13% of the world total. It now makes 500m tonnes a year, 33% of the
total, and has a steel industry four times larger than America’s. Nearly 90%
of Chinese production is for domestic consumption, in particular for its
building boom.
This is driving the demand for iron ore. China supplies less than half of its
own, and much of that is low-grade, with a small iron content. Increasingly,
it has had to look overseas, and in particular to Australia. An iron-ore
carrier takes just 11 days to carry 170,000 tonnes from the Pilbara to
China. “Our forecast is that China will double its iron-ore imports over the
next six years,” said Sam Walsh, chief executive of Rio’s iron-ore division.
Prices have rocketed, and what was previously a low-mar-gin business is now,
for want of a better word, a goldmine. Rio’s Pilbara operations have a gross
margin – ebitda (earnings before interest, tax depreciation and
amortisation) to sales – of 58%. BHP’s is 54%. Last year Rio’s Pilbara
ebitda was just under $4 billion.
It is about to get much, much better. Most Australian ore is sold at prices
negotiated once a year between big producers and customers. This benchmark
price for ore landed in China is about $85 a tonne. The spot price, for
sales outside this benchmark, is about $200, reflecting the acute shortage
of supply. The annual contract negotiations are under way, and even the most
pessimistic analysts expect a price rise of 50%.
“Steel mills are banging on our doors asking for more tonnage,” said Ian
Bauert, sales and marketing boss of Rio Tinto Iron Ore. “The market has
never been so hot.”
Rio is confident the looming downturn in America won’t derail the China
juggernaut. Rio estimates that if America went into recession, Chinese GDP
would drop by 1%. “If you do the numbers, it is just really, really hard to
generate any large negative effect for China,” said Rio economist Vivek
Tulpule.
As well as sharply higher prices, Rio has plans to increase production. It
ships 200m tonnes a year from the Pilbara – an operation that involves
not only the mines, but one of the largest private railways in the world,
with 30,000-tonne freight trains travelling the equivalent of London to
Liverpool to two ports on Australia’s northwest coast – and plans
to boost this to 320m tonnes by 2013. Beyond that, Walsh said it has “a
clear pathway” to 420m tonnes a year.
Some analysts have identified the Pilbara as the key. Tim Ger-rard, analyst at
Australian investment firm Austock, said both companies’ iron-ore operations
will be “dramatically” rerated. “There is a case to be argued that Rio’s
iron-ore assets may be valued, within three to four years, at the entire
[current] stock-market value of the company.”
BHP is, understandably, keen to play down the attractions of the business.
“The reason they want to showcase it [Rio took journalists to Australia last
week to see its operations] is because it is one of the few areas in which
they can claim an advantage. It is only 17% of its sales,” said one senior
BHP executive. “The combined company would be about much more than iron ore.”
The Pilbara bonanza has supercharged the Western Australian economy. At 5am,
crowds of overalled workers with brick-red faces crowd the charter airline
terminals at Perth for the flights two hours north. They typically work two
weeks on, one off, living in camps alongside the mine and earn good money –
£45,000 to £70,000 for a truck driver.
As well as the heat, the life has other hazards. Each camp has a snake catcher
in case one of Australia’s numerous reptiles has to be removed. Staff
turnover is high – 20% a year is normal –a clear sign of an
economy in overdrive. A three-bedroom house in the tiny town of Karratha,
near the ports, can be rented for £670 a week, five times the price in
Perth, which is the most expensive city in Australia.
The face of the iron-ore trade will change dramatically if BHP’s bid succeeds.
The entire region, and 350m tonnes of ore a year, will come under the
control of one company. The proposed deal has already drawn cries of protest
from steelmakers, and not only those in China.
Competition regulators will also want to give the takeover the closest
scrutiny, although BHP believes it can steer it through.
The immediate question is whether BHP will finally put its cards on the table
with the February 6 deadline looming.
Senior sources at BHP say the company is reluctant to go hostile, preferring
to secure the recommendation of the Rio directors – which, given their
forthright rejection of the present terms, would require BHP to sweeten the
offer.
Albanese would not comment on what terms would bring Rio to the table. He does
believe that whatever the outcome, investors will take a fresh view of the
attractions of such stocks.
He said: “With all the turmoil in financial services, investors are
finally thinking about putting money into companies with real assets, real
cashflows and real growth – and that’s us.”
Thats impressive - it really is.
Its nice to see the Aussies doing well.
I hope they can reinvest some of this windfall in the event of a downturn.
Gavin, Cambridge, UK.