Citigroup suggests Cdn$300b available for mining M&A in 2008

Citigroup recently highlighted a mining M&A frenzy as acquisition-minded major mining companies have cash to burn and a number of prospective targets to acquire.

RENO, NV -

Citigroup metals and mining analysts recently suggested that a potential cash pool of more than Cdn $300 billion is available for mining M&As this year.

Among the top large cap global companies Citigroup predicts will acquire other mining companies are Xstrata, Teck Cominco, Oxiana, Newcrest, Vale and Kazakhmys. Other possible acquisition-oriented companies include Peter Hambro Mining, Peabody Energy, CONSOL Energy, and Sally Malay China Shenhua.

Swiss-based mega miner Xstrata was also identified by the analysts as a top acquisition target, as well as Anglo American, First Quantum, Freeport-McMoRan Copper & Gold, NovaGold, Steel Dynamics and Foundation Coal. Other potential acquisition targets identified by Citigroup are Lonmin, Iluka, Alumina, Equigold and Oxiana.

Analysts Craig Sainsbury, John H. Hill, Graham Wark, Heath R. Jansen, and Liam Fitzpatrick said the current wave of mining M&A will continue, driven by: "free cash flow yield premia, mounting cash balances, dwindling reinvestment opportunities, frictional barriers to new mine capacity, and aggressive forays by sovereign investors."

The analysts forecast that, by 2010, "the sector as a whole will be in a net cash position."

Citigroup's analysis found that the next generation of copper mines will incur development costs of roughly $3.50 to $4/lb capacity. Meanwhile, Citigroup warned that "the scarcity of quality undeveloped copper project should not be underestimated, particularly after the slew of recent transactions by acquisitive majors and strategic Asian buyers."

Barriers such as permitting, tax deals, drilling, construction engineering, equipment vendors and labors are expanding mine project schedules from one to three years, according to Citigroup. ‘Combined with 15 years of under-investment, this is why the industry has been unable to catch up with demand and replenish inventories," the analysts asserted.

"Trends in acquisitions show valuation premia for ‘world class' potential in scalability/costs, and discounts for politically challenged or long-date timetables. Notable standouts are assets like Lumwana, Oyu Tolgoi, Tenke, Pebble, or, for high gold content, Cerro Casale."

While acquisition and construction of copper development projects may appear cheaper to would-be acquirers than the valuation of a copper producer, Citigroup analysts stressed that the unique risks of each development project must be manageable. Common project development pitfalls include:

• Development cost inflation, which "can nullify an entire project's value."

• Delay: "With producers now enjoying towering copper cashflows, expedition of the construction process is crucial to maximize value. Underestimation of infrastructure costs, permitting demands and specially licensing are all case-specific, but will likely remain recurring deviants to the timetable, sapping tremendous cashflows that would otherwise ensure swift payback."

• Increasing claims on cashflows: "Rising metals prices have emboldened all stakeholders to angle for an unprecedented share of profits, particularly organized labor and governments. New projects may be disadvantaged relative to incumbent producers who benefit from historical investment contracts and mining laws etched in past troughs."

Citigroup's analysts said they believe that acquisition-oriented top miners are looking mainly for a mix of commodity and/or geographical diversification, as well as assets that could increase production growth. The target companies are generally worth at least $10 billion, "which makes them generally a company-transforming deal. However, there is a scarcity of stocks in this territory, which highlights the likelihood of strong competition in any deal."

The analysts noted that several recent mining M&A deals have been focused on generating mining companies' exposure to new geographies, such as India, Russia, Central and West Africa and Kazakhstan, which offer significant resource potential. As traditional mining regions, including Australia, Chile and the United States mature, the analysts concluded that "we expect the global mining focus to shift toward the ‘emerging mining countries.'