Navigating the Mining Sector

Considering how well the mining sector is doing, especially in Canada, no wonder the industry is going through a slew of mergers and acquisitions. I mentioned last week in PROFIT CONFIDENTIAL the trial and tribulations that Inco is going through as of late, trying to close a friendly merger with Falconbridge. Now, the plot thickens, as Teck Cominco Ltd. has put forward a hostile bid for Inco.

For Teck Cominco, an acquisition of this type makes perfect sense. The company is a diversified producer, it boasts considerable cash flow, but it has no room to grow from within. Taking over a nickel producer like Inco would provide Teck Cominco with the necessary growth boost, all the while protecting it from becoming a takeover target by larger “dogs,” such as BHP Billiton or Rio Tinto.

Teck Cominco’s offer actually has a chance of succeeding for several reasons. Firstly, the company is not a major nickel producer, so no one can claim Teck is trying to monopolize the market. Also, Teck Cominco has the necessary cash to bail Inco out of some of its costlier projects.

However, one of the conditions of Teck Cominco’s offer is that Inco drops its bid for Falconbridge. Inco, on the other hand, is likely to advise its shareholders against this, particularly since Inco has been fighting a lion’s fight against anti-trust charges leveled against the company in the U.S. and Europe. On the other hand, with Teck Cominco’s bid coming in at a hefty premium, convincing Inco’s shareholders to vote against its bid may prove difficult.

In the pot is also Swiss-based miner Xstrata PLC, which is a significant shareholder in Falconbridge, with an option to buy more shares in the company mid-May. Whatever role Xstrata may or may not play in this takeover melee remains to be seen.

But, that does not mean that speculators are sitting idle. Before Teck Cominco came on stage, Xstrata was expected to make its own bid for either Falconbridge or the combined Inco- Falconbridge, if for no other reason than to sweeten Inco’s bid.

Now, Xstrata is a wild card. We know that Xstrata wants to get in on the nickel deal, as it already tried to bid for a nickel producer, but it was outplayed by BHP Billiton. At this point, we cannot tell for sure what Xstrata’s next move will be.

But, why am I talking about a turf fight in the nickel business? Simply, think of a takeover as an auction-type fashion show. The takeover targets are beautiful models, strutting their stuff down the catwalk; while in the audience sit potential bidders for what the models are wearing. Designers, models, show organizers, even the cleaning crew are stakeholders. So, obviously, the higher the bid, the better the chances to get the stakeholders to accept your terms.

In the takeover business, regardless of whether it is a friendly or a hostile one, a takeover target is the one getting all the attention, including its stock price. With more attention comes better market performance. So, investors with high risk tolerance, and of a speculative nature, may find it profitable to jump in on a takeover target, for example, during a pullback, which happens relatively often as the deal develops.

Typically, as the takeover date approaches, the share price of a takeover target tends to appreciate, which is often a clue for speculators to close their long positions. Alternatively, shares of companies initiating takeover bids often depreciate during the process; so, some short selling may also result in profit taking.

In any event, as the takeover business intensifies, it is worth looking into mergers and acquisitions, if purely from a speculative perspective. This is particularly true with commodities, since almost all have been doing extremely well as of late.