LONDON () -- The increasing importance of M&A activity in the mining sector has been a recurrent theme at recent resources conferences around the world.
At the in London last November, for example, Michael Lynch-Bell of Ernst & Young illustrated how rising commodity prices have been a bonanza for mining companies already in production. As the charts below show this has resulted in a huge increase in cash flow which in turn has led to ever increasing levels of M&A deals in the mining sector.
Lynch-Bell demonstrated also that to date the recent M&A activity has rewarded the acquirer. Even though the prices paid for the acquisitions had often been at a significant premium to the pre-bid market valuation (he quoted typical premiums in bid-for-control transactions of 65% or even 85% above the undisturbed share values) it can be shown, with the benefit of hindsight, that total shareholder returns to the acquirers out-performed those of the non-acquirers (see a previous article, "").
This week, at the BMO Capital Markets conference in Hollywood, Florida the opening presentation was again on the theme of M&A. David Haughton, co-head of Mining Research for BMO began with a similar opening premise to Lynch Bell: in the current era of high commodity prices companies in production have a large cash flow, but there are only limited opportunities to expand production organically following years of underinvestment in exploration during the 1990s and early years of this decade.
Even though exploration expenditure has surged in the last four years an exploration dollar buys less than it used to, as costs have been rising sharply. Moreover there is a long and increasing lag between exploration and a mine actually going into production.
Earnings growth meanwhile for the majors is stagnating leaving the companies with the problem of how best to grow and spend the cash. Of course a quick method of delivering growth is to buy rather than to build, and as BMO's chart below shows, recent deals have been getting bigger and more expensive, with buyers have paying increasingly high premia to win their prize.
M&A activity has already had an enormous impact on industry concentration. Haughton cited the example of the Australian gold sector where, as shown in the chart below, the universe of companies from a few years ago has been drastically reduced through acquisitions.
He predicted however that there is still room for further consolidation in the gold industry globally as concentration is still much lower than for base metals or bulk commodities.
M&A activity has also impacted on the size distribution of the industry. The mid-caps, for example, (which Haughton defined as around $5-20bn by market capitalisation) have been severely squeezed, and many "old favourites" such as Inco, Falconbridge, Western Mining, Mount Isa, Pechiney and Alcan have disappeared.
Some of the remaining mid-caps, according to Haughton, will be acquired by the Majors or the Chinese though some were "take-over proof" if either they had a dominant shareholder or if they had a high earnings multiple which would make it "value destructive" for another company to bid for them.
Meanwhile the majors will seek to take out anything of size including the mid-caps without a takeover shield, the small caps with world class projects and, of course, each other! Haughton foresees a world with just four super majors; an Australian major "AusCo" (comprising BHP and Rio), a Brazilian-based "BrazCo" (Vale and Xstrata), "RussCo" (perhaps Norilsk and others) and AfriCo (Anglo plus others).
Haughton concluded that the wave of M&A activity will continue, resulting in an industry structure comprising perhaps the four super majors, a thinner mid-cap sector and a positive environment for successful juniors who will be able to move into the mid-cap arena. He predicted also record payouts by the mega-miners once the next round of consolidation is over.