Sent: 24-08-2010 08:02:08
In this issue:
Return to full article list
HomeFree weekly newsletterSelf Managed Super Fund ArticlesContact usLogin
Too Big to Succeed
The bid by global mining leader BHP Billiton for Potash Corporation of Saskatchewan rekindles thoughts about the life cycle of mining companies.
Mining companies typically follow a well-trodden corporate development path from their early years to their ultimate demise.
Initial exploration success, in the first phase of development, eventually leads to a working mine and, during the second phrase, possibly several years of output growth. Once the mine reaches its peak production, in the third phase of the corporate life cycle, the company's earnings will be driven exclusively by fluctuations in commodity prices.
The earnings of BHP Billiton before interest and tax rose from US$9.9 billion in 2005/06 to US$24.3 billion in 2007/08 in the most recent cyclical upswing. However, if commodity prices had not risen, the company's earnings would have fallen. In other words, it had passed into the third phase of its corporate life cycle.
Some companies might be able to re-engineer themselves to recapture the growth which characterizes companies in the second phase. Woodside Petroleum is an example of one company that has been able to achieve this turnaround.
More usually, phase three companies slide ignominiously over the abyss into a fourth stage from which they never recover.
In the fourth stage, companies are confronted with falling output as mine lives shorten, costs rise and commodity prices weaken. Financially stressed, they run out of strategic options. They often seek links with others in a similarly uncomfortable financial position only to discover that two sick companies do not make one healthy company.
This process ends, more often than not, with assets being picked over by others still at the earlier stages of their corporate life cycles. And, so, the circle of life continues.
One of the reasons BHP Billiton is the largest resources company in the world is that its predecessors, faced with this predicament, failed to survive.
Unlike a manufacturer, a miner has far less discretion as to the size of its operations. Generally, mine size is dictated by the geological conditions bequeathed by mother nature. For the largest miners, consequently, projects that can make a meaningful impact on their earnings are hard to find. That is why Rio Tinto felt compelled to take over Alcan and why BHP Billiton wanted to take over Rio Tinto.
The Australian Financial Review reported in one of its Chanticleer columns last week that BHP Billiton was motivated to pursue the PotashCorp acquisition because the fate of Alcoa had flashed before the eyes of the company's decision makers. Once the undisputed global leader in its sector, Alcoa is entering its twilight unable to sustain the dynamism that had taken it through the second phase of its life cycle.
In seeking to buy public companies, bidders like BHP Billiton end up paying $40 billion for something worth $40 billion. That seems fair enough but leaves the acquirer even more heavily reliant on higher commodity prices in the future.
The PotashCorp purchase may yet add value. This will depend on a range of operational outcomes as well as on how macroeconomic conditions play out. Whatever these outcomes, however, BHP's Escondida copper mine in Chile is set to go from one of the world's biggest mines to one of the smallest. There is nothing over a 20 year horizon that look capable of substituting for its lost production.
True, this decline will happen over decades rather than months but BHP Billiton is facing the same challenge as all its predecessors in the sector: simply becoming too big to succeed.
This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.