SA may dilute Xstrata/Anglo benefits

Allan Seccombe | Mon, 29 Jun 2009 13:37
[miningmx.com] -- A COMBINED Xstrata and Anglo American would benefit from the greater spread of assets, but moves to appease the South African government and powerful unions could dilute that upside, ratings agency Fitch said.

Xstrata said on June 21 it had proposed a merger of equals with Anglo American.

Anglo’s board rejected the proposal, saying it had a superior suite of assets that would be diluted by blending them with those belonging to Xstrata, and that the board rejected the overture that carried no premium as “totally unacceptable”.

Fitch sees the proposed merger of two of the world’s largest resources companies as offering a “variety of business benefits stemming from increased commodity and geographic diversification”.

Fitch said: “In the current low commodity price environment, Fitch would consider a share-based transaction, such as that broadly outlined by Xstrata, as being an appropriate route for M&A (merger and acquisition) activity.”

However, a share-based transaction was unlikely to yield a positive rating because of the state of the commodities markets, which are expected to post a slow and weak recovery, it said. Both companies are also seen to have weak operating performances over the next one to two years.

“Fitch also considers that the combined group could pursue more aggressive acquisition and financial policies compared to those historically followed by Anglo,” it said.

The combined entity would be the biggest source of platinum, thermal coal, zinc and ferrochrome. It would be the second-largest producer of metallurgical coal and copper. Based on share prices at midday on Monday, the combined entity would have a value of about $72bn.

The South African government is a major shareholder in Anglo American through the Public Investment Corporation, which owns 5% of the LSE- and JSE-listed company.

The South African government, which has close ties with its powerful alliance partner, the labour federation Congress of South African Trade Unions (Cosatu), is concerned about job losses as thousands of workers have already been laid off by mining companies in the commodity price downswing.

Xstrata has taken what Fitch described as a conciliatory stance towards job losses, but “Fitch believes that firm conciliation action is likely to be required, potentially diluting the synergy and other cost benefits of the transaction”.

Analysts have put cost-saving synergies at between R7bn and R9bn a year in taxes and head office expenses.

Another upside to the deal, Fitch said, would be a diluted exposure to South Africa. Anglo generates more than 50% of its earnings in South Africa, but a combined group would bring this down to about 40%.

A risk in South Africa is the rising cost of electricity, which is a result of state-owned Eskom embarking on a large capacity programme to bulk up generation to avoid the shortages that shut down the South African mining sector for a week in January 2008.

Fitch estimates that over the next three to five years electricity tariffs for companies will increase annually by about 20%.

South Africa’s Chamber of Mines estimates Eskom's approved 31.3% electricity hike for this year will add an extra R2bn in costs to the mining industry.

The South African gold, platinum and coal sectors are engaged in wage talks, with the unions demanding increases of between 15% and 20%. This contributes to the erosion of profit margins in these times of depressed commodity prices.