Big enough is no longer good enough

[miningmx.com] — YOU’VE got to hand it to Brian Gilbertson: he’s got vision on his side. The merger of Billiton with Australian firm BHP in 2005 was a grandly audacious move. On market cap alone, there’s simply nothing to compare; it has scale and reach.

Almost anything that’s happened in the diversified mining market since then has been an attempt to recreate the consequences for respective shareholders of the BHP Billiton union.

One wonders the effects had Gilbertson been allowed to chase down the oil giant he was supposed to have in his sights before Don Argus, former BHP Billiton board chairman, levered Gilbertson out. But that’s another matter.

So what has been happening in the diversified sector? Well, since the financial crisis and ensuing crisis in confidence that subsumed (submerged) key economies, a great deal.

As a broad theme, diversified mining companies such as Xstrata, Rio Tinto and Anglo American have been restructuring their balance sheets as if this was the disprin to the post-supercycle hangover.

For Alan Bird, however, think more blip than hangover.

Bird works at Bain & Co, the consultancy, where he advises clients on mining as part of a broader portfolio of industrial goods and services. He’s also a senior partner of Bain’s South African division.

Bird thinks the supercycle barely went away. China is driving demand. As most tend to agree, he buys China’s expected 10% GDP growth story and thinks India is its foil. The commodity demand of the past few years is quickly resuming. Confidence is restored. All hail the metal makers.

Which is right.

The question is, though, how the majors are going to meet the challenge. In the predominantly macho world of mining, it’s always a size thing. There’s been speculation again, recently, that were Glencore to list it could take out Xstrata, in which it has a 34% odd stake and then have enough heft to sweep Anglo American finally away.

I think that might be wishful thinking, but Bird from Bain thinks the scale thing is not in itself, a solution for meeting the challenges of the supercycle.

“Big enough is no longer good enough to win,’ he writes in an article given to me before our meeting. The factors that power real growth for shareholders in firms that ultimately deal in wasting assets is scale and diversity.

There’s a bunch of points he makes in the paper including smoothed cash flows, economies of scale and repeated capability which is being able to acquire assets and habitually drive value.

But it was the issue on option value that caught my eye, possibly because it’s the one characteristic that solves a long-standing issue in mining: that as an industry, it is profoundly inefficient.

Demand drives prices which drives expansion. But long lead times and the increasing element of investment buying of metals makes demand more difficult to read, fragile even. No sooner has capacity flooded into the market than the metal prices react downwards.

Option value, however, allows a mining company to plan projects such that they can actually respond to market volatility. So to crib Bird directly, having access to reserves even when they are “out of the money’ has value because at some point they might become economic to mine.

In essence, having expansive reserves is not, of itself, enough unless planning allows miners the flexibility to develop projects that take account of market fluctuations.

Incidentally, BEE in South Africa has often worked against option value. Anglo Platinum lost huge option value by having its millions of platinum ounce resources hived off into different, empowered, chunks such as the Twickenham , Booysendal and Der Brochen enterprises.

Big enough is no longer good enough to win

“Being big can provide further strategic options,’ says Bird. “Neither BHP nor Billiton would have been able to make an approach for Rio if they had not merged.’

Bird reckons the flight to size will continue. This means that, in the main, the mid-cap firm is to become less common, although one can always make a case for a gold pure play because the economics that inform the gold industry’s business are exogenous ones. In other words, gold’s position in respect of the dollar, or as an alternative to fiat money in times of distress, means the metal requires a single focus.

But the advent of the mega-merger is not bad news for junior exploration business. Large companies normally don’t have the expertise to develop greenfields developments.