Almost every day brings news of another mega-deal in the mining and resources industry.
BHP Billiton Ltd makes a $40 billion bid for Potash Corp. of Saskatchewan Inc.Vedanta Resources Plc pays $8.4 billion for a controlling stake in the oil driller Cairn India Ltd, while Korea National Oil Corp. offers £1.87 billion for UK exploration company Dana Petroleum Plc.
Mergers-and-acquisitions bankers who know anything about oil, iron ore or potash are no doubt looking forward to generous bonuses this Christmas. The City of London, where many of the resources companies are listed, is enjoying a frenzy of wheeler-dealing. Speculators and hedge funds can make a fortune taking positions in the shares.
And yet, shareholder value is more likely to be destroyed in this flurry of bids. Most of the efficiency savings promised by the bidders will turn out to be an illusion. The new mining conglomerates will provoke a backlash from governments and regulators that will hit profits and dividends. And all the deal-making will distract executives from their main task: finding more stuff in the ground and digging it up.
The upsurge of resources deals has been gaining traction for at least a year. Last summer, Xstrata Plc proposed a huge merger with Anglo American Plc. That deal didn’t work out, but plenty of others have. So far this year, commodities companies have announced $362 billion of takeovers, according to Bloomberg data. Resources deals account for 28% of this year’s $1.26 trillion merger market, double their average share during the previous 10 years.
It isn’t hard to understand why. Interest rates are at a record low. If you believe that China and the rest of the developing world will carry on growing at anything like the current pace, minerals and resources will be a great industry for the next two or three decades. It looks like a good time to borrow as much money as you can, and make your conglomerate as huge and as dominant as possible.
But will shareholders get anything out of it? No, only bankers and executives will make money.
Shareholders are about to get burned. Here’s why.
First, most of the promises announced by managers when the deals are unveiled will prove a lot easier to make than to keep. Executives promoting a mega-merger have a standard, well- rehearsed repertoire of lines they trot out: greater efficiencies, stripping out layers of costs, removing overlaps, more pricing power, and so on. And yet as anyone who has ever worked in business realizes, the bigger a company gets, the more bureaucratic it becomes. Some costs are stripped out, but others are added in. The net result is rarely positive.
Second, an industry dominated by resources conglomerates is going to cause a regulatory and political backlash. We have already seen signs of that. Australia proposed a harsh 40% tax on its mining giants. China, the world’s biggest metals consumer, has said it plans to extend a tax on oil, gas and coal output from one province to the entire nation. Tom Albanese, chief executive officer of Rio Tinto Group Plc, has warned of the rise of resource nationalism, as governments around the world try to take a greater share of mining profits.
The bigger the companies get, the more that kind of pressure will grow. If you see a conglomerate making billions in profits in your country, and you suspect it has got something approaching a monopoly as well, there is the temptation to tax it, or control its prices and profits. Lots of smaller companies, making more modest profits, are far less attractive. There’s no benefit for shareholders in being a big, easy target rather than a small, slippery one.
Distraction for managers
Third, spending all your time either preparing a bid, or fighting one off, is a distraction for senior management. In the 1990s, the pharmaceuticals industry went through a similar frenzy of deal-making, creating companies such as GlaxoSmithKline Plc. There is little evidence that any new wealth was created for their shareholders in the process. It just used up time and energy that could have been devoted to finding new medicines, which is why that industry exists.
Likewise, the resources deals will just distract companies from exploration and development, which is what their business should be about.
There’s little point in just buying resources companies. All you are doing is stock-piling assets. You will almost certainly be buying at something close to the top of the market—prices are never cheap in the middle of a merger boom.
It would be far better to focus on exploration and mining. That’s where the real money will be made—from the engineering that involves drills and cranes, rather than the financial sort.