Will Xstrata Make Another Bid for Lonmin?

Whilst walking away from a full bid for the world’s third-biggest platinum miner, Lonmin (LNMIY.PK), at this stage, Xstrata (XSRAF.PK) has simultaneously boosted its stake in the company to 25%, effectively blocking other bidders from gaining control of the company. We fully expect Xstrata to return, however the recent turmoil in financial markets gives the company the perfect excuse to cool its heels.

Our last review of this stock was in August (Fat Euro Mining 82).

Since reaching an all time high of 4434p in May, there has been a significant deterioration in the outlook for Xstrata. As evident on the daily chart, prices have sold off heavily over the past five months, reaching a low of 1112p last week. This is the lowest level for the stock since August 2005.

In the absence of a base or reversal pattern, we cannot rule out a deeper decline in the coming days. However, prices are now clearly oversold, which increases the likelihood of a sharp recovery rally, once this decline has run its course.

From a broader perspective, the past four months has interrupted the longer-term upward trend. In our opinion, a sustained period of consolidation and base building will now be required, before rally attempts are likely to lead to a sustainable upward trend.

Xstrata has spent 440 million acquiring an additional 14.2% stake in Lonmin at an average 1,979 pence a share, after scrapping a planned hostile takeover bid at 3,300 pence a share. The company cited what it describes as "extreme'' financial-market turmoil, which impacted upon its funding plans for the deal, as its reason for walking away from Lonmin for now.

Lack of clarity and certainty regarding the future availability of credit introduced 'significant risks' to the offer, according to Xstrata. Furthermore, the need to refinance a "substantial portion'' of the debt for the plan within a year increased the risk of the transaction, given volatility in financial markets, the company said.

The move is also a possible short-term facing-saving more for Xstrata, given that Lonmin’s share price has fallen to around 15 pounds, less than half Xstrata’s 33-a-share offer.

We fully expect that Xstrata will return and bid for Lonmin at some stage in the foreseeable future, but at this stage it is prevented from doing so for a six-month period in accordance with London Stock Exchange rules. Xstrata can come back and bid at 3,300 a share after six months, or at a lower price after 12 months.

Mick Davis, Xstrata's Chief Executive Officer, has made no secret of the fact that he wants control of Lonmin's South African mines and smelters, as he believes platinum is a great business to be in. "We continue to believe the medium and long-term fundamentals of platinum are robust and that the structure of the platinum industry remains attractive,'' Davis said in a corresponding statement.

And as we have previously highlighted, Lonmin is in a great position to benefit, but has a recent history of under-performance.

From Lonmin’s perspective, the board says it notes Xstrata’s statement regarding the withdrawal of its offer. Lonmin believes that the current prices of platinum and other PGMs have been substantially impacted by forced selling of platinum investments, physical inventory-selling by automotive companies, and negative sentiment on the economic outlook and supply-demand dynamics. While these factors have significantly depressed prices, the board says it remains confident in the longer-term demand fundamentals for platinum and other PGMs.

As we have previously highlighted, Lonmin possesses long-life and high-quality assets, and is the lowest-cost integrated producer of PGMs in South Africa’s Bushveld region. This means that Lonmin is better positioned than most of its platinum peers to withstand the current challenges presented by any period of lower PGM prices.

And platinum prices are currently not reflective of the host of supply-side risk factors affecting the industry in South Africa, namely rising costs (both operating and start-up), credit tightness and ongoing power supply issues. South Africa currently supplies about 70% of the world’s platinum.

Ian Farmer, Lonmin's new CEO, is leading a review of the Group's operations, focused on improving performance and maximising value from Lonmin’s assets.

Both Xstrata and Lonmin remain core holdings in our European Mining & Resources Portfolio. Both companies have the capability of benefiting strongly from an eventual recovery in commodity demand and prices. Both companies importantly possess world-class assets at a time of critical supply-side restrictions.