Big Mining Is in Big Trouble

Major mining companies’ takeover party of the last few years is starting to yield a globalized hangover of epic scope. Many of the world’s top producers of primary materials have found that the belle of the ball they danced with and wed in better times has turned into a debt anchor chained to their balance sheets.

Rio Tinto (RTP) announced yesterday that it would shed 14,000 jobs worldwide in an effort to reduce its debt load by US$10 billion by the end of next year. If successful, the company will still owe $28.9 billion. The bulk of this liability stems from Rio’s acquisition in 2007 of Canadian aluminum giant Alcan. The company secured a $40 billion credit facility to finance the acquisition.

According to Tom Albanese, CEO:

We will minimize our operating and capital costs to appropriately low levels until we see credible and meaningful signs of a recovery in our markets, but will retain our strategic growth options. We will expand further the scope of assets we are targeting for divestment. By taking these tough decisions now we will be well positioned when the recovery comes.

Notwithstanding the current financial turmoil, we continue to enjoy a suite of key assets which operate in the lower half of the cost curve in their industries, and our suite of growth assets remains capable of re-activation as soon as market conditions justify.

Rio is in a better position than Canadian poly-metallic miner Teck Corp. (TCK).

Teck had the misfortune to acquire The Fording Canadian Coal Trust this year when commodity prices for coal and its other primary product, zinc, plummeted. Teck is also a significant miner of copper, gold and other specialty metals.

Teck is the world leader in metallurgical coal production used primarily in the production of steel, global production of steel is falling. As a result, Teck’s customers have asked that some of their contracted deliveries for coal in 2008 be deferred until market conditions improve.

As a result of reduced revenue from its coal business, and a parallel drop in zinc sales, the company was forced to sell assets, including its 60% interest in the Lobo-Marte gold project in Chile to Kinross Gold Corporation (KGC) for US$40 million in cash and US$70 million in Kinross common shares.

Freeport-McMoran (FCX) has responded to weak global conditions by reducing copper production and sales by 5%, or 200 million pounds for 2009 and a $1.2 billion reduction in capital expenditures. They have also elected to suspend the dividend of their common stock.

Freeport-McMoran acquired Phelps Dodge in March 2007, which saw it incur more than $17.5 billion in debt, of which $10 billion has already been retired.

While these debt reducing strategies might seem sufficient now, the plain truth is that a protracted recession or depression means that revenue fall-off has a lot further to go. Each of these companies has a threshold of income below which they will be forced to first sell more assets (for which there will be increasingly fewer buyers and therefore at deeper discounts), and second raise capital through the sale of equity. The only problem with that though is that if this is indeed the early stages of a depression (say, year one of four), then that’s going to be just as tough if not tougher than selling assets.

The endgame in this scenario would be some very big mergers with taxpayer dollars supporting them. While this will be very bad indeed for these companies’ investors in the short term, they could prove very beneficial to the surviving company’s investors in the long term.

What all investors need to bear in mind at this point is that any investment in the resource sector is going to take a long time to mature, but when it does (in the case of producing companies), the rewards will be spectacular. Whereas share prices are down for many of these companies 40 -60%, those are easily the gains that will be realized once this business cycle moves back into the growth phase.

Bear in mind also, that as long as the inclination of fiscal government is to boost economic growth by Keynesian capital over-saturation and its attendant low interest rates and loose terms, the peaks and troughs of these cycles will continue to amplify as the global economy continues to merge and grow.

Comments

[k45:]

Good observations. Consolidation during boom times is always at risk of overpaying. Buyouts at the bottom, at firesale prices, make better sense, but a company has to have the financial strength to execute such moves. It's easy at the top, but only quality companies can do it at the bottom.

2008 Dec 12 08:27 AM

[NOWHEREMAN:]

Then again regarding FCX, when its annual is released next year the $17.5 Billion purchase of PD will be almost totally reflected by The $10 Billion in Debt repuchase and the $6 Billion in Goodwill it plans to write off. This of course will be a non cash transaction.

The $1.5 billion left over should be manageable from the PD purchase should be manageable.

IMHO

2008 Dec 12 08:33 AM

[secmaven:]

Does the acquisition model gone awry tell us something about why the junior golds are in the doldrums?

2008 Dec 12 11:58 AM

[NOWHEREMAN:]

The junior golds aren't the only ones wgo were hammered, Nem, kgc, auy, gg etc including the XAU.

The whole sector was reamed.

They are in the process of rebuilding but only the ones who have production will be able to continue to really expand. IMO

2008 Dec 12 01:03 PM

[Vox Rationalis:]

"...[Teck] was forced to sell assets, including its 60% interest in the Lobo-Marte gold project in Chile to Kinross Gold Corporation (KGC) for US$40 million in cash and US$70 million in Kinross common shares."

By all accounts, Teck's been considering selling its gold assets for some time. While I find the sales price a bit disappointing (though the KGC common has promise), I wouldn't call a sale that raises just $40 million of cash a "forced sale."

Plus, it's not like Teck's operations aren't profitable. It's expecting to pay down more than a billion dollars of its bridge debt by 3/31 from operating cash flow.

Long TCK, fingers crossed the credit markets regain sanity.

2008 Dec 12 03:56 PM

[Robert Nabloid:]

"Teck had the misfortune to acquire The Fording Canadian Coal Trust this year when commodity prices for coal and its other primary product, zinc, plummeted"

My grandma had the misfortune of owning some of those Fording Canada Coal Trust shares - They were paying outstanding dividend yields (I can't remember if it was 15% ish or 30% ish, but it was very high!) - but Teck stole it from us! At least they paid well... LOL. I was surprised it still went through! I wouldn't have minded her still owning the shares instead. They gave her some Teck shares and some cash if I remember correctly...

"Bear in mind also, that as long as the inclination of fiscal government is to boost economic growth by Keynesian capital over-saturation and its attendant low interest rates and loose terms, the peaks and troughs of these cycles will continue to amplify as the global economy continues to merge and grow."

I agree fully. Keynes died. For some reason they're trying to revive him and put him on steroids as it he won't just keel over again after making the mess bigger. Oh well, I guess if you invest in the right areas we can take advantage of the foolish system. Still sad that they can't comprehend such basic economic ideas like "live within your means".

2008 Dec 12 05:14 PM

[Urbane Gori...:]

And then there's Lundin Mining (LMC) which has dropped from a high of $14 a share to under a buck and can now be found standing under a lamppost swing a purse trying to sell itself to any drunken sailor.

jegan

2008 Dec 12 05:45 PM

[PeteK:]

Metals will always be needed, be it gold, silver or copper.
Go for it when it's at this low. Just love it.
There will always be digging.

2008 Dec 12 06:52 PM

[Greg Pinelli:]

Besides some irrelevant and indecipherable comments above about FCX it isn't clear at all that any mergers will require or ask for taxpayer funds.
The cycle we're going thru has been unusually harsh but gold miners with secure production like GG and AUY will do very well. I have no idea why someone (above) would classify GG as a junior (market cap 20.37B)..but then that is hardly the most inane comment presented.
My take is to look at the gold and silver stars (SLW..AUY..GG) much differently than FCX..which took on a one note copper producer and will have a very long wait for inventories to dissipate.....

2008 Dec 12 08:32 PM

[NOWHEREMAN:]

Geo is back and still altering the posts of others. Since I'm the only one who included GG, his inane post must refer to me.

My post: "The junior golds were not the only ones who(I altered my own mispelling here) were hammered, Nem, kgc, auy, gg, etc including the XAU."

Are you able to read or does a statement go in one way but is altered and regurgitated another?

What part of the "whole sector was reamed" didn't you understand?

What is inane is your continued inability to comment on posts as presented and to disregard the contents of written articles because your views differ. IMHO

2008 Dec 13 04:55 AM

[NOWHEREMAN:]

To anyone interested, click on my comments.

I found an insightful article written about 18 months ago from the WTO regarding its outlook for 2008. It had only one post attached to it. (guess who's) So I added a comment to make it easily accessible to others.

All I can say is that I will look at future WTO pronouncements favorably, instead of dismissing them entirely. IMO

2008 Dec 13 05:06 AM

[NOWHEREMAN:]

"commodities"

2008 Dec 13 05:32 AM

[Kunst:]

Now children, use your words! Oh, that's what you're doing, isn't it?

2008 Dec 14 02:24 AM

[NOWHEREMAN:]

Kunst, its a matter of perception.

I look at Articles for insight, post comments and respond to the queries of others, if I am able to.

Secmaven made a post regarding "acquisitions gone awry" and wondered if this was affecting the Juniors. I responded. I did not know I would get attacked because of that response.

Meanwhile, almost every post by Geo ridicules the article or some poster or even all posters.

There are many old Articles which were correct in their calls regarding the current situation. I am bringing them forward so that others may view other Articles by the same authors for future insight.

The Hulbert Digest rates Market Newsletters in a similar fashion. I do not have their resources. Since Geo thinks every article has no merit, I have run across these negative posts more often then I would have thought possible.

PS Just 5 days ago, he was extolling the virtues of FCX.

2008 Dec 14 05:28 AM

[NOWHEREMAN:]

Kunst: a December 13th alpha article by Mark J. Perry regarding "traffic volume" had a single post, I added another.

What is your take on the first post?

2008 Dec 14 05:52 AM

[andy_miner:]

FCX reduced their 5% production or they short 5% in production?

2008 Dec 14 08:03 AM

[NOWHEREMAN:]

Andy, as far as I could tell, only the mines in the US are affected. They reduced. This means the PD properties, my opinion.

2008 Dec 14 10:58 AM

[ritr54:]

As an LMC shareholder I know Hudbay got a steal!!!!!!!!!!!!!!!


On Dec 12 05:45 PM jegan ;-) wrote:

> And then there's Lundin Mining (LMC) which has dropped from a high
> of $14 a share to under a buck and can now be found standing under
> a lamppost swing a purse trying to sell itself to any drunken sailor.
>
>
> jegan

2008 Dec 14 05:19 PM