Anglo and Xstrata Merger Makes Sense - BMO

Anglo American PLC (AAUK) directors might not think so, but a merger with mining rival Xstrata PLC (XSRAF.PK) is not a bad idea, says Tony Robson, BMO Capital Markets analyst.

On June 17, Xstrata proposed a $39-billion merger of equals with Anglo American that would create a mining giant to better rival BHP Billiton (BHP), the world's largest diversified miner. However, five days later Anglo-American's board of directors rejected the offer, saying it was "totally unacceptable,” and would dilute Anglo’s “unique exposure” to platinum, iron ore and diamond markets.

"[We] find merit in the concept of merging Xstrata and Anglo American in order to create a larger and more powerful diversified miner," said Mr. Robson in a note to clients.

Based on his calculations, the combined company would have an estimated market capitalization of $63.3-billion, sales revenue of $53.1-billion and net profit of $5.4-billion in 2010. Total net debt at the end of this year is forecasted at $21.3-billion.

Mr. Robson thinks Xstrata will wait and see what type of pressure Anglo shareholders will exert in the coming weeks and based on what unfolds decide whether it will launch a hostile bid or walk away.

If it decides to take up pursuit, Xstrata can likely up its bid from a ratio of 2.65 times, as currently implied, to a ratio of 3.3 times, and still squeeze out the $1-billion worth of synergies it has predicted. Priced to the maximum, Anglo investors could net as much as 20% if the deal were to proceed.

The BMO analyst said:

Risk aware investors may want to consider the pair trade of long Anglo and short Xstrata. As can be expected, this has already benefited investors but there may be more to come, assuming Xstrata is willing to pursue its prize.

Longer term, Mr. Robson believes a merged company has potential for a 50% re-rating over the next two years, based on price/earnings and EV/EBITDA forecasts.

He wrote:

The creation of a $63-billion diversified miner, the third largest by market capitalization, means that investors will have to spend time to decide whether or not to hold the shares. Buying pressure could result in further share price upside.