Evaluating Commodity IPOs

| About: BWAY Holding (BWY)

The WSJ recently ran an article pointing out (shock!) that the IPO business is hopping. The usual suspects are in the headlines: computers and electronics, finance, healthcare. But hey, what's this? Mining? Yes, mining.

With commodity prices high (even after their recent downturn), mining and steel companies are in the midst of a huge influx of money … to the tune of $13.86 billion. That's three times as much as last year. This kind of capital activity isn't uncommon in hot markets - we all remember the heady times of the dotcom era and the biotech boom, where money was showered on anyone with an idea and a shingle. Or a pet store. We're not quite there in the mining sector yet, but recent heightened interest in commodities and the power of the "big China story" is fueling the money machines in a major way.

As we sift through all this, here's the thing to remember: with IPOs and stock offerings, the perception of good business is as important … if not more important … than the reality of good business. When "everyone knows" that widgets are hot, a widget maker's IPO is guaranteed to be bought up. But performance may not—and usually doesn't—live up to day-1 expectations. The latest example is Bway Holdings (NYSE:BWY), a relatively boring packaging company whose stock has performed below expectations since its less than expected IPO. After pricing its IPO at $15/share, the stock now trades for less than $10/share—just one month later. Cavaet emptor.(In a quirk, BWY recently reported Q3 losses due to management bonuses paid out to top executives for “successful completion of the IPO”).

Given the many different ways you can invest in commodities (futures, stocks, bullion, etc.), deciding whether to jump on these new IPOs boils down to this: What kind of investor are you? As an individual investor, analyzing and making decisions on IPOs or evaluating mergers and acquisitions is very different from looking at commodities. In the broadest sense, it's the difference between macro and micro economics.

Being a successful commodities investor requires big picture analyses: economic health and growth, political analysis, supply and demand fluctuations. You process all this information to make choices based on your best guess as to how the commodity in question is going to move over a certain, generally confined, period of time.

IPOs and capital markets equity deals require a different set of skills: deep forays into the company's balance sheets and related financials, exhaustive analysis of management's skill, style and vision, knowledge of the financial rules that surround market transactions, and finally, a sense of the company’s underlying business.

Investor, know thy self.

As mentioned, this IPO analysis applies equally to evaluating the fallout from M&A activity, which can be just as complicated … and where a lot of activity is heating up today.

Remember the hostile bid by Alcoa for Alcan back in May, and the nail-biting suspense as we waited for either Rio Tinto or BNP Billiton to step into the saddle as a white knight? Well, the winner turned out to be Rio Tinto (NYSE:RTP). Not a company known for heavy M&A activity, RTP jumped in big-time recently with a $38 billion dollar bid for the Canadian aluminum company, trouncing Alcoa's measly $27.5 billion offer (a billion here, a billion there). When asked why, the RTP CEO Tom Albanese commented to every reporter he saw, "It's all about China."

Maybe. But to analysts, it wasn't as clear as all that. Sure, the deal makes sense for Alcan. Alcan has been lusting after RTP's assets for years in order to expand their own business. But the positives aren't as clear cut or immediate on RTP’s side of the equation. In the long term, RTP may be able to achieve in aluminum the same market dominance it holds in iron with its rivals BHP and CVRD, but investors weren't sure when the news hit, and the initial reaction was a drop in RTP share. The latest news is that RTP has raised $40 billion for the deal, floating commercial paper hotter than Rolling Stones tickets in a geriatric facility. All those investors surely must believe it's a good investment.

Elsewhere, BHP (NYSE:BHP), which has long used mergers and acquisitions as a growth and diversification strategy, is looking to continue this strategy according to both its CEO (Chip Goodyear) and its CEO designate (Marius Kloppers). Kloppers, who takes over the reins in the coming months, stated that "the company will continue to focus on acquisitions that are long-life and low cost." In fact, he’s expected to increase the pace of acquisitions … and BHP is in the position to do just that, with its recently announced 28% rise in profits. BHP hasn't done an M&A deal since buying WMC Resources Ltd. in 2005, so the time is right.

In the steel arena, private, India based JSW Steel has announced the planned acquisition of three companies in Texas. In this deal, it's all about pipelines. The buyout will make JSW Steel the "largest pipe-making facility in the US," which is where the JSW vice chairman and managing director, Sajjan Jindal, sees a future demand for "over 25,000 miles of pipelines." And it's not the only private Indian steel company to participate in the M&A hoopla: Tata Steel and Essar Steel both acquired foreign companies this year. Tata Steel acquired Corus for $13.7 billion and Essar Steel snatched up both Algoam for $1.6 billion and Minnesota Steel for around $100 million.

How long can the capital furor last, given recent less-than-exciting market conditions? According to the gurus at the Financial Times, the three-year "acquisition binge" that has been seen in the general market had peaked "even before the turmoil in the credit markets." The uncertainty comes in that many investors are still upbeat on equity deals because of how the market looked before the credit sell-offs. And while most of the punditry is about the market in general, IPOs and M&A activity tends to come in waves, and this could be true for commodity related companies specifically. As Neil Boyd-Clark from ABN Amro Asset Management in Sydney put it: "The commodities markets are pretty solid across the globe. Subprime issues are more confined to Western markets, rather than the Chinese economy, which drives their growth."

In other words, if commodity prices remain strong, commodity-related companies may buck the M&A slowdown, and commodity stock investors will have their work cut out for them.