Vale-Xstrata Deal Collapses; What's Next?

Is the demise of the proposed deal between Cia. Vale do Rio Doce (RIO) and Xstrata PLC (XSRAF.PK) the end of the M&A wave in mining? Definitely not, according to Citigroup Global Markets analysts John Hill, Alexander Hacking and Craig Sainsbury. In fact, it could set off a new wave with both firms on the prowl for targets.

They point out that all the drivers for mining M&A are still in place: soaring cash balances, a dwindling pool of reinvestment opportunities, barriers to new capacity, and competition with the Chinese for resources.

In a note to clients they wrote:

The strategy is 'Build and Buy.' We see profound ripple effects whether or not the headline [mining] deals proceed. Freeport and Alcoa are the next largest, accessible global franchises. If iron ore is further consolidated, expect a rapid follow-on wave of M&A in steel, as mills band together to face a duopoly.

History suggests that Vale and Xstrata won't sit on their hands for very long. Mr. Hacking wrote that Brazilian giant Vale "will almost certainly" look for further acquisitions. Copper and metallurgical coal are logical areas for Vale to pursue, but he also points to aluminum, nickel and thermal coal as possibilities.

As for Xstrata, Mr. Sainsbury said the Anglo-Swiss firm could continue its recent trend of bolt-on acquisitions (like Jubilee Mines NL). One possibility he suggests is First Quantum Minerals Ltd.[FM/TSX], which would give Xstrata its first exposure to the copperbelt in Zambia and the Democratic Republic of Congo.

But Mr. Sainsbury figures that the market will continue to look for Xstrata to do a mega-deal. He thinks the most sensible one would be a combination with Anglo American PLC (AAUKD), but points out that cultural clashes could prevent that from ever happening.

He added:

The other option is for Xstrata to go it alone and wait for the commodity/equity markets to stabilize and Vale to return with another bid in six months time.