Xstrata brings the green (May 29, 2006)

Surprising few, Xstrata (XSRAF-O, XTA-L) has launched a $16.1-billion, all-cash bid for the 80.2% stake in Falconbridge (FAL.LV-T, FAL-N) it doesn’t already own.

The Swiss-based diversified miner’s offer of $52.50 per share trumps Inco’s (N-T, N-N) recently increased cash-and-share bid of $51.17 or 0.6927 of one of its own shares accompanied by a nickel. In all, Xstrata’s bid values Falconbridge as a whole at around $20 billion, whereas Inco’s friendly offer rings in at just more than $19 billion.

Xstrata says that Inco’s offer for Falconbridge has enjoyed a knock-on premium owing to Teck Cominco’s (TEK.SV.B-T, TCKBF-O) $17.8-billion bid for Inco, which has boosted Inco’s shares. Teck’s bid requires Inco to drop its plans with Falconbridge.

Inco has urged its shareholders not to tender their shares until it has issued its evaluation of the proposal. Teck’s bid expires on July 24.

Stripping out that premium, Xstrata’s bid beats Inco’s fully pro-rationed offer by around 12.3%, based on Inco’s closing share price in Toronto on May 5, the day before Teck unveiled its offer. It also represents an 11.2% premium over Falconbridge’s closing share price that day.

Xstrata’s offer is conditional on at least 66.67% of Falconbridge’s fully diluted shares being handed over. Xstrata will put the plan to a shareholder vote in June; the company has already locked in the support of Glencore International and Credit Suisse Securities, which, together, own around 37.57% of Xstrata’s shares.

The offer expires on July 7, unless extended.

To succeed, the bid must absorb a US$450-million break fee payable by Falconbridge to Inco. Inco retains the right to match any competing offer.

“I believe our all-cash offer of $52.50 per share delivers to Falconbridge shareholders a compelling opportunity to realize a guaranteed cash value with no market and minimal regulatory risk and is significantly superior to the revised offer that Inco has made for Falconbridge,” said Xstrata chief executive Mick Davis. “I have no doubt that Xstrata has today made a superior and more certain offer to Falconbridge shareholders.”

Falconbridge disagreed, saying the offer does not reflect the full and fair value of the company, given its current earnings prospects. To prove it, Falconbridge took the rare step of releasing a single month’s financial results.

During April, the company earned US$238 million (or 63 per diluted share), nearly triple the amount it earned in April 2005. Revenue between the two periods nearly doubled to US$1.3 billion, while cash flow from operations more than doubled to US$422 million.

Falconbridge says it will use some of the extra cash flow to redeem its remaining junior preference shares for US$253 million.

“While we realize that the release of monthly results is unusual, and we will not make a habit of it, we felt it was important that shareholders understand the magnitude of the earnings that we are generating at this crucial time,” said Falconbridge CEO Derek Pannell in a statement.

Conditional offer

Pannell also said Xstrata’s offer is conditional, and doesn’t provide the same “unique and real synergies” as those expected from the combination of Inco and Falconbridge’s Sudbury, Ont., operations. Inco recently upped its estimate of annual synergies to US$375 million from US$350 million.

He added that, unlike the proposed union with Inco, Xstrata’s offer does not allow his shareholders to participate in “the growth of a global mining company and in an industry that is consolidating.”

Still, the company said it would evaluate a formal offer, once received, and provide its shareholders with a formal response.

Inco echoed Falco sentiments in its own statement, and defended its bid, calling it the best alternative for Falconbridge shareholders. The nickel miner also hammered home the enormous Sudbury basin synergies it says are available only under an Inco-Falconbridge marriage. The company estimates the after-tax net present value of those savings at around US$3 billion, based on current metal prices.

Xstrata says its plan delivers “immense value” via the combination of each company’s Latin American copper assets. It also provides for potential expansions of the Las Bambas, Collahuasi or the recently acquired Tintaya operation using Falconbridge’s Chilean or Canadian processing facilities.

The addition of Tintaya and Falconbridge would increase Xstrata’s annual attributable copper production capacity to around 1 million tonnes.

Xstrata recently agreed to buy the Tintaya copper mine in central Peru from Anglo-Australian giant BHP Billiton (bhp-n) for up to US$860 million, including deferred payments geared to the price of copper. During the year ended March 31, the mine produced 51,600 tonnes of copper-in-concentrate and 28,700 tonnes of copper cathode.

The company also says that its plan would deliver annual savings of around US$120 million via reductions in head office and administrative functions and certain exploration activities outside Canada. It would also achieve a proportion of the savings Inco and Falconbridge have identified in Sudbury, but would do so via optimization rather than layoffs, on which Xstrata has placed a 3-year moratorium.

Greater diversification

If successful, Xstata’s bid would create the world’s fifth-largest diversified mining company, with an enterprise value exceeding US$50 billion. The company would hold market leading positions in copper, nickel, thermal and metallurgical coal, and zinc. It would also be an important player in the ferroalloys industry. Its operating assets would span North and South America, Europe, Australia and South Africa.

The combined nickel assets would be housed under the Xstrata Nickel banner, which is proposed as a standalone business headquartered in Toronto. Regional offices for the combined copper and zinc units would also reside in Canada; existing Canadian operations would run as usual.

“We believe there is considerable value in growing the Falconbridge nickel assets into a major global business from its Toronto base,” Davis said.

The Swiss miner says the deal would be substantially accretive to earnings per share and cash flow per share within a year of completion.

With less overlap than the proposed merger of Inco and Falconbridge, which would create a nickel juggernaut, Xstrata does not expect substantive anti-trust issues in Canada, the U.S. or Europe. In contrast, Inco’s bid for Falconbridge has been extended three times to allow for more thorough regulatory review. The lack of overlap is also expected to promote long-term employment growth in Canada.

Xstrata plans to fund the acquisition with new debt facilities underwritten by Barclays, Deutsche Bank, JP Morgan Chase Bank, and Royal Bank of Scotland. The company would then refinance a portion of the facilities via an equity capital raising to maintain an investment grade rating.

Similarly, Xstrata recently placed nearly 62 million shares for gross proceeds of around US$2.5 billion to repay some of the debt associated with the acquisition of its existing Falconbridge stake and one-third interest in the Cerrejn thermal coal operation in Colombia. It paid Glencore US$1.7 billion for that asset earlier this year.

Shares in Falconbridge ended $1.60 better at $55.60, while Inco’s issue slipped 31 to $73.19 in Toronto following news of Xstrata’s bid. For its part, Teck dropped $2.83 to $67.15. Xstrata finished 92 pence cheaper at 2,009 pence in London.