Xstrata takes Falco stake (August 22, 2005)

Zug, Switzerland-based, diversified base metal miner Xstrata (XTA-L) has added significant nickel exposure to its portfolio by picking up a 19.9% stake in Canada’s renovated Falconbridge (FAL.LV-T, FAL-N).

Xstrata bought more than 73.1 million Falconbridge shares from asset-management company Brascan (BNN-T) for around $2 billion. The price tag translates to $28 per share; the shares closed at $28.38 in Toronto on Aug. 12, the last business day prior to the deal’s announcement.

Falconbridge ranks as the world’s third-largest nickel and zinc producer and the eighth-biggest producer of copper. It also produces 10% of the aluminum consumed in the U.S. Xstrata, the world’s largest exporter of thermal coal, also has standing in the copper, ferrochrome, vanadium and zinc markets, with additional exposures to gold, lead and silver.

“We went for the 19.9% stake to secure the option on the whole company,” Xstrata Chief Executive Mick Davis explained to analysts during a conference call. “It puts us in the position that if we go after the whole, we won’t likely face interloper interference.”

Such was the case earlier this year, when BHP Billiton (BHP-N) trumped Xstrata’s bid for Australian-based copper and nickel miner WMC Resources. Since that defeat, Xstrata has been rumoured to be eyeing Melbourne-based copper and gold producer Oxiana Resources and Canadian nickel giant Inco (N-T). Xstrata acquired Australian-based zinc and copper producer M.I.M. Holdings via a cash-and-debt takeover deal valued at A$4.9-billion in mid-2003.

Davis also said that under Canadian law, the newly acquired equity level does not compel Xstrata to make an offer for the rest of Falconbridge’s shares. If Xstrata does go after those shares, at more than $28 per share, within nine months it would need to top up the consideration paid to Brascan.

Davis would not confirm whether his company would proceed to a full takeover, but said that the most important thing at the moment was to secure what he called “one of the most significant options available in the mining industry.”

“I think that the value in this investment is the option which it gives us,” he said. “We don’t intend to be a long-term shareholder with minority interest in the company.”

He also stressed that it would be wrong to assume that the recent acquisition would necessarily lead to a full-on offer for Falconbridge. While he did admit that due diligence completed on Falconbridge last year, prior to its merger with parent company Noranda, indicated that a combination with Xstrata would make a lot of sense.

Xstrata will pay US$1.327 billion in cash plus US$375 million in 12-year convertible bonds. The bonds can be converted into 12.1 million new Xstrata shares at a rate of 17.1315 pounds per share, a 35% premium to their closing price on Aug. 11. The shares represent around 1.9% of Xstrata’s current ordinary share capital.

Xstrata says it will also use a new debt facility from Deutsche Bank and JPMorgan Chase & Co. to finance the acquisition. The Falconbridge purchase does not require approval by Xstrata’s shareholders.

Davis said that Brascan requested part of its compensation in the form of a convertible debenture. He suggests the company wants to retain some exposure to the sector, and that they “clearly have a positive view of Xstrata being that vehicle.”

Brascan has long considered Falconbridge a non-core asset, and expects the sale to result in a pre-tax gain of around US$750 million that will be reported in the third quarter. In all, the company figures it has netted pre-tax gains of around US$1.3 billion by selling Falco shares over the previous six months. The company still retains US$570 million worth of Falconbridge junior preferred shares.

“This completes our strategy of monetizing our resource investments, and enables us to continue to move forward on our transformation of Brascan into a global specialist asset manager,” says Brascan CEO Bruce Flatt.

The new Falconbridge was founded in June via the $3-billion merger with Noranda, which saw Brascan more than halve its stake in Falconbridge to 20%. That deal came about after talks between Noranda and Chinese-state owned China Minmetals concluded without a deal.

Xstrata now ranks as Falconbridge’s largest single shareholder, something Falco views as a positive reflection on the company.

“Xstrata’s significant investment in the company is yet another positive confirmation of the asset mix and growth potential that we have accumulated within Falconbridge,” says Falconbridge CEO Derek Pannell.

The company expects the investment to immediately boost earnings.

Xstrata recently posted an 80% jump in first-half earnings from the year-earlier period to US$763.8 million (before exceptional items) thanks to higher realized prices for all of its commodities. Revenue between the two periods climbed by 28% to US$3.76 billion.

Xstrata also managed to cut its operating costs by US$5 million thanks to an ongoing efficiency program, which helped offset a US$46 million rise in energy, fuel and freight costs. Free cash flow from operations amounted to US$700 million, despite a 53% increase in sustaining capital expenditures, with net-debt-to-equity reduced to 18.6% from 29.5%.

Privately owned Swiss commodity trader Glencore International owns 40% of Xstrata.

Shares in Falconbridge ended 87, or 3.1%, higher at $29.25 in Toronto following the news on Aug. 15. Xstrata shares jumped 6.2% to a new all-time high of 1,352 pence in London.