Rio Tinto-Alcan: Just the Start

Heated M&A in the sector could create a mining giant while driving Alcoa to a deal and pulling private equity firms into the game

by Mark Scott

Editor's note: This is an updated version of a story that first appeared on BusinessWeek.com on July 11, 2007

The sizzling mining sector is getting even hotter. After days of volatile stock movements across the sector as merger rumors swept the markets, London-based Rio Tinto (RTP) made a $38.1 billion bid for Canadian mining company Alcan (AL) on July 12, snatching it away from U.S. aluminum giant Alcoa (AA), which had earlier launched its own $27.9 billion offer for Alcan.

If the deal goes through, the newly renamed Rio Tinto Alcan would become by far the largest mining company in the world, controlling 11% of the world's aluminum supply and 14% of global bauxite reserves. The merger comes at a time of growing consolidation in the natural-resources sector, when high commodity prices driven by Chinese economic growth are lifting mining stocks to record highs.

Rio Tinto's move likely puts an end to Alcoa's attempt to buy Alcan. "Alcoa has been outbid," says Charles Cooper, a mining analyst at brokerage NCB London. The company could respond with a higher counteroffer, but most analysts think the price set by Rio Tinto is now too rich for Alcoa to beat.

Priced Out of the Market?

What might happen instead is that another mining concern, such as BHP Billiton (BHP), Xstrata (XTA.L), or Brazil's CVRD (RIO), could turn around and grab Alcoa. There have been persistent rumors for the last month that BHP might bid as much as $40 billion for Pittsburgh-based Alcoa, perhaps in partnership with private equity players.

Analysts caution, though, that the high price set for Alcan could raise the bar and make Alcoa too expensive to swallow. Its shares were up 2.7% in early trading July 12, to $45.47. That gives the company a market capitalization of $39.5 billion, and any takeover deal would certainly have to include a premium over that.

Targets for Private Equity

Given the eye-popping amounts spent in recent private equity transactions, such a deal is not out of the question. Indeed, a report issued July 11 by consulting and accounting firm Ernst & Young suggests that mining companies could soon become a target for big private equity firms such as the Blackstone Group (BX) and Kohlberg Kravis Roberts.

A private equity move into mining may be not so far-fetched. Flush with cash and in stronger, more consolidated positions, mining companies could make tempting targets for private equity capital that's unafraid to take a chance on an historically risky sector undergoing a prolonged bull run.

Base metal commodity prices, notorious for their boom-and-bust cycles, have been riding high since the start of the year. "From what we've seen recently, it looks likely there's going to be a longer bull run in commodity prices than many people first thought," says NCB Group's Cooper.