Major mining companies the world over are shelving expensive projects as they tackle soaring development costs and irate shareholders who want higher dividends. Yet copper miner First Quantum Minerals (FQM) is ploughing in the opposite direction. It is making an enormous C$5.1bn (£3.3bn) hostile takeover bid for Inmet Mining, which could dangerously stretch its balance sheet just as rivals are slimming down. We view the bid as the catalyst for a derating and downgrade First Quantum's shares to a 'sell'.
- Highly rated management
- Low production costs
- Hostile takeover could backfire
- Slowing growth and rising costs
- Highly levered to copper price
- Loss of M&A premium
Big acquisitions made near the peak of a commodities cycle have hurt major miners in the past, most recently during the 2008-09 credit crunch. But First Quantum's highly rated bosses sailed through that turbulence and have a reputation as world-class mine-builders, able to develop mines cheaper and faster than anyone else. First Quantum's large team of engineers and geologists has just finished building two mines, Kevitsa and Ravensthorpe, with a third project, Sentinel, under construction and expected to come online next year.
Rather than risk losing its established and expensive construction team (or keeping them on the payroll underused), First Quantum wants to take control of Inmet's huge Cobre copper project in Panama to plug the gap between development projects. But the company is bidding top dollar for the acquisition and analysts from Citigroup estimate that First Quantum will have to make at least $400m of cost savings just to make the deal add to earnings even at today's high copper prices. That might be plausible, given First Quantum's reputation, but its bosses admit they have not been allowed to conduct "even the most cursory due diligence review" of the project because Inmet refuses to support the bid. Citigroup analysts also reckon there is a 70 per cent chance that First Quantum will have to increase its offer now that Inmet has entered talks with other suitors - and that would further undermine the economics of the bid.
First Quantum would have to take on significant debt to fund the Inmet acquisition and build two big mines, so it would not generate free cash until 2014 at the earliest. Meanwhile, its copper production, which rose 16 per cent in 2012 to 307,115 tonnes, may stagnate at between 302,000 and 330,000 tonnes in 2013. Simultaneously, its production costs may rise slightly, although they should remain among the lowest quartile of global copper miners.
These factors mean First Quantum's balance sheet could come under pressure if copper prices soften considerably. That said, most industry commentators don't think they will. Copper is most analysts' standout favourite metal and almost none of them expects a significant price drop in the near term - especially not in the first quarter following strong starts to the year in the US and China. That said, few industry analysts predicted iron ore's quick meltdown last summer, when prices dropped nearly 40 per cent in four months.
FIRST QUANTUM MINERALS (FQM) | ||||
|---|---|---|---|---|
| ORD PRICE: | 1,286p | MARKET VALUE: | £6.13bn | |
| TOUCH: | 1,286-1,306p | 12-MONTH HIGH/LOW: | 1,579p | 1,010p |
| DIVIDEND YIELD: | 0.8% | PE RATIO: | 6 | |
| NET ASSET VALUE: | 679p | NET CASH: | $817m | |
| Year to 31 Dec | Turnover ($bn) | Pre-tax profit ($bn) | Earnings per share (¢) | Dividend per share (C¢) |
|---|---|---|---|---|
| 2008 | 1.74 | 0.39 | 13 | 5.2 |
| 2009 | 1.90 | 0.75 | 123 | 11.8 |
| 2010 | 2.39 | 0.99 | 76 | 16.0 |
| 2011 | 2.58 | 1.12 | 118 | 18.1 |
| 2012* | 3.02 | 2.23 | 359 | 16.0 |
| % change | +17 | +99 | +204 | -12 |
Normal market size: 200 Matched bargain trading Beta: 2.4 £1=$1.574=C$1.572 *Citigroup forecasts | ||||
Yet new copper supply from miners is forecast to rise by 6.7 per cent in 2013 and, unless labour disputes significantly curtail production as in years past, the copper market could head into surplus towards the tail-end of 2013. With First Quantum highly levered to copper prices, any serious dip could send its share price downwards fairly quickly.
What's more, the acquisition of Inmet would see First Quantum lose its status as a prime takeover target for other miners. The size of the enlarged group could deter predators, especially as the biggest industry players are trimming their operations worldwide. Many brokers, including Citigroup, have a 20 per cent bid premium built into valuation models for First Quantum - and that could soon be removed.
