Digging deep

Miners lead the rush to raise equity.

IT IS supposed to be the canary’s job to give the warning, but this time the miners have done it themselves. Anyone who doubted that a surge in equity issuance from indebted companies is coming should recant after events in the mining industry. Since January 26th three leading firms—Rio Tinto, Freeport-McMoRan and Xstrata—have indicated that they will probably try to raise equity in one form or another. Together they could target as much as $17 billion, lopping a fair chunk from their combined net debt of $62 billion, and equivalent to just over a quarter of their stockmarket value.

Why miners? All three firms have high borrowing, in large part due to overpriced acquisitions they made during the boom years. Indeed, Freeport also announced that it was writing off half of the $26 billion it paid for Phelps Dodge in 2007, and Rio will surely have to write down Alcan, which it bought for $38 billion in the same year. But all three had reasonable liquidity and could have hunkered down for at least another year. Perhaps they reacted more quickly than other firms because the damage a downturn does to miners’ earnings is immediate. Denial is not an option.

Despite being first out of the blocks, Xstrata and Rio Tinto show just how tortuous it is to raise equity when investors have been hammered and may face liquidity problems of their own. Xstrata’s founding 35% shareholder Glencore, a privately held trading firm, lacks the cash to take part in the $5.9 billion rights issue. To fill Glencore’s pockets, Xstrata has agreed to buy a Colombian mine from it, and to give it the option to buy it back within a year. In effect Xstrata is lending Glencore money with the mine as collateral. The deal’s fine print looks reasonable, but corporate-governance watchers are not amused.

If Xstrata’s deal involves helping an old friend, Rio is supping with its toughest customers. It is wondering whether to take an investment from Chinalco, China’s state-controlled aluminium firm, in place of a rights issue. A year ago Chinalco hugely overpaid for a 9% stake in Rio, which has a dual listing in London and Sydney. This time the Chinese firm could buy convertible bonds or direct equity stakes in mines.

Unless the price is extraordinarily high, it is hard to see why Rio would prefer this to a rights issue, however arduous. China is one of Rio’s biggest customers, responsible for one-sixth of sales, and has a political interest in pushing down the price of its raw-material imports. Chinalco’s presence has the potential to create a big conflict of interest, which is why Australia’s government may block a straightforward equity purchase. A deal might also end up acting as a poison pill for other potential acquirers. To overcome these big drawbacks Rio would have to exhibit a degree of dealmaking skill that has so far eluded it.

The sheer pain of raising equity right now is one lesson from the miners’ experience. The other is just how good it feels to be looking on with a solid balance sheet. Anglo American, BHP Billiton (which pulled out of a takeover of Rio, citing its debt) and Brazil’s Vale (which raised $11 billion of equity in mid-2008) all have low gearing. That will allow them to drive home their advantage during this downturn by buying assets. Vale has, in fact, already picked up some from Rio. It also gives them the flexibility to maintain capital spending. On February 4th BHP said its budget next fiscal year would fall by only 13%. Cuts of over 50% are the order of the day for the three indebted miners, hurting their long-term growth.

The mining industry has cut capacity remarkably quickly: global capex this year could be half the level of 2008. That should help stabilise commodity prices, particularly if, as many hope, demand from China holds up courtesy of its government stimulus. Yet already this downturn seems to have created winners and losers, with balance-sheet strength the differentiating factor. The same is likely to happen in many other industries, too.

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