Hogsback on the high costs of takeovers

REPORTS that takeover activity in the coal industry will be on hold for a while because of low prices did not surprise Hogsback because what’s more of a surprise is that anyone in the mining industry ever acquires anything given the huge losses from failed deals.

Staff Reporter

The best example of a coal producer botching an asset acquisition was Rio Tinto’s ill-fated $3.9 billion purchase of Riversdale Mining in 2011 – and the subsequent re-sale of coal leases in Mozambique which were the heart and soul of Riversdale for $50 million.

As well as flushing almost $4 billion around S-bend, the Riversdale flop cost Rio Tinto’s then chief executive, Tom Albanese, his job.

So, when Marian Hookham from the consultancy IHS Coal told a conference in Sydney last week that low prices would delay an expected wave of M&A activity, she was issuing a timely reminder of the tough conditions in the coal industry.

But, what she also did was pre-empt a similar warning from one world’s top investment banks that takeovers can be bad for the health of the acquirer.

Hookham is well-known in the coal industry and a former editor of International Coal News (then known as International Longwall News) but even she might have been surprised to read a few days after her talk in Sydney that Citibank told clients that big miners have written off around 90% of the value of deals completed since 2007.

Taken together, the Citi analysis and Hookham’s observations, are a sobering assessment of mining company management and its near-universal ability to make the wrong decisions, apparently in the belief that commodity prices always rise.

The view from the people in charge at any point in the price cycle is that a high price for an asset can be justified because of a belief that the underlying commodity price will be higher in the future and that means asset values will rise, washing away the excess paid to claim victory in a takeover.

That view is, of course, utter nonsense given the historic price trends of all commodity prices that rise and fall with supply and demand.

Hookham’s warning was based on an observation of the forward curve for coal prices which was indicating a fresh price fall, providing potential buyers with a good reason to remain on the sidelines because lower future coal prices means lower future asset prices.

Citi took the discussion over M&A action a step further, singling out coal as an industry facing more problems in the months ahead, particularly as mining companies rule off their books at June 30 and are forced to cut the value of assets they already own.

“We believe there are potentially more impairments to come from thermal coal and metallurgical coal businesses where we have seen a structural down-shift in prices,” Citi said.

In other words, asset values will continue to fall in line with lower coal prices, so what might be available for sale today should be cheaper tomorrow.

Citi’s assessment of mining company decision making when it comes to M&A activity is devastating, with that 90% deal-value write-off asking a question of everyone at a senior level in a mining company: why do you do it?

If, for example, The Hog was a small business and he acquired another small business, only to then write-off 90% of the price paid within a matter of years he would be first to admit that he paid far too much to complete the deal, and is an exceedingly poor business manager.

Citi’s analysis means that the charge of poor decision making can be laid at the feet of the world’s top five mining companies because collectively BHP Billiton, Rio Tinto, Anglo American, Vale and Glencore, have impaired $110 billion of assets acquired over the seven years up to 2014.

Excuses, and there are plenty of those, is that the write-downs were required because commodity prices fell, a poor defence because commodity prices always rise and fall.

As one commentator noted after the release of the Citi report mining company managers tend to be quick to “forgive” themselves when they make a mistake in an M&A deal.

“However, most mining companies have made mistakes in both buying and building at the wrong point in the cycle, as evidenced by significant impairments and capex over-runs and ramp-up delays,” Citi said.

What happens next will be worth watching because Hookham’s observations about more price falls ahead, and Citi’s sobering examination of massive losses from past failed deals, should serve as a double-barrelled warning for anyone planning a spot of M&A action.

But, whether the warnings are heeded is the critical question because there is always an urge for managers to grow the size of the business they’re running without looking too closely at whether size equates to profitability or future asset values.