NDP position on Falconbridge-Phelps Dodge takeover

[BitWhys]

Layton calls for coalition to defend northern communities through Falconbridge-Phelps Dodge takeover process

Thu 29 Jun 2006

SUDBURY, ONT – NDP Leader Jack Layton is calling today for the creation of a coalition of Labour, Northern Ontario Civic and Business representatives and both the Federal and Ontario NDP to press the Harper government to ensure that the rights and jobs of Canadian workers are at the centre of any negotiations over the future of the mining industry in Canada.

Layton, who this week is visiting the Northern Ontario communities of Sudbury, Sault Ste. Marie and Timmins where the possible Falconbridge-Phelps Dodge merger will have a massive impact on workers, says the takeover is unprecedented in Canadian mining history.

"This takeover is so great, it would see a firm based in Phoenix, Arizona in charge of smelting from Thompson, Manitoba to Newfoundland and Labrador. Like the decisions concerning mining that we've made in our past, the stakes are very high with this decision. "

Throughout our history, Canada has always intervened to ensure mining serves its people and communities. Going back to the Nickel Question around the First World War, pressure from the federal government on US mining firms helped encourage re-investment in Canada, creating jobs and building communities.

"We're calling on the Prime Minister to give mining communities and all Canadians his personal guarantee, that when the future of the mining industry is discussed through these mergers, the federal government will be at the table," said Layton. "And that re-investment, jobs, and competition will guide the government's decisions.

"Phelps Dodge has not produced a single nickel ingot in its 172 year history and has a history of cutbacks and closing operations when copper prices fall. We need an industry that sticks with its workers and with Northern Ontario communities in good times and bad."

"Investment Canada's test should be more stringent than a net benefit. We need a strategy to protect our jobs, our communities and the sovereignty over our resources," said NDP MP Charlie Angus (Timmins-James Bay). "This deal raises serious competition issues. Giving monopolistic control of our smelting capacity to a company based out of Phoenix will be bad news for junior exploration companies and the thousands of spin-off jobs in exploration."

"Just a year and a half ago Inco CEO Scott Hand said that if either Falconbridge or Inco disappeared, 'you would have hollowed out the corporate headquarters and Canada would be lesser as a result,'" said NDP MP Tony Martin (Sault Ste. Marie) "The impact of this potential takeover will be felt in Toronto, in the Sault and in communities right across Canada. The Canadian government must be at the table."

"The McGuinty Liberal government also has a responsibility to safeguard direct as well as indirect mining jobs in Northern Ontario," said NDP MPP Shelley Martel (Nickel Belt). "We need to hear from Dalton McGuinty and the Minister of Northern Development and Mines regarding what they're going to do."

If not a monopoly then an odds-on oligopoly at the CR8 at least, which would be serious enough.

 

[Toro]

The simple fact is that over the past 3 decades, global mining companies have not earned their cost of capital. They have been poorly run, with too many costs bringing too few resources out of the ground. So consolidation is good for the industry, but not good for the small towns in which they operate.

However, I don't know if this deal is final.

June 27, 2006
Birthing an elephant in Inco-Falco, Tues., June 27, 2006, 9:15 AM

It's fitting that the gestation period for an elephant is about 22 months and that the newborn comes along about once every five years. Traders are watching a similar process with Inco and Falconbridge.

Toronto is, together with London, the mining finance capital of the world. That exalted position may come to an end should these mining giants be taken over by a tier two player Phelps Dodge Corp. That sets up an interesting confrontation between the federal government in Ottawa and the Bay Street Boys of Toronto who pull the strings of Inco and Falco management.

In fact, while investment analysts and mining companies around the world will be frothing over the combined 22 pct global share of refined nickel by Inco-Falco, my eyes will be focused on others, such as Vancouver Canada’s Teck-Cominco and Zug Switzerland’s Xstrata. These are the players in the delivery room claiming dual foster parentship.

Yes, I don’t think the Phelps Dodge deal is much more than a stalking horse, and can be dismissed.

The best I can say about the deal on the table today is that traders have a timely opportunity to buy PD shares at a discount. When this deal collapses, PD shares will rocket higher. In time, “Phelps Dodge will become dinner, not diner” as one wag suggested today.

Moreover, I’m interested to see how Teck-Cominco manages to maneuver into the catbird seat, to be favored as the grand acquisitor of both Inco and Falco. That is the scenario Ottawa will want to see, and I believe they will grease the wheels to ensure it. The new head office of Teck-Inco-Falco would be in the financial centre of Toronto.

Xstrata will still play a role, buying up the foreign assets, as I see it. The bottom line is that combining the Sudbury nickel operations of Inco-Falco is the key to this deal, so I can’t see Swiss-based Xstrata walking off with a core asset here.

The bottom line then is that the Canadian government will help broker the final deal, and Phelps Dodge will be left to fight its own battles. Canada will emerge with a global mining giant similar to (but still smaller than) Australia’s Billiton BHP (BHP), Rio Tinto (RTP) or Brazil’s Companhia Vale do Rio Doce (CVRD).

http://www.billcara.com/archives/2006/06/birthing_an_ele.html

The last paragraph is speculation, but is certainly possible.

 

[BitWhys]

You figure the Inco-Falco is the better part of the strategy and the Tories will keep PD out?

"When this deal collapses, PD shares will rocket higher." :lol:

I would have never guessed.

 

[Toro]

RE: NDP position on Falco

This is a reverse engineered deal, I think. PD is susbtantially smaller than the combined Falconbridge-Inco, so I'd guess that if the deal were to go through, the majority of the executives would end up being Canadian, not American, and many of the executives would remain in Toronto. I don't know, but that's what it looks like.

I don't know if the Tories will keep PD out. But I have to believe that the government is trying to find a way to keep the HQ in Canada.

Its fairly common for the shares of the acquiring company to fall when they make a bid for another company. If the deal didn't happen, you'd then expect the shares to rebound. PD's shares fell $5 when the deal was announced.

 

[BitWhys]

RE: NDP position on Falco

Is there regulations on which company carries the cost fo the aquisition on its books (credit? on the G/L)?

No doubt the list of financiers would be a who's-who of sorts.

"Head Office" is a very thin line in the neoliberal scheme of things.

 

[BitWhys]

Re: RE: NDP position on Falco

Its fairly common for the shares of the acquiring company to fall when they make a bid for another company. If the deal didn't happen, you'd then expect the shares to rebound. PD's shares fell $5 when the deal was announced.

makes sense. thanks.

 

[Toro]

Re: RE: NDP position on Falco

Is there regulations on which company carries the cost fo the aquisition on its books (credit? on the G/L)?

No doubt the list of financiers would be a who's-who of sorts.

The company that does the acquiring carries the cost since the acquired no longer exists. What happens is that accountants make a fair assessment of the target company's assets, then the price paid above that amount is booked on to the acquiring company's balance sheet as goodwill. In other words, if the fair value of Inco-Falconbridge is $20 billion, and Phelpps Dodge pays $24 billion, the $20 billion is added to Phelpps Dodge balance sheet by account (i.e. accounts receivable, property, etc.) and a new account called "goodwill" worth $4 billion is also added to PD's balance sheet. Theoretically, that $4 billion is supposed to be the value that will arise from the merger, but that often isn't the case, which is one reason why the shares of the acquiring company falls after the announcement.

And just to clarify a bit further why the share price drops, if a company earns $1 per share, and its stock is worth $10 per share, it has a multiple of 10x earnings. Then if it wants to acquire another company that earns $0.50 per share for $10 per share by issuing the same number of shares (or pay in cash, it doesn't matter), the earnings of the new company will be $0.75. Applying a 10x multiple gives you a share price of $7.50, a $2.50 drop in price.

 

[BitWhys]

RE: NDP position on Falco

How is the cost of goodwill recovered?

 

[Toro]

Re: RE: NDP position on Falco

How is the cost of goodwill recovered?

The accounting cost of goodwill is charged off over time of up to 40 years. So in this case, if there is $4 billion in goodwill, PD will charge $100 million against income every year for 40 years. But that's an accounting cost, not a cash cost.

The way the company thinks it can recover the $4 billion extra in cash they've put up to close the deal is either through increased sales or because of cost cutting. Usually its more of the latter than the former. So, in our example, PD must believe that the merger will accrue an extra $4 billion in sales and cost cutting to justify the premium paid above the value of the company.

 

[BitWhys]

How does a copper company get an extra $4B in sales and savings by owning a nickel mine? Do the books on profits forward merge?

btw,

looks like they're at it in Indonesia at the same time.

 

[Toro]

I used $4 billion as an example. I don't know how much goodwill the company will book.

The value of any asset is the cash flow that derives from that asset over time. The new company will produce a lot of nickel, copper and zinc. Currently, copper is trading at around $3.25 a pound, nickel $9 and zinc $1.40. However, the stocks of the two companies do not reflect those prices. The stocks are discounting metals at a third to one half those prices. If PD is right (they pretty much have to be considering how much debt they are taking on to do this) and metals stay higher for longer than the market expects (i.e., higher sales), they will have purchased an undervalued asset in Inco and Falconbridge.

 

[BitWhys]

RE: NDP position on Falco

thanks for taking the time.

how do the PD stockholders get their share of the nickel pie?

 

[Toro]

RE: NDP position on Falco

The PD shareholders may curse this deal one day.

 

[BitWhys]

RE: NDP position on Falco

Wouldn't ruffle my feathers but if it does pay off for PD stockholders how does the consolidation get greenbacks in their pockets?

 

[Toro]

RE: NDP position on Falco

It will benefit PD shareholders if the price of metals stays higher for longer than the market expects. Its as simple as that.

PD has been a very well run company, and has done a good job creating value for shareholders lately. That's why this deal is a little surprising because they are paying a high premium. Five years ago, you could have purchased Inco stock for $15. Today, its above $70.

 

[BitWhys]

8)

I think I get it. The interest PD will have in Inco and Falconbridge will be its cash value as an asset. Can that asset or a portion thereof then be used to back financing if its outlook is positive?

I assume the Board of Directors up here will need a new nameplate or three.

 

[Toro]

Not quite, but you're getting there.

The value to PD will be the profits that accrue to the company over time. If the company makes more money than the market believes, then the deal is a good one. If the company makes less money than the market believes, then the deal is a bad one.

Its similair to if you purchased a stock in any company. You buy it because you think that the company will grow profits over time. If the company makes less money than you thought, the stock won't do as well as other investments. If the stock makes more money than the market thought, you will have done very well.

(Here is one way to describe this process.)

Same with PD. They are buying the companies because they think Inco and Falconbridge will do better over time than the market believes, and that they will be able to reduce costs within the newer company creating economies of scale.

Of course, they could be wrong. And its not just PD shareholders. Its the shareholders of Inco and Falconbridge as well who have to think about this. A good example is when AOL bought Time Warner. Time Warner essentially gave away half its company for shares in another company that was only worth a fraction of what the market believed at the time. Time Warner shareholders should have voted to not merge with AOL. It may be that shareholders of Inco and Falconbridge should vote this down for this reason (though that's doubtful.)

The assets of the company (i.e. land, buildings, equipment) are what generates the income. They have a value based on what they can generate. But what matters is the profits those assets can generate.

 

[BitWhys]

So this is really a no holds barred takeover with none of the nasty foriegn ownership rules of old. In effect there is no longer an Inco or Falconbridge and the executive of the assets that WERE two of the largests nickel companies in Canada will be under tremendous pressure to perform better than expected, as it were.

What happens if it doesn't meet PD expectations? Defensive downsizing and liquidation?

 

[Toro]

So this is really a no holds barred takeover with none of the nasty foriegn ownership rules of old. In effect there is no longer an Inco or Falconbridge and the executive of the assets that WERE two of the largests nickel companies in Canada will be under tremendous pressure to perform better than expected, as it were.

What happens if it doesn't meet PD expectations? Defensive downsizing and liquidation?

Its a friendly deal. The new company - if the merger happens - will be called Phelps Dodge Inco. Another Canadian company called Teck Cominco is trying to buy Inco. The deal is, in part, due to Inco not wanting to be taken over by Teck, probably because the executives at Inco will wind up having great influence, if not running Phelps Dodge. If Inco is purchased by Teck, my guess is that the Inco executives will be gone.

The risk to the deal is not the deal itself, though in the long run, it might not be in the best interests of shareholders. (Oddly, the majority of mergers underperform expectations - that is, shareholders would have been better off not merging.) The risk is the financing. PD will be using a lot of debt. If metals prices stay high, then it won't be a problem. But if metals prices fall hard, then the firm could find itself in financial distress. That doesn't necessarily mean liquidation - many companies emerge from bankruptcy - but it would mean that shareholders are wiped out.

 

[BitWhys]

RE: NDP position on Falco

I think its the sheer size of the current market share involved that's got my attention the most. That's one hell of a slice. I've gotta figure that's a big part of what's so attractive about the aquisition.