Opportunities in Mining's Takeover Game
“The tide of globalization will continue to rise. The movement and restructuring of assets – mergers, acquisitions, and divestitures – are currents in this evolutionary whirlpool. Front-page news and trends are inexorably reflected in a deal.”
– Bruce Wasserstein, Big Deal: Mergers and Acquisitions in the Digital Age
I often think about investing as an arbitrage between the stock market and the private markets. An investor can do well by staying in whatever market is cheaper at the moment. This philosophy is a key premise underlying my own book, Invest Like a Dealmaker.
I always follow the deal-making that goes on in the stock market, the shuffling of assets by way of mergers, acquisitions, IPOs and the like. As Wasserstein’s quote up top points out, these deals reflect important investment trends. They can tell you a lot about what’s going on in markets and where the opportunities are…or are not.
As such, the one acquisition that really caught my interest last week was Caterpillar’s $8.6 billion deal for Bucyrus, a maker of mining equipment. Cat wants to boost its exposure to mining. Writing a check for Bucyrus was an easy way to do it.
Before we consider what Cat paid and what this says about the mining business, let’s look at mining more generally. The most important thing to appreciate is that mining is viciously cyclical. The only extractive business that is consistently profitable is dentistry. But right now, miners are flush with cash. As The Wall Street Journal reports: “The mining industry is printing money: Citigroup expects it to have aggregate net cash of $70 billion by the end of 2012.”
So, when miners do well, the thinking goes, so do the companies that sell the picks and shovels. “Cash chases a slow-growing supply of tools, driving up prices and profits for the likes of Bucyrus,” says the WSJ.
But what about that cyclicality? Well, the world has changed a great deal in the last couple of decades. Doug Oberhelman, Cat’s CEO, an old hand in the business, says: “When I entered the business world, three-fourths of the world was closed – China, Russia, Vietnam, India, most of Africa… In 2010, the entire world is wide open, the developing world is growing twice as fast as the developed world and there’s still arguably several billion people out there that will modernize and progress.”
I have been chronicling his trend for several years now. And I believe the development of these emerging markets is the biggest investment story of the 21st century so far. It’s impacted nearly everything. And US industrials with exposure to these markets have led the profit resurgence in 2010. For mining, the impact is equally transformative. China, India, Brazil and other markets drive the demand for coal, iron ore and other goodies that come out of the ground.
And since this “new” demand for industrial commodities shows no signs of abating, the long-term outlook for the mining industry is more compelling than ever…and probably less cyclical.
“Mining is a wondrous business,” the FT gushes. “Prospects for the decade-long boom in commodity prices to continue have sprinkled magic coal dust over valuations of all companies connected to the extraction of raw materials.”
But, everything has a price at which it starts to not make sense anymore. And here we get to the price paid.
Cat paid 10.5 times Bucyrus’ estimated 2011 EBITDA (or earnings before interest, taxes, deprecation and amortization). That is a rich multiple to pay for a cyclical business. Many acquisitions get done at 7-8 times. In fact, Bucyrus paid 9 times EBITDA for Terex in February. By some estimates, Cat will have to double operating income at Bucyrus to have the deal payoff. (And though unrelated, KKR is in talks to buy Del Monte for 7.5 times.)
Mining equipment companies rallied on the buyout, as you might expect. Joy Global, a competitor of Bucyrus, trades at 52-week highs and about 10.5 times EBTIDA already.
In that light, Cat’s big buy is a signal of some kind. It’s like a bell going off.
The reason is that mergers and acquisitions tend to come in waves. Author John Brooks, who wrote a couple of classic books on great bull markets – Once in Golconda about the 1920s and The Go-Go Years about the 1960s – also wrote a book called The Takeover Game.
In it, he described the takeover waves in US history. “Exactly why mergers should come in waves is not well understood,” he wrote. “What is clear is that they do.” What is also clear is that as the waves crest so do the multiples paid by corporate acquirers. Inevitably, the whole thing crashes.
I have to think we’re approaching a cresting of that wave as far as mining equipment companies go. I would stay away from the frothy action there. In fact, much of the market related to mining has become expensive – unless you believe mining is no longer cyclical.
I think there are still some outstanding opportunities in mining – and I have identified a few of them for the subscribers of Mayer’s Special Situations. In particular, I’d cite gold and uranium stocks as two mining industries that still look attractive. Gold stocks because the shares of gold stocks has lagged the increase in the gold price. The uranium industry is still early in its bullish phase; the price of uranium is below the cost for new projects.
I also like metallurgical coal – or hard coking coal – for the simple reason that high-quality deposits seem in such short supply with no easy relief in sight for at least a couple of years. And though much more speculative, the mining of rare earths is also attractive given the tight supply in the near-term.
All to say, the easy money is gone. When it comes to mining, investors should pick their spots more carefully than ever.