Australia | Jul 13 2007
By Greg Peel
Of the ten brokers/advisors in the FNArena database, four decided to report on Rio Tinto’s (RIO) bid for Alcan this morning. The others may yet be reviewing. And of the four, Credit Suisse, which previously held a Neutral rating, is restricted due to advisory involvement, and GSJB Were is advising Alcoa so it has little to say as well, other than maintaining an Outperform (L/T Buy) rating.
That leaves Merrill Lynch and Macquarie.
Merrills analysts have left no doubt as what they think about the deal that will make Rio the world’s biggest aluminium producer. They have maintained a Buy rating and raised the target price by 20% – from $100 to $120. There will likely be some early share price weakness, the analysts suggest (and there has been) as the market absorbs the nuances of the deal. But given the quality of the assets acquired, the potential for operational synergies, and Merrills’ positive view on aluminium, it should soon be apparent that all is good, the analysts suggest.
There will no doubt be some “sell the fact” profit-taking as well, as this bid hardly came out of left field.
Rio has bid US$101 per share for Canada’s aluminium giant. That represents US$38 billion and it’s all in debt-funded cash. (US$44 billion according to Macquarie) The Alcan board has unanimously recommended shareholders take the money. The bid eclipses that of Alcoa, made on 5 July, that valued Alcan at US$73.25 per share on a cash/scrip mix. Despite scoring a much better deal from Rio, one suspects there was just something a bit distasteful from Aluminium Canada’s point of view about being taken over by the Aluminium Company of America. Hence the Commonwealth joined forces in a classic “white knight” move.
As well as becoming aluminium producer #1, Rio Tinto Alcan will be alumina producer #4. It is the smelting assets that are the real prize, says Merrills, given more than 50% of capacity is in the lowest global cost quartile. Rio intends to dump Alcan’s packaging division, and could pick up around US$6 billion.
The company expects to gain about US$600m of annual synergies by about 2010. While an acquisition of this magnitude would usually signal some pretty serious earnings per share dilution at the outset, this is not necessarily the case.
But it all comes down to what your view on the aluminium price is, and let’s face it – most analysts are as good at picking commodity prices as they are at picking ties. Rio’s management has declared the deal immediately accretive, but that’s based on a pretty positive view on aluminium. You would hardly expect any different. Merrills has a 10% dilution of net present value on the analysts’ numbers, but a 7% year one EPS accretion. Macquarie comes up with only 2.5% accretion in year one. Any accretion is clearly a factor of the Rio cash generating machine being able to find nice cheap debt funding in a world awash with liquidity.
Macquarie analysts find it hard to argue with strategic rationale of the deal, citing Alcan’s long term, attractive power contracts which will only improve in value as energy demand increases and carbon costs begin to bite. Streamlining the supply chain right through from bauxite to metal also helps, and the smelting assets provide significant leverage opportunities. So Macquarie is thrilled, right?
Not quite. In terms of the price paid, Macquarie analysts suggest their “resolve is clearly tested”. They value Alcan’s stand alone assets at only US$53.51 per share (compared to US$101). There’s a lot dependent on commodity price views and synergistic capacity, they say.
Nevertheless, based on their discounted cash flow valuation, and relying on commodity price upgrades, the analysts are holding onto their Outperform rating and $102.91 target for now. This gives us a 7/2/0 B/H/S ratio in the database (one restriction) and an average target of $113.74, ranging from Macquarie’s low at $102.91 to Deutsche bank’s high at $129.00.