Too pricey for M&A

One of the recent stock market puzzles is that, since it became obvious Australia would not be hammered by GFC, there has not been a significant rise in M&A activity. Over $100 billion in capital was raised on the market in response to the GFC. The supposed reason was to “maintain balance sheet strength” (translation: take advantage of the fear to get more cash). So why has there been so little acquisition activity? It does suggest share prices are expensive. But a report by Southern Cross argues that it is about to happen in resources, and that the strong $A is partly due to potential predators cashing up:

The cashed up corporate world will take advantage of the disbelieving and short-sighted equity market/equity casino. Long duration assets, particularly teir 1, irreplaceable, expandable, low cost resource assets in politically stable jurisdictions are currently mispriced by the short-sighted equity market, with our view being it now makes far greater sense for the corporate world to buy over building. There is a clear disconnect not just between commodity prices and commodity equities, but also between today’s real world capex costs and the long-term commodity prices analysts are using.

The commodity supply response continues to be pushed back. The cost of new production continues to increase. For example, BHP is guiding that new iron ore expansions will cost around $180 per tonne of new capacity, vs $50 in 2004. In coking coal they are guiding to around $400 per tonne of new capacity, up from $100 in 2004. Interestingly, the spot iron ore and coking coal prices are also up around +300% to 400% in that period, reflecting the rising cost of new production.

Yet for some reason consensus commodity price forecasts across the entire industrial commodity price spectrum continue to show sharp declines over the near to medium-term. This is even before you take into account an further price effect of the depreciating US Dollar.

I just have this very strong gut feeling here that analysts will start forecasting “slower and less deep” commodity pricefade in their forecasts, which will lead to heavy consensus earnings and NPV upgrades, while currently a monster M&A cycle will be breaking out.

It is interesting to consider why M&A activity has not occurred. One reason is probably that the cashed up cartels have few options to buy locally and are aware that they are hopeless at making international acquisitions work (that is certainly what investors think, not unreasonably). The high currency would certainly discourage foreign investors. But, to repeat, it suggests that the market is not as cheap as it looks.

Southern Cross nominates Woodside, Alumina, Fortescue, Newcrest, Paladin, Aquila, Western Areas and Oil Search as possible targets. Question is: are they fully priced?

Southern Cross

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  1. I’ve seen this argument before recently, that the high $A is due to predators cashing up. But the counter argument is, given how long an acquisition takes, and the uncertainties associated with the process, why cash up now?

    WRT resource prices, no doubt there is an element of talking up their own book in the guidance BHP and others are giving about future development costs. But my feeling is that analysts have not yet factored this into their future price estimates, either. BHP and Rio are also both forecasting very tight supply for some time, which certainly would keep prices up.