Vale Should Keep Hold of $12 Billion War Chest, Blackrock Says

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29 Jun 2009

Vale SA, the world’s largest iron- ore producer, should keep hold of its $12 billion in cash rather than bidding for Anglo American Plc or Xstrata Plc after prices fell, shareholders Blackrock Inc. and Bradespar SA said. Anglo American’s board last week rejected Xstrata’s offer for a so-called merger of equals, saying it was unattractive for shareholders. Citigroup Inc. and Nomura Securities Co. said the decision could spur Vale to revive last year’s failed bid for Xstrata or make a rival offer for London-based Anglo.
A move by Vale to buy either company would be risky after the global economic contraction damped demand for iron ore, used to make steel, said Will Landers, senior portfolio manager for Latin America at Blackrock, the world’s biggest publicly traded asset manager. Brazil’s Trade Ministry is set to report June exports, including iron-ore shipments, on July 1.
“We’re not completely out of the woods yet, and a transaction of this size would bring a lot of complications,” said Landers. Blackrock is the biggest holder of preferred stock in Bradespar, which, through investor Valepar SA, is one of Vale’s controlling shareholders. “There’s good value in keeping flexibility in your balance sheet,” he said.
Vale raised 19.4 billion reais ($10 billion) in Brazil’s largest-ever share offering in July 2008. At the time, Chief Executive Officer Roger Agnelli said the proceeds would be used to fund acquisitions and expand existing operations.
Cash Holdings
Vale said in a regulatory filing that it had $12.2 billion in cash holdings at the end of the first quarter.
On Dec. 31, Anglo American Plc had $2.77 billion, BHP Billiton Ltd. had $7.2 billion, Rio Tinto Plc had $1.18 billion and Xstrata Plc had $1.16 billion, according to Bloomberg data.
Vale’s cash, near-cash and marketable securities were equal to 1.32 times current liabilities at the end of last year, compared with a ratio of 0.23 for Xstrata, 0.2 for Anglo and 0.6 percent for Rio Tinto.
Iron-ore contract prices are down in 2009 for the first time in seven years, with Vale agreeing to cut prices for its benchmark product by 28 percent for customers including Nippon Steel Corp., Posco and ArcelorMittal. The company has yet to agree on prices with Chinese steelmakers, which are asking for larger discounts than those obtained by other Asian producers.
Under current market conditions, “the risk is too high and uncertainties too great” for Vale to make a bid for Anglo or Xstrata, said Renato da Cruz Gomes, Bradespar’s investor relations director and its representative on Vale’s board.
Iron-Ore Demand
Demand for iron ore slumped after the global contraction pared steel demand, leading producers to idle capacity. Brazilian steelmaker Gerdau SA said June 22 it renegotiated the terms of $3.7 billion of debt after earnings dropped.
A friendly bid for Anglo’s “premier assets would be an enticing prospect for Vale,” Citigroup analyst Alexander Hacking wrote in a June 22 note to investors. Still, “the challenges to a deal remain substantial, including Vale’s lack of experience in Africa, lack of synergies and difficult financing.”
Vale shares have plunged 25 percent since its share offering on July 17, compared with a 14 percent drop for Brazil’s benchmark Bovespa index. Vale fell 1.9 percent to 30.10 reais on June 26 in Sao Paulo trading.
Mining analysts Nick Hatch at ING Groep NV and Paul Cliff at Nomura Securities said last week that Xstrata’s offer for Anglo may spur Vale into action.
‘Ambitious’ Vale
“An ambitious Vale wishing to increase its geographic diversification is likely to be able to swallow either” Xstrata or Anglo, Hatch wrote June 22 in a note to clients.
Vale, which now has a market value of about $91 billion, sought to buy Xstrata last year in a deal valued at about $90 billion. The Zug, Switzerland-based company’s market value is now about $33 billion. Vale also lost a bidding war for Canadian aluminum producer Alcan Inc. to Rio Tinto.
“Vale has perhaps been lucky in avoiding buying Alcan and Xstrata when they wanted to,” Liberum Capital analysts including Michael Rawlinson wrote in a June 19 note. “They have one of the best balance sheets in the business.”
Vale has been cutting investments amid the economic contraction. The company said May 21 that it cut 2009 planned capital spending by 37 percent to $9 billion, down from a previously announced $14.2 billion. The company delayed the start of operations at Brazil’s Onca Puma and New Caledonia’s Goro nickel projects, citing uncertain demand for metals.
Short-Term Focus
“The market can be really focused on the short term, but a company like Vale has to have longer horizons,” said Eduardo Favrin, who oversees about $4 billion in stocks, including Vale shares, as head of equities for HSBC Global Asset Management’s Brazil unit. “Vale is opting for the most prudent path.”
Still, almost a year after selling shares, some investors are weary of the company sitting on the cash. Philip Schwartz, who oversees $1 billion in global equities, including Vale shares, as senior portfolio manager at ING Investments LLC in New York, says Vale is unlikely to get a good price for Anglo or Xstrata. Vale should instead consider a dividend, he said.
When Vale sold shares, it said the money would go to “organic growth or M&A,” said Gilberto Cardoso, a Banif Securities analyst in Rio, who has a “Buy” rating on Vale. “It has done neither of these things.”
Vale Chief Financial Officer Fabio Barbosa said June 24 that the company is “striking a balance” between preserving cash and growth. The next day, CEO Agnelli told reporters any takeover talk is “market speculation,” and that the company isn’t planning to buy.
Ability to Acquire
“If they have the ability to make an acquisition at a good price, then they should,” ING’s Schwartz said in a telephone interview. “But there aren’t many targets left, so it seems to me that we are getting to a point where they either make an acquisition or return the money to shareholders.”
Vale should seek out smaller coal or copper assets or expand existing operations, said Blackrock’s Landers.
Vale is “in the driver’s seat,” he said. “They have plenty of opportunities for growth internally.”
Markets
The Bovespa rose 111.84 points to 51,485.61 last week, led by Duratex SA, which gained 8.3 percent.
The real gained 2 percent to 1.9364 per U.S. dollar, from 1.9752 on June 19. The yield on Brazil’s benchmark zero-coupon local-currency bond due in January 2010 had a weekly decline of 9.5 basis points to 8.835 percent.

Source: Bloomberg