Amid the excitement of BHP’s long awaited proposal to Rio Tinto, it probably wouldn’t hurt for investors and commentators to take a leaf out of Kevin Rudd’s playbook and take a “cold shower” before heaping hyperbole on the mooted deal. The business press are falling over themselves to note that a merger between Australia’s own BHP-Rio would be the fourth largest company in the world.
Heck, the merger would be the second biggest ever – after only UK-based Vodafone and German-owned Mannesmann in 2000. (Not many journalists care to mention that the Vodafone-Mannesmann entity, which was worth £228 billion at the time of the merger, is now valued at only £95 billion).
Some even suggest that a BHP-Rio combination would create synergies of US$5 billion. Yes, that is US$5 billion. As with war, when it comes to takeovers, truth is often the first casualty. While the US$5 billion synergy figure is bandied around, London-based investment banker, John Meyer, claimed that the cost-synergies would be around $1 billion (a similar figure was suggested by BHP adviser, Macquarie).
The AFR today claimed that US$3.5 billion of synergies will be apparent by 2013 (although presumably that isn’t a “discounted” amount). The difference between the hi-lo synergy estimates (based on current price earnings ratios) represents around US$50 billion in market capitalisation. But let’s not let US$50 billion get in the way of a good story.
Of course, with any monster transaction, the biggest winners are the advisers (and usually the shareholders in the target company). The losers are almost inevitably shareholders in the acquirer. First and foremost the investment bankers (specifically Goldman Sachs JB Were and Macquarie), stand to collect literally hundreds of millions in fees. The lawyers, including Blake Dawson Waldron (long-time BHP adviser) and Allens Arthur Robs, will probably get in the realm of $5 million each, as will the accountants.
The management of the acquirer will be rewarded – they run a bigger company so they must be paid more. The management of the target will be paid generous termination payments, while their “in-the-money” options will vest (upon a business combination) and may be cashed for a significant profit. With such largesse on offer, you can be sure that everyone will be hankering to get the deal done.
The business press has also glowed that the decision by new BHP boss, Marius Kloppers, and Chairman, Don Argus, vindicates the commodities super-cycle. Heaven knows, if the guys who run the biggest mining company think the boom will go on forever – it must.
A not dissimilar theme appeared only seven years ago (albeit in a different the industry). In early 2000, just before the tech boom reached its peak, AOL “bought” Time Warner in a US$250 billion deal – not too indifferent in size to a potential Rio-BHP combination. Nina Munk, in the book Fools Rush In noted that after the merger was announced, the business media fawned over the deal, with the Wall Street Journal calling it “the deal of the century”. Business Week noted that: “… the digital will prevail over the analog, new media will grow faster than old, and the leaders of the Net economy will become the 21st century Establishment.”
After the initial enthusiasm died down, it became clear that the marriage was an unhappy one. Two years and a tech crash later, more than US$200 billion value had evaporated from AOL-Time Warner. It turned out the masters of the digital universe weren’t even the masters of their own closet.
No one is suggesting that a BHP-Rio merger would be anything like the AOL-Time Warner fiasco. If the deal clears the regulatory hurdles, a BHP-Rio marriage does make good sense. While there would be significant cost synergies, the real benefit of the merger lies in gaining greater pricing power, especially in iron ore.
Of course, how good the deal is for BHP will come down to price, and at the mooted US$170 billion price tag – the vast majority of benefits may end up in the hands of Rio shareholders.
Disclosure: The writer owns BHP shares and holds an economic interest in the performance of Rio Tinto.