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An audacious plan to create a mining colossus with a market capitalisation of £170 billion ($467.5 billion) could be derailed by lengthy anti-trust inquiries, analysts warn.
BHP Billiton's £67 billion bid for rival Rio Tinto has been rebuffed, but advisers to both companies are expected to meet this week to thrash out legal issues that centre on the market dominance of a combined group which will have nearly 40 per cent of global iron ore production.
One well-placed observer said: "I would guess that before the two sides can reach an agreed deal, shareholders will want reassurance from management that this is a transaction that is deliverable."
He adds: "The danger is that it could get bogged down with the competition authorities for over a year. The question then is whether a deal will be worthwhile if they are forced into divestments that prevent the extraction of massive savings - £500 million according to some analysts."
One of the biggest issues will be the response of customers, particularly China, which is overtaking America in the amount of copper it consumes, a trend that is expected to accelerate in the coming years.
Charles Kernot, metals expert at broker Seymour Piece, says that the Chinese "may be none too happy" to find that supply is even more tightly controlled, raising the prospect of higher prices and fuelling inflation.
Kernot says that among the scenarios being floated in the City - London's financial district - is that Chinese companies or one of its sovereign wealth funds will try to forge a consortium to snatch Rio from BHP, where South African-born Marius Kloppers recently took over as chief executive.
Tom Albanese, head of Rio, has dismissed the offer from BHP on the grounds of price, but City sources say that he is not against the idea of a merger in principle if it can get past the anti-trust bodies in the US and Europe. But BHP will have to significantly increase the value of its offer, which Kloppers proposes to fund by issuing shares. Some observers say that Albanese could push for a partial cash alternative.
Kernot reckons competition worries will weigh heavily on the outcome of any future talks between the two companies. He says that the authorities, especially in the EU, have always been sensitive about the possibility of insufficient competition in mining.
"It is not so long ago that the EU blocked a platinum merger between Lonmin and Impala; when it comes to natural resources, they tend to be meticulous."
During the last few years, the commodities boom, driven by China, India and Brazil, has spurred a series of mergers, the latest of which was Rio's takeover of North American aluminium producer Alcan.
News that BHP had fired off the first salvo in a possible bidding war for Rio sent share prices in the sector soaring and temporarily acted as a break on the downward drift in equities markets, spooked by the global banking crisis.
Analysts say that a number of other companies could get involved in a defensive merger with Rio, including Russian giants Rusal and Norilsk.
Other areas where the two companies would be strong include coking coal, where the combined entity would speak for 25 per cent of all production.
But some analysts believe that despite concerns over competition, investors would support a deal at a time when there is no sign of the commodities boom abating.
In a recent interview, Kloppers boasted that BHP had delivered volume growth of nearly 10 per cent a year since 2002.
When asked if the euphoria surrounding the industry was justified, especially in the wake of the global liquidity crisis and a possible US recession, he said: "I am not saying the sector is immune to business cycles. But a seminal event is happening in the world: 2 billion people are entering the industrial age.
"It's like rebuilding Europe after the Second World War, but on an even bigger scale. And remember the driver for China is not only exports, but Chinese domestic demand; in India, it's the same. So a slowdown in the US would not necessarily impact as heavily on Asian economies as some suggest."
One thing that the competition authorities will be aware of is that the recent round of mergers has done nothing to increase capacity. Analysts point out that mining mergers allow companies to absorb working mines, without any need to invest in costly exploration and production. That way prices stay high. Since January, for instance, copper prices have smashed previous records, while other base metals have run up strongly as well.
One expert says: "By acquiring each other, the mining companies can rip out costs and boost revenue and profits - but at the end of the day, you are left with the same number of mines. All that has happened is that there has been a change of ownership. What we really need are new mines to come on stream to ease inflationary pressure that could eventually bring the house down."
* THE PLAYERS
BHP Billiton: The world's largest mining company. Created in 2001 when Australia's Broken Hill Proprietary Company (BHP) merged with Britain's Billiton. Listed on the Australian Stock Exchange and the London Stock Exchange.
Rio Tinto: Multinational mining group founded in Europe in 1873. Listed on the Australian Stock Exchange, the London Stock Exchange and the New York Stock Exchange.
- Observer
