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The M&A tide in ’07 could become a tidal wave in ‘08

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It's tempting to characterize 2007 as the year of consolidation in the metals industry. But if there's a good reason not to, it's because there's every chance that what we've seen during the past year will pale in comparison to what might take place in 2008. As long as the China-fueled commodities boom lasts, there will be demand for natural resources—and producers, profiting from high prices, will have money to spend on acquiring competitors, suppliers or customers.

The steel, aluminum, copper and scrap sectors have all experienced major consolidation during the past year. But if the players in any one of those sectors need any reminder that the consolidation process probably still has some distance to run, they need look no further than recent events in the iron ore industry.

The potential takeover by BHP Billion of Anglo-Australian rival Rio Tinto has caused quite a storm, and rightly so. Steel mills, particularly in China, are concerned about a potential combination of the second- and third-largest producers of a key raw material. But steel producers not reliant on Australian iron ore, and even companies in other metal sectors altogether, also should be watching this potential deal closely. BHP's bid for Rio Tinto tells us so much about how far the consolidation of the raw materials sector has come, and where it might be going.

One thing it demonstrates is that globalization has made it very difficult for regional regulators to control merger and acquisition activity. Only a few years ago, the threat of a single player controlling a significant proportion of a market in one nation or one region was enough to spook regulators. Today, the matrix on which every commodities deal is judged is a global one.

Even in today's industry, there are few metal or raw material markets that really have a high degree of concentration, measured by a few companies controlling a majority of global supply. Iron ore is the exception. BHP Billiton, Rio Tinto and Brazil's Vale control more than 70 percent of the international iron ore market. And if BHP does succeed in buying Rio Tinto, it suggests that we might be a long way from reaching the limits of consolidation in markets like alumina, aluminum, copper or steel. ArcelorMittal's control of 10 percent of global steel production looks puny by comparison.

One certain consequence of a BHP-Rio Tinto deal would be to spark many more mergers and acquisitions. Competitors in the various markets in which the combined company operates—like Vale, Xstrata, Alcoa, United Co. Rusal and Freeport-McMoRan Copper & Gold—would doubtless refocus their attention on the next deal they could make to prevent themselves from falling too far behind their giant rival. Customers of BHP and Rio Tinto would start thinking about consolidation, too, because the easiest way to retain bargaining power when dealing with such a giant supplier would be to grow to be a giant yourself.

With each successful merger, the bar as to what constitutes an acceptable deal from an antitrust perspective will be raised even higher. So if BHP and Rio Tinto form an aluminum producer with 5.5 million tons of capacity, there can't be any complaints if UC Rusal and Alcoa put together deals to take themselves to a similar level. In a short time, half of the world's aluminum production would be in the hands of three companies and there might be little that antitrust authorities could do about it.

The sounds of concern emanating from China about BHP's intentions were muted in the weeks following its announcement, but there's no guarantee that won't change. China and its rapidly growing state-funded metal enterprises are increasingly aware of the need to secure sources of much-needed raw materials.

If a Chinese government entity or a state-owned steelmaker like Baosteel Group Corp does enter the bidding for Rio Tinto it will create a major stir. For all of China's integration into the global economy, there remains strong concern in the West about state-run companies acquiring the cream of the developed world's privately owned enterprises, as the failed attempt by China Minmetals to buy Canada's Noranda three years ago demonstrates.

But it is by no means certain that there would be such strong opposition this time around. Anti-China sentiment isn't nearly as pronounced outside North America—note the lack of much furor when the Chinese government took a stake in Britain's Barclays Bank in 2007. Australia might be expected to kick up the largest fuss, but the country is increasingly dependent on Chinese raw materials demand to underpin its economy, and also has just elected a Prime Minister who is seen as far more pro-China than his predecessor.

Even if a Chinese player doesn't enter the fray this time, the world has at least been served notice that such a deal is a distinct possibility in the future. And for those who still fear Chinese control of Western assets, that should ring alarm bells. Indeed, as publicly listed companies in London and New York continue to gobble each other up and form ever-larger global commodity players, the impact of a major Chinese buy, if and when it finally comes, could be huge. China buying Rio Tinto would be one thing; China acquiring a joint BHP-Rio Tinto in a year or two would have an entirely different impact on the global market.

So 2007 was a year of consolidation, but probably not the year of consolidation. If BHP's bid for Rio Tinto opens the industry's eyes as to where we're heading in this process, 2008 might well be that year. At least until 2009 arrives.

DAVID BROOKS

SENIOR VICE PRESIDENT


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