article from youn tim

According to young Tim here we can't get the smile of our faces.


BHP lights an iron ore fire
By Tim Treadgold

October 19, 2009


PORTFOLIO POINT: Its takeover bid for United Minerals sparks an investor stampede into iron ore juniors.


There are two ways of looking at BHP Billiton’s takeover bid for United Minerals Corporation, announced at the weekend. Either it is a $204 million payment for a six-year old management mistake or it has turned the entire junior end of the iron ore sector into a red hot investment opportunity.

The first possibility, ignored so far in media reports, is that BHP Billiton (BHP) is doing nothing more than buying back a portion of an exploration tenement in WA’s Pilbara region that it owned for 39 years, from 1964 to 2003.



There will be more on how BHP Billiton let a $204 million fish off the hook later in this article, but the history of the Railway tenement, which is United Minerals Corporation’s (UMC) plum asset, is a key part of what happened on Friday when BHP gazumped a Chinese bid for a major stake in UMC.

For investors the key message is that Friday’s bid sparked a stampede into small iron ore stocks, with investors interpreting BHP Billiton’s $1.30 a share offer for UMC as both an industry-changing event and a sector-wide buy signal.

The rush into junior explorers was so sudden that it caught the ASX off-guard, with stockmarket regulators apparently not making the connection between the price offered by BHP Billiton for UMC and its industry-wide effect. Brockman Resources (BRM) and Iron Ore Holdings (IOH) were among Friday’s innocent recipients of ASX “speeding tickets”. Brockman provided a standard “know of no reason”, but management at Iron Ore Holdings noted that “there has been increased interest in junior iron ore explorers with significant identified JORC-code resources”.





Translated, Iron Ore Holdings was saying that companies with a proven resource in the ground are suddenly being viewed in a different light. They have become takeover opportunities for bigger miners keen to bolster their own resources because Chinese demand for iron ore continues to rise, defying all predictions of a post-crisis slump.

Just how strong demand remains was highlighted by Rio Tinto on October 14 in is third-quarter operations review, which reported a 12% increase in worldwide iron ore production and an 18% increase in output from its Pilbara mines in WA, to a new quarterly record of 57 million tonnes.

The production surge is easy to explain. Demand for commodities is up worldwide thanks to government economic stimulus spending, and mining companies benefit whether it is private sector or government demand.

That’s why it was not just UMC, which rose from a pre-bid 91¢ to $1.27 on Friday, just short of the $1.30 a share being offered by BHP Billiton with a raid that has the potential to restart a name-calling row with China. Brockman added 11¢ on Friday, from $2.06 to $2.17, but has gained 66¢ (44%) over the past 10 trading days. IOH added just 1¢ on Friday to 87¢, but has gained 27¢ (45%) in 10 trading days.

Both Brockman and IOH are stocks to continue watching, along with:

BC Iron (BCI), another small explorer, which has just moved into the trial mining phase at its Nullagine project. BC has risen from $1.05 to $1.16 in 10 days, well short of the 40%-plus increases by other stocks.



FerrAus (FRS), which has a large and growing high-grade iron ore resource close to BHP Billiton’s Newman production centre. FerrAus has risen from 58¢ to 77¢.



Giralia (GIR), an unusual player in the game in that it invariably spins off or sells discoveries rather than attempt production. It has a large number of iron ore projects across WA, and has risen over the past 10 days from 91¢ to $1.21.



There are five reasons why BHP Billiton’s proposed takeover of UMC is so important. They are:

It recognises that demand for iron ore continues to grow, as demonstrated in the Rio Tinto quarterly, and that premium-quality material is hard to find and commands a premium price.
It sets a new benchmark price for undeveloped iron ore deposits.
It represents a totally new approach by a big miner in dealing with small explorer/miners.
It signals the start of an industry consolidation phase, which will see dormant value crystallised in takeover and merger activity.
It is recognition by BHP Billiton that small miners can create value in ground it once owned but never explored properly.

It is this combination of factors that drove the share price of every small player in the WA iron ore sector sharply last week, but still left a value gap which is easy to demonstrate.

The best example is Iron Ore Holdings, which like UMC has a reasonably large, but undeveloped deposit of high-quality iron ore close to tenements owned by BHP Billiton, Rio Tinto and Fortescue Metals Group (a company also enjoying a renaissance).

The Iron Ore equation looks like this. At its Iron Valley project it has a resource of 160 million tonnes of premium (direct shipping) iron ore grading a high 59% iron, and with the potential of a lot more to come. But, on the stockmarket Iron Ore, even after a 45% share price rise, is valued at $101 million. BHP Billiton’s takeover target, UMC, has 158 million tonnes of ore and is valued by BHP Billiton at $204 million. Either Iron Ore Holdings is undervalued by about half, or BHP Billiton is paying double the going rate for iron ore in the Pilbara.

Equations like that are never quite right, but there is no doubt that the price offered by BHP Billiton for UMC and its Railway tenement resets the Pilbara valuation clock.

Value recognition is one issue, but of equal importance is the fact that BHP Billiton dealt at all with a junior miner. Until now the big Pilbara miners have treated the smaller operators as fleas to be brushed aside, or totally ignored. That position might be changing, with the next step being admission of third party (junior miner) ore on to the railway and port systems operated by BHP Billiton and Rio Tinto.

Another point to consider is the potential for industry-wide consolidation as smaller players in the iron ore game merge (as seen in the ongoing battle for Polaris Metals – see Polaris suitors slug it out) to achieve economies of scale and to provide a more attractive target for investors or big companies seeking takeover targets.



But, the most interesting aspect of the UMC deal is to consider whether BHP Billiton is simply paying for a past mistake, and while we will probably never know the truth a trip back in time is enlightening, if not amusing.

In 1964, at the birth of WA’s Pilbara iron ore industry, BHP Billiton was awarded vast tracts of land, including a temporary reserve designated TR3156. For the next 39 years, partly because iron ore prices were low for much of the time, it never fully explored what was issued to it by the WA government.

In 2003, under “use-it or lose it” rules governing exploration tenements, BHP Billiton dropped 264 square kilometres of TR3156 – not in a single piece but a series of blocks that did not look particularly attractive to rival miners.

However, those relinquished blocks were attractive to seasoned Pilbara explorers such as the private company DFD Rhodes Pty Ltd, a famous Pilbara name once closely associated with the father of the Pilbara iron ore business, the late Lang Hancock, and after whom the Rhodes Ridge deposit is named, a project soon to be developed by Hancock’s daughter, Gina Rinehart.

Securing the ground was step one, but it required exploration funding. In 2006 Rhodes sold the ground to UMC, which proceeded to do what BHP Billiton could (and should) have done earlier: it drilled.

The result was the discovery of thick and rich deposits of iron ore, admittedly under about 30 metres of sand cover, but running directly into the portion of the tenement retained by BHP Billiton. In effect, dropping that portion of the ground in 2003 meant dropping $204 million into the pockets of UMC shareholders; no wonder they can’t get the smiles off their faces.

Once you know the history it would be wise to think about whether what happened on Friday, the payment of a premium price for a small iron ore explorer, was an event that reset the valuation clock, or was payment for a past mistake.

Given other events, such as Rio Tinto’s booming production numbers and ongoing Chinese demand for iron ore and Australian mining assets, it is more likely to be a combination of both factors, which is why the uplift in the entire iron ore sector is likely to continue.