Also worth remembering what Charlie had to say pre-merger (I'm...

Also worth remembering what Charlie had to say pre-merger (I'm not judging his accuracy - I'm just sitting on the fence here) -

Oz Minerals not OzJet
By Charlie Aitken
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Wednesday June 25: Zinifex (XFX) shareholders have voted overwhelmingly in
favour of the merger proposal from Oxiana (OXR). The result is Oz Minerals, a
new major domestic resource company, and the world's second largest zinc
producer.
I have always been a strong supporter of Owen Hegarty and the "Mighty Ox".
However, even from the first announcement of the Oxiana/Zinifex merger, the
majority of domestic resource analysts showed little interest in the prospect.
The major criticism of the proposed "merger of equals" focused on the absence of
earnings synergies. Consequently the lack of instant earnings gratification for
analysts relegated the proposal to the backburner of domestic resource research.
You would have thought that analysts may have learned the lesson about instantly
earnings per share positive acquisitions, but alas no. Apparently putting two
debt-free companies together to create a company of world significance is
uninteresting if there isn't instant earnings per share growth. The great
winners of the credit crunch will be debt-free companies, particularly those
that merge to create an even stronger entity.
Short termism
In addition, the significant earnings exposure of the merged group to the
falling zinc price has provided little excitement for the consensus view, which
is overwhelmingly focused on the short-term outlook. Further, I believe the lack
of incentive for arbitrage and hedge fund activity has similarly weighed on the
performance of both companies. As a result, in between the announcement of the
merger proposal, and the vote by the Zinifex shareholders, there has been an
absolute dearth of broker research. It's as though nobody cares.
It must be very frustrating for management with a clear vision of the future to
be constantly held hostage to short-term views and judged on short-term
performance. The lack of interest in Oz Minerals reminds me very much of the
dismissive view of Fortescue (FMG) until recently, when the index weight has
become an important focus for some domestic institutional investors and
analysts.
It is ironic that Oz Minerals is set to become Australia's fifth largest
resource company and the third largest domestic diversified play with an
expected market cap of about $A8.5 billion. Oz Minerals is expected to rank
about 26th in the ASX 200, with an index weight of about 0.8%. It is worth
noting that the market cap is expected to increase to about $A12.5 billion given
the capacity to make an $A4 billion acquisition. Subsequently, Oz Minerals would
rank just behind Newcrest (NCM) at 21st by market cap with an ASX 200 index
weighting of about 1.1%.
Scale and diversity
There is little doubt that the primary aim of the merger was focused on scale,
diversity and complementary assets, rather than operational synergies. As a
result the merger has provided Zinifex shareholders with the diversity of copper
and gold exposure while providing Oxiana investors with production scale,
balance sheet strength and the opportunity to become part of a major global
resource company. Importantly, both scale and diversity have been the underlying
theme of global resource consolidation over the past five years.
Brazil's Vale, for example, has pursued a commodity diversification strategy
with the Inco acquisition. The Inco takeover generated absolutely no synergies
but provided Vale shareholders with nickel scale and new commodity diversity.
Subsequently, Vale has sought a merger with Xstrata and is rumoured to be
looking at Anglo American or Freeport McMoran.
Similarly Rusal, the largest global player in aluminium/alumina, is not

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generating operational synergies with a 25% interest in Norilsk, the world's
biggest nickel producer. Rusal is seeking a merger with Norilsk to achieve a
global scale and commodity diversification. The Rusal chief executive was
actually quoted as saying that the aim of a merger was to provide the ability to
directly compete with BHP.
There is no doubt that the proposed BHP/Rio merger is both compelling and unique
with complimentary tier-one assets and a forecast $US3.7 billion in earnings
synergies. However, in addition, BHP chief executive Marius Kloppers has
constantly reinforced the additional scale a Rio merger would provide in order
to meet the unprecedented supply challenge and the rising cap-ex costs currently
facing resource companies.
The structural increase in commodity demand driven by Chinese industrialisation
against a backdrop of chronic supply constraints will support a global resource
consolidation resulting in three or four "super majors". In this regard, it
appears resources are the new rainmakers on Wall Street. The value of mining
takeovers has more than tripled to $US199 billion in the first five months of
the year compared to last year. This is despite a 37% fall in global merger &
acquisition activity over the same period. This represents the first time mining
mergers have topped the global M&A table since Bloomberg began compiling data in
1998.
There is little doubt that the recent global consolidation has been driven by
the aim of achieving scale of production and commodity diversification. However,
despite the Oxiana/Zinifex merger clearly reflecting this theme, it appears the
majority of domestic analysts remain sceptical. It is baffling and illogical. I
think the negative view provides a genuine opportunity to generate real
long-term outperformance for an investor not constrained by a short-termist
view.
Diversified model
In order to highlight the opportunity for Oz Minerals, I believe it is worth
reflecting on the rise of Xstrata from relative obscurity to the world’s
fourth-largest resource company.
The emergence of Xstrata as a global resource major is the direct result of an
aggressive "growth by acquisition" strategy by current chief executive Mick
Davis, a former Billiton finance director. In conjunction with the marketing
expertise of Glencore, which owns a 40% stake, Xstrata has built a portfolio of
quality tier-one assets with the aim of replicating the scale and diversity of
the BHP Billiton model. With the recent merger proposal by Vale, Xstrata has
become both predator and prey in the current global consolidation.
As a result, Xstrata has grown from market cap of less than $US1 billion in
October 2001, when Davis was appointed chief executive, to over $US80 billion
now. Consequently, the aggressive "growth by acquisition" strategy has supported
a return of 835% over the past five years. In addition, it appears Davis
believes there is still significant current value in Xstrata after a London
Stock Exchange filing revealed he purchased 167,480 shares on May 22 at an
average of £41.50.
Consequently, I believe Oz Minerals has a similar opportunity, like Xstrata, to
build a quality diversified portfolio of assets providing the unique situation
of becoming both predator and prey in the imminent acceleration of the global
resource consolidation. It is ironic that while Oxiana has both the aim and
opportunity of replicating the diversified model, I believe Xstrata may see an
opportunity to add scale to its own growth aspirations with a takeover proposal.
Either way I expect significant outperformance for Oz Minerals shareholders.
In this regard, Andrew Michelmore recently stated the intention of Oz Minerals
was diversification through acquisitions. "We would like to have some
longer-term contract prices where you don't get that volatility and fluctuation
… and that is why we'd like to get into bulks and energy."
He listed uranium, coal, gas and hydro-electricity as opportunities considering
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energy consumption accounted for about 25% of the company's operating costs. He
is keen to hedge energy costs, particularly at Century, by "locking up supply"
of coal seam methane in Queensland.
In addition Michelmore indicated the board would not be wasting time looking at
small bolt-on acquisitions, adding: "Don't chase rats and mice." Further, he
said, “25–35% debt to equity is a sensible range … so you could add $A3 billion
of debt to the books and stick within the range." Considering Oz Minerals has
$A1.2 billion of cash, there is a $A4 billion war chest for possible
acquisitions. It is worth noting that just Prominent Hill and Century alone, are
expected to generate 2008-09 operating cash flow of about $A1 billion a year.
As a result, Oz Minerals is strongly positioned to participate in further
consolidation of the resource sector. In this regard, Michelmore also said his
aim was to make Oz Minerals a "leader in mid-caps" globally, which implies
expanding the market cap to more than $A20 billion.
Zinc: the bottom
It appears that analysts remain blindsided by the short-term performance of
zinc. There is no doubt that the 50% fall in the zinc price over the past 18
months has reflected a deterioration in the demand/supply fundamentals. A
significant increase in Chinese production has resulted in a zinc surplus with
London Metal Exchange zinc stocks up 70,000 tonnes this year to a 21-month high
of nearly 150,000 tonnes.However, there are a few factors pointing to an end of
the decline, and a floor for the zinc price.
There is little doubt that the tripling in zinc prices between 2004 and 2007
encouraged a massive increase in Chinese investment in small-scale, lower-grade
projects. The Chinese market is both highly fragmented, with the average mine
under 10,000 tonnes a year, and relatively high cost. In addition, the majority
of new Chinese zinc capacity was commissioned at $US1.50–2 a pound.
Consequently, I believe at current levels a significant amount of Chinese
capacity is well below the marginal cost of production. As a result, I expect
mine closures and a decline in zinc production. In this regard, customs
statistics revealed that Chinese net imports for May were 4000 tonnes. In
addition, the first sign of a slowdown in Chinese metal production has emerged
with the news that 28 of the largest zinc smelters have cut production in the
traditionally high demand period, with average operating capacity down to 78% in
May compared to 83% last year.
Further, signs of distress for domestic high cost producers have emerged with
sector margins under pressure. In the March quarter, Perliya (PEM) reported
operating costs of US94¢ a pound, while CBH Resources (CBH) has announced
lay-offs in NSW. In the meantime, the independent expert forecasts Oz Minerals
to produce about 795,000 tonnes of zinc next year at an average cash cost of
just US52¢ a pound.
Despite the significant increase in production, it is worth noting that Chinese
zinc demand remains strong, with year-to-date consumption growth 14.7% up on the
previous corresponding period. China now accounts for 32.1% of global zinc
consumption, up from just 14.9% in 2000. This step-change in long-term demand
has supported a massive reversal in the Chinese net zinc trade. Between 2000 and
2007, Chinese zinc demand growth has averaged 15.7% pa while mine output and
metal production have lagged, up just 7.3%, and 10.2% respectively.
As a result, since 2001 China has swung from a significant exporter to a net
importer, which is a trend that will continue. It represents the crucial
long-term theme for the zinc market, not short-term fluctuations.
Oz Minerals
I believe the Oz Minerals negative consensus view is typically the "glass
half-empty" approach to investment, where short-termism overrides the positive
long-term fundamentals. In an environment where the rising cost of debt is
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exposing companies with weak balance sheets, Oz Minerals has effectively no debt
and $A1.2 billion in cash. I expect Oz Minerals to generate $A1.5 billion in
operating cash flow next year, implying a 2008-09 price to cash flow multiple of
five times, compared to our target of 8–10. In addition, on our figures, the
merged entity is now trading on 2008-09 price/earnings multiple of 10 times.
Oz Minerals is a strong buy and my 12-month target is $4.50. Yes, I stand by my
12-month price target being 68% above the current Oxiana share price and I think
the "Mighty Oz" is a complete risk-adjusted bargain at current prices. This is
the bottom in zinc and the bottom in Oxiana.