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Iron Ore-pportunity for the brave – BCI, IOH, FMG

The iron ore price continues to slide as burgeoning seaborne supply swamps falling Chinese demand levels. With that backdrop, BC Iron’s takeover offer for Iron Ore Holdings looks fraught with danger but a cool-headed approach might yield something worthwhile for investors.

BC Iron is offering 0.44 new shares plus $0.10 cash for each IOH share.

On the 8th of August when the offer was first made, BCI was trading at $3.31 per share and IOH at $0.95 per share. At that level, BCI’s offer valued IOH at $1.56 per share with the combined group worth approximately $649 million.

Since then, however, the iron ore price has slithered its way below US$90/dmt and this may yet turn out to be a deal-breaker.

20140904 Iron Ore

For BCI, it has been the main reason behind the company’s 30% share price slide to its current level around $2.32 per share while IOH has increased slightly to $1.12 per share. At that level, IOH is valued just above the implied value of $1.10 per IOH share of the current offer.

Both companies hold a reasonably large amount of cash on the balance sheet. BCI has $159 million ($1.29 per BCI share) and IOH has $50.9 million ($0.32 per IOH share).

The deal appears to be a good one for IOH shareholders as BCI is arguably in a better position with regard to access to infrastructure and by virtue of its relationship with Fortescue Metals Group. The latter is BCI’s partner (BCI 75%, FMG 25%) in the Nullagine joint venture which produces around 6mtpa of iron ore fines.

The deal is quite complementary as each company has something the other needs.

A key positive factor for BCI is its access to FMG’s rail and port infrastructure along with marketing and shipping services. BCI’s short 5 year mine life is its biggest negative issue, iron ore prices notwithstanding.

IOH has two projects which, on the face of it, appear reasonably good but which lack access to low cost rail infrastructure. However, the reserves of 269mt would go some way to alleviating BCI’s problem.

IOH made a net loss before tax in FY14 of $22.2 million, an improvement on the $40.3 million loss in the previous year. Management and Board members extracted $3.7 million worth of remuneration in FY14 ($3.6m in FY13) including quite a swag of options. At the end of FY14 there were 7.65m options issued to key management and Board members; a potential dilution of nearly 5% if vested and exercised although most appear to be out of the money.

Given the decline in BCI’s share price, and assuming the deal does complete, buying BCI shares now would be a lower risk way into the deal.

Buying IOH shares is slightly more risky given the lack of liquidity in the shares, but this would also be a relatively cheap way into the deal.

Kerry Stokes’s company, Wroxby, which owns 52.7% of IOH has agreed to accept the offer and IOH’s Board has unanimously recommended the offer to all shareholders.

Stokes would be the largest shareholder in the combined entity at 23%.

If all IOH shareholders accept the offer, IOH will effectively own 36.6% of the combined entity.

Although the iron ore price is causing consternation for miners and investors alike, as always it will be the lowest cost producers that can withstand the trend and still make money. Adding scale to a company is likely to be one way of ensuring that overall costs are optimised.

With that in mind, buying FMG below $4.00 per share will also look like quite good investing regardless of the iron ore price.

More ore

In August, Australia exported 37.4mt of iron ore with 32mt heading to China. That’s yet another record. Despite China’s slowdown this year, it should be remembered that its US$10 trillion economy is still growing at 7.5% pa.

The long term demand for steel and its raw material constituent, iron ore, will remain in an upward trend which is why BHP, RIO and FMG have been able to commit such vast sums to iron ore production from the Pilbara in Western Australia.

RIP Mining Tax

It was a momentous week in Australia with the scrapping of the idiotic Kevin Rudd/Ken Henry mining tax on Tuesday.

The original 40% Resources Super Profits Tax (RSPT) introduced in May 2010 was supplanted by the watered down Mineral Resources Rent Tax (MRRT) by Julia Gillard as a means of placating the big mining companies. Yet even that version was completely dopey as it failed to raise anything like the billions it was supposed to and simply made a mockery of the government of the day.

Along with the dumping of the Carbon Tax, the mining industry and others can perhaps consider the regulatory risk of investing in Australia has returned to more normal levels.

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