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No. of Recommendations: 3
About BHP and the Metals Sector:

First let me say – I don’t know anything about this. That being said let me start with a summary of things as I found them in the metals area.

Right now interest is in Iron Ore because of the attempt of BHP to take over RPT. And also that is has been so profitable with the increased demand from China. Demand has clearly dropped but many are hopeful that this will return full blown because the Chinese stimulus package is so heavy in infrastructure building. But even so the year being bandied about as when oversupply will return is 2012.

The mining for ore business is dominated by three companies: Brazil's Companhia Vale do Rio Doce (RIO)( 11 of 12 Cap Stars) and Australia’s, BHP Billiton (BHP)(11 of 12 Cap Stars) and Rio Tinto (RTP) (9 of 12 Cap Stars – debt problems). All are heavy in iron ore production. But they are diversified all over the different metals and ores in mining. BHP has even started doing Oil production. All these companies look like good long term investments, but are going to be hurting in the next year due to the drop in world demand.

Not much is expected to happen price wise in the next year is why the possibility of buy outs is so interesting right now. Even though BHP has just dropped its hostile bid for Rio Tinto, this is expected to be a short lived breather. Both these companies are expected to looking for purchases as soon as they get there own houses back into order. In addition the smaller companies know this and are looking to improve there own outlook but seeking to merge or buy others like themselves. So in the shorter term it looks like the best buys will be in expectation of price run ups in M & A.

The two most likely buy out targets look like Fortescue Metals Group (FSUMF: OTC) and Anglo American PLC: NASDAQ) FSUMF is the pure Iron play, and it is now third largest Iron producer in Australia. Anglo American PLC is not pure, but closer to the capitalization size BHP says it is interested in.

The contenders in the Iron Ore area are:

BHP has revenues of $40 Billion and earnings of $13 Billion. Market Capitalization is $43 Billion with 1 Billion shares outstanding. And an outstanding revenue per employee of 1.4 million with a current price $40. Is cash rich having around 1 billion cash left after paying all costs in a year. It is the largest mining company in the world.

Brazil's Companhia Vale do Rio Doce (RIO) and Australia’s, BHP Billiton (BHP) and Rio Tinto (RTP) are the three biggest iron producers in the world (listed in order of size). BHP has just dropped its year long attempt to take over Rio Tinto. During this process a Chinese firm Chinalco purchased a stake in Rio Tinto. This seems to be the Chinese strategy to insure supplies. They are buying stakes in companies and control of smaller ones.

When discussion turns to likely time of supply shortage, 2012 is the year being mentioned. Output for the next year is being cut back and it’s expected that efforts of consolidation will continue once prices recover somewhat. It is possible that BHP will restart its attempt to take over RTP since the reason it gave for dropping it was that current prices would not allow it to recoup its costs due to their current low price. RTP could counter this by attempting to buy BHP. Financially BHP is in much better financial shape of the two. Or they may give up on one another and try to expand by taking over smaller companies.

Western Australia is where the current iron ore mines are owned and developed. Australia produces 16% of the world’s ore and of that 98% comes from this region. Of that BHP and RTP own 94% of it. But new mines are being created in Western Australia’s Mid West. This is new development begin done by new much smaller companies. The area is expected to produce 100 million metric tons a year eventually, compared to 240 million in the older more developed areas.

It looks strange that BHP and RTP have stayed out of the race to develop these new mines. Problem is that besides the mines, the supporting infrastructure (roads and harbors) are also lacking and must be built. Both seem to have decided to let others do this initial development with the expectation of coming in and getting there share later. This strategy opens up possibilities for the investor.

The companies developing the area are
1) Anglo American PLC (AAUK): NASDAQ (7 of 12 Cap Stars – lack of revenue) is mentioned often as a take over candidate. They recently sold off some secondary sides of their business such as Paper and pointed their company more too just its core business. This company use to be Gold and Silver but has greatly reduced its stakes in these, and moved into Iron and Coal. This makes them an even more attractive take over candidate. It is the largest of these companies.

2) Fortescue Metals Group (FSUMF.PK):OTC (5 of 5 Cap Stars) is the largest of these new comers. It is expected to begin producing 25 million metric tons in 2009 which will grow to 40 million by 2011. They say they can pay for expansion from internal cash (100 million was just raised by sale of preferred stock). But it is possible they will get into a cash flow bind with no where to borrow the needed money. Seems to me this will make them a even more suitable take over target if it happens.

3) Murchison Metals Ltd (MUMTF):OTC (not CAPS rated) is expected to start production in 2008 with 1.5 million ton output, growing to 40 million in 2011.

4) Midwest Corp Ltd (MISKF): no US market (not CAPS rated) Murchison Metals has proposed merger with the smaller Midwest

5) Mount Gibson Iron (MTGRF)(no US market) (not CAPS rated)

6) Gindalbie Metals (GDBGF)(OTC no trading) (not CAPS rated) -- Anshan Iron & Steel, China's third-largest steel maker, has signed a $1.6 billion deal with Australia's Gindalbie Metals to develop two iron ore projects.

So all these companies are possible acquisition targets, both BHP and RTP are likely buyers as well as the Chinese. I tried to look at the price changes for this sort of thing in the recent past with these companies. The BHP bid for RTP seemed to have the same effect on both companies stocks, but Chinese buys did not have a run up, since they are done by negotiations with the company involved, and all you get is a announcement, and some gain after that.

In addition both BHP and RTP have recently said they do not plan to develop any precious metal sites. Both have announced internal consolidation moves.

While I have just talked about Iron Production both these companies are very diversified within the natural resource field.

BHP
The company has nine primary operational units:
• Iron ore
• Manganese
• Petroleum
• Aluminum
• Base Metals (primary products include copper, lead, zinc and uranium)
• Metallurgical Coal
• Thermal Coal
• Stainless Steel Materials (nickel and cobalt)
• Diamonds & Specialty Products (diamonds and titanium minerals)
BHP has been the most aggressive in the last few years. This is likely to continue because it now has experience in this and has the cash flow to back it up.

RTP
The company has investments in:
• Iron ore
• Copper
• Energy
• Industrial minerals
• Bauxite
• Diamonds
RTP seems to have a different approach to ownership of subsidiaries. Instead of 100% ownership as BHP and RIO tend to go for they are often happy with 45-50%. Seems to me this would give them more reach than the other approach. But also a better take over target since splitting these subsidiaries should be profitable and painless.

RIO
The company has nine primary operational units:
• Iron ore
• Copper
• Kaolin
• Nickel
• Coal
RIO has shifted revenues from non-ferrous metals from 7% in 2000 to 34% in 2006. RIO main mines are in Brazil, with most of the rest in the Americas. It started out by buying everything else in Brazil, and in the last few years has expanded out to picking up what ever it can in North or South America. Its holdings in copper look interesting since shortages may be appearing in this metal before the others.

CONS:

BHP best financial shape, but is very big and very diversified in metals. So it is not a good pure play on any one metal (though Iron seems dominate).

RTP: Currently selling off pieces to cover debt it ran up to counter BHP moves. These sell off will likely be at depressed prices, and the debt is large.

Fortescue Metals Group - can not find financial information - .Said to have quite a lot of debt. Market cap is 4 billion. So it is much smaller than Anglo American but is mostly in iron. It is third larges Iron producer in Australia. I have not been able to find out for sure, but looks like quite a bit of insider sales in last two months.

Anglo American PLC – (iron and coal) – small volume trading. Market Cap is 31 billion. Below the stated level BHP says they are looking at. Material will often say its in Gold and Siver but it has sold these off and moved into Iron and Coal. The five businesses of the Company are platinum, diamonds, base metals, iron ore (ferrous metals) and coal.

Murchison Metals Ltd - can not find financial information
Gindalbie Metals – can not find financial information. Australian-listed Gindalbie Metals will issue $A162.1m worth of new shares to 12.6 per cent shareholder AnSteel a Chinese company. Says it needed war chest. Existing stockholders upset at this dilution of their stocks.

Mount Gibson Iron – can not find financial information

Midwest Corp Ltd - can not find financial information

Final Ideas

Think its still six months to soon to get into these. Began this by seeing Fortescue Metals Group being recommended a lot. But now I feel that its risks are too high. Instead I would look to Anglo American PLC for an acquisition play.
In the shorter term I would look into Copper for breaking out sooner than iron. I base this on reports of supply problems in Chile.
In the longer term both BHP an RIO look good but may not take off for another year.
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