Small miners to merge to pool cash

Small mining firms are likely to merge to pool cash during the credit crisis, whereas major miners are buying back shares.

LONDON (Reuters)  - 

Plunging share prices have opened up possible bargain takeovers in the mining sector, but activity is due to be limited and focused around smaller firms rather than majors, which have already bulked up.

The larger firms are more likely to exploit the sharp fall in share prices to buy back their own shares.

Valuations of mining firms have tumbled, with the UK mining index down by two thirds since touching a peak on May 19 while the blue chip FTSE 100 has shed one third.

While a lack of credit will cast a chill over possible takeovers, junior firms low on cash and pressured by plunging commodity prices will likely be forced into mergers to survive the crisis, analysts and fund managers said.

"Amongst the juniors, getting companies together in more of a merger type approach, someone who's got cash and someone who needs cash, I think you should start to see that happening," said analyst Alison Stent at Blue Oar Securities in London.

London-listed small-cap Serabi Mining, which had seen its shares plunge by 90 percent after it ran into operational and funding problems, said this week it was in preliminary talks about a possible takeover.

RUNNING OUT OF CASH

"Smaller companies are running out of cash resources to develop projects and they need to somehow push these projects forwards or risk losing their licences. That means deals need to be done," said analyst John Meyer at Fairfax in London.

In another recent case, it was cash needs of a mining firm's owner rather than the company itself that sparked a deal.

In October, Ukrainian billionaire Kostyantin Zhevago sold a 20.8 percent stake in iron ore producer Ferrexpo to raise cash to repay a loan that used the shares as collateral.

The parent of Czech coal producer New World Resources bought the stake at a 30 percent discount, raising speculation among analysts of a merger between the two firms, both of which produce raw materials for steelmakers.

Some companies that have wanted to take advantage of rock-bottom share prices and valuation have been wrong-footed by the credit crunch.

A source at a London investment bank said one client was working on buying a stake in a smaller firm, with a view to an eventual takeover.

The firm had regarded the target's share price at 1 pound as good value and even though the shares later became much cheaper at around 25 pence, by then the predator had encountered its own difficulties and cancelled the plans.

"I think they lost money in other areas and they probably couldn't get the bank finance to leverage their equity," the source said.

BIG FIRMS MAY BUY BACK SHARES

Many of the big diversified firms are highly geared after a consolidation wave in recent years and the one with the lowest gearing -- BHP Billiton -- is already busy with a planned takeover of rival Rio Tinto.

"If you look at the big guys, BHP's obviously busy with Rio, if that falls through, then they are likely to pursue other options. But they can also buy back their own shares, which would also offer them a good return," said Henk Groenewald, portfolio manager at Coronation Fund Managers in South Africa.

Other analysts agree that the big firms may find that buying back their own shares at low levels might offer better value than risky takeovers.

The majors say they are on the prowl for possible takeovers at cheap prices, but analysts say they will be picky.

"You won't find a big guy going for a company that is too small... The only thing they would consider is what they call first tier assets, which is low-cost, long life and large enough to make a difference in their lives," Groenewald said.

The head of the world's biggest iron ore producer, Brazil's Vale, said this week that any takeovers would have to be very high quality and it would focus on organic growth and buying back shares.

Credit markets and volatile share prices have already inhibited a planned deal by highly acquisitive Xstrata.

The Anglo-Swiss firm leapt at the chance to buy the world's No. 3 platinum producer Lonmin in August after the shares fell, but it called off making a formal bid two months later after it balked at loan terms banks had offered.

The further sharp fall in Lonmin's share price during the two-month interval was also a factor, convincing Xstrata to walk away and keep open the option of coming back later at a still lower price, analysts said.

Xstrata said on Oct. 21 it was well placed with loan facilities and did not have any major refinancing due for three years, but analysts said it would likely be cautious with cash.

"Certainly, I think they would probably be a little bit concerned about really paying down their debt, meeting their own capital expenditure commitments and probably preserving cash in the current environment," said a London analyst who declined to be named. (Reporting by Eric Onstad; Editing by Chris Wickham)

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