When Roger Agnelli, the chief executive of Brazilian mining group Companhia Vale do Rio Doce (Cvrd), finally acquired Canada’s Inco for $17.7 bn after a three-month battle, it marked not only the biggest ever transaction to involve a Latin American company but also the final part of a lengthy process to transform a former nationalized company into a major international player in the mining sector.
Today, Cvrd, which had its roots in the Vitória-Minas Railway Company, has a market capitalization in excess of $90 bn – almost double its size at the start of the battle – and is the world’s largest producer of iron ore and nickel. And if Agnelli enjoys a wry smile at his audacious acquisition of Inco, he can perhaps be forgiven. This was not Cvrd’s first attempt to enter the Canadian mining sector, but this time it was determined not to be outmaneuvered.
The company has also refinanced its $14.6 bn two-year bridge loan just three months after acquiring Inco.
The road to Inco
Agnelli, a former investment banker, was appointed chairman of Cvrd in 2000, just three years after the company was privatized by the Brazilian government, which retains a small stake. Agnelli, who in his previous role as head of capital markets at Brazil’s Banco Bradesco had advised on the sale of the nation’s steel and mining companies, recommended a diversification strategy.
But shareholders agreed to support the dramatic proposal only if Agnelli became Ceo, which he did in 2001.
Over the next three years Agnelli simplified Cvrd’s ownership structure, shed unproductive assets and financed an aggressive program of acquisitions in the local mining sector. The Brazilian company became the world’s fifth largest mining group, but Cvrd remained an essentially Latin American group and Agnelli wanted to expand its global footprint. This path took him to Brascan, a Torontobased conglomerate that had itself embarked on a diversification strategy. Brascan owned a 42 percent stake in Noranda, a Quebec-based mining group that, in turn, owned a 58.4 percent stake in Ontario-based rival Falconbridge, a copper and nickel mining company.
Brascan’s initial stake had been acquired in 1981; 23 years later, the conglomerate wished to sell its mining interests. Cvrd submitted a takeover proposal, code-named Project Walking, and waited.
Embarrassingly, news of the negotiations leaked: under a two-stage proposal, Cvrd would pay cash to acquire a 40 percent stake in a combined Noranda and Falconbridge. The Brazilian company would then transfer its Sossego copper mine to the new company, subsequently boosting its stake in the Canadian mining group to 50 percent. Unbeknownst to Agnelli and his team of advisers, however, Brascan had also entered talks with China Minmetals Corporation, a Chinese government controlled enterprise.
Cvrd planned to announce its acquisition – the largest in Canadian mining history – on September 1, 2004. It hired a Toronto PR firm to prepare press releases and even booked a celebratory party in Rio de Janeiro. But the night before the scheduled announcement, Agnelli was summoned by Brascan and told that Minmetals had made a better offer.
‘Brascan said it required an additional C$400 mn,’ one insider says. ‘We argued, but eventually said there was no deal, we would not pay any more money. We said, Good luck with the Chinese, and walked away.’
Just over two months later Brascan announced that it was no longer in exclusive talks with China Minmetals. Later the conglomerate repackaged its mining holdings by merging the two companies into a diversified copper, nickel and aluminum group under the more respected Falconbridge name.
The end of the discussions with Brascan signaled a change in direction for Cvrd. ‘We were a large player in non-ferrous minerals,’ recalls Roberto Castello Branco, director of IR at Cvrd. ‘We had several projects underway and decided to look for opportunities in copper and nickel mining in South Africa, Asia and South America. But our focus was organic growth.’
Building credibility
Just weeks after Brascan signaled the end of its Chinese whispers, Cvrd unveiled record net income of $2.57 bn for 2004, up 66 percent over the previous year. The strong commodity boom was also playing its part: revenues rose from $3.9 bn in 2001 to more than $6 bn in 2004, and analysts noted that Cvrd was generating more cash than it knew what to do with.
‘We were investing a lot of money,’ recalls Castello Branco. ‘We were involved in a lot of major projects, particularly in bauxite [a major component of aluminum]. We were developing new mines, new plants and new Brownfield projects.’
But Cvrd was also establishing its capital markets credentials. The company set out to build a benchmark curve of plain vanilla bonds when it launched a $300 mn 10-year issue in August 2003, followed in January 2004 with a landmark $500 mn 30-year issue. In 2001 Cvrd had been forced to use its own iron-ore export receivables as collateral to back a $300 mn bond issue. The proceeds of the new bonds were used to buy back the collateralized issue.
‘We were constantly visiting investors, and working with the credit ratings agencies. It was all designed to boost confidence in Cvrd,’ recalls Castello Branco. ‘We had an open dialogue whereby we not only supplied information on a regular basis, but also followed the agencies’ advice in order to improve the risk premium attached to our borrowings.’
The efforts paid off. Cvrd became the first Brazilian company to secure an investment grade credit rating from Moody’s Investors Services, when in July 2005 it was upgraded from Ba1 to Baa3. Standard & Poor’s awarded Cvrd an investment grade rating of BBB shortly afterwards.
the 30-year issue to raise a further $300 mn. Its annual funding costs fell by 50 basis points as investors accepted a narrower spread over US treasuries. ‘Our bonds now trade at lower spreads than Brazilian government debt,’ says Castello Branco. ‘We have a better rating than the government.’
The firm also acquired Vancouver based Canico Resource Corporation, owner of the Onca Puma nickelmining project in Brazil, for C$870 mn. Despite this public persistence in pursuing an organic strategy, however, when Ontario-based Inco unveiled a friendly C$12.5 bn cash-and-share takeover of local rival Falconbridge to create the world’s largest nickel producer in October 2005, Cvrd was watching carefully.
An unmissable opportunity
Part of Cvrd’s interest was fueled by management’s recognition of the need to diversify its asset base outside Brazil and reduce its dependence on exports. The company’s main costs were denominated in Brazilian real, but its exports were paid for in a basket of currencies as diverse as Australian dollars, Canadian dollars, Japanese yen, Korean won, Indonesian rupiahs and sterling. The main attraction, though, was Inco’s position as the world’s second largest nickel mining group. ‘Inco has the world’s largest reserves of nickel and the most advanced technology in the nickel marketplace,’ explains Castello Branco. ‘It was also a powerful brand, in the market since 1904.
Inco presented us with an opportunity to gain access to a world-class asset, with minimal learning costs.’
But Cvrd had been stung before by showing its hand too early, so the Brazilian group just watched the Canadian saga evolve from the sidelines. ‘This time we were very patient,’ says Castello Branco. ‘M&A has to be cold-blooded, and we wanted to wait until the players were all acting before we made our move.’
Everybody was expecting Xstrata, the Swiss-headquartered mining group, to make an immediate move. In August 2005, three months before Inco and Falconbridge announced their deal, Xstrata bought Brascan’s 19.9 percent stake in Falconbridge for C$2 bn. But the deal came with a hidden clause: if Xstrata bought additional shares in Falconbridge at a higher price over the following nine months, it was required to make a special payment to Brascan to make good the ‘premium’ it had missed out on. Unknown to its competitors, this premium acted as a temporary brake on Xstrata’s ambitions.
Ironically, it was news of Xstrata’s purchase that had prompted Inco and Falconbridge to act. The two presented their proposed merged entity as a national champion, hoping to elicit public and government support. But the argument held less sway with Europe’s regulators and antitrust officials, who were concerned the deal would give Inco control over Falconbridge’s Nikkelverk refinery in Norway – and thus more than 80 percent of the world’s supply of nickel alloys. These products are predominantly sold to aerospace and armament companies.
The ensuing debate was time-consuming and expensive, and took place against a backdrop of soaring nickel prices that pushed Falconbridge’s share price above Inco’s offer level. It was only a matter of time before a competing bid emerged.
A cast of thousands
It came in the form of a hostile takeover bid for Inco from Vancouver-based Teck Cominco, a diversified mining group and world leader in the production of zinc and metallurgical coal. The C$17.8 bn cash-and-share offer on May 8, 2006 was designed to break up the Inco-Falconbridge deal.
Inco had other ideas, however. The nickel miner rejected Teck Cominco’s approach and raised its cash and stock offer to acquire Falconbridge. Just four days later, however, Xstrata finally emerged from the shadows and launched its all-cash C$16.1 bn offer for the 80 percent of Falconbridge it did not own.
The price tag of C$52.50 per share was almost double what Xstrata had paid Brascan for its 20 percent stake but, importantly, its nine-month agreement had expired, so Xstrata did not have to pay the Canadian conglomerate an additional C$1.8 bn.
The maneuver prompted Inco’s chief executive, Scott Hand, to seek a white knight in the form of Arizonabased Phelps Dodge. It announced plans to buy both Falconbridge and Inco for C$40 bn and create the world’s biggest nickel producer and second largest copper producer.
Scott had initially approached Cvrd about launching an offer for both Inco and Falconbridge, but the feasibility of raising more than C$40 bn in cash made the transaction seem impossible. More importantly, as Castello Branco puts it, ‘when we like an asset, we are very selfish. We want to enjoy it 100 percent, and we’re not willing to share the risks and the benefits with any third party.’ When Xstrata boosted its all-cash bid for Falconbridge by 7 percent, however, the writing was on the wall for the three-way merger. Shareholders accepted the money.
Nevertheless, Phelps Dodge and Inco continued with a two-way merger in an effort to thwart Teck Cominco’s attentions. But on August 11, 2006, Cvrd caught the market by surprise when it launched an unsolicited C$86 per share offer for Inco. Hand was prepared, though – Agnelli rang him at his Toronto home the night before and said: ‘Scott, we are going to move.’
Cash counts
Despite Hand’s attempts to gain shareholder approval for the Phelps Dodge-Inco merger, market observers claim the deal basically died the moment Cvrd moved into orbit. Teck Cominco withdrew almost immediately. Cvrd had offered cash, and cash is king. And there was a C$15 bn difference between the cash Phelps Dodge was offering and the cash Cvrd put on the table.
The bulk of Phelps Dodge’s offer comprised shares, their value determined by market conditions, which, at that moment, were not looking bright. Phelps Dodge gets three quarters of its revenues from mining copper. North America is the second largest consumer of copper, and the most important use of copper is in construction. But figures from North America were indicating a housing market in meltdown.
For the Phelps Dodge deal to make sense to Inco shareholders, it needed copper prices to remain high for several years to come. And if demand from the world’s second biggest consumer were to slump, copper prices would certainly fall. ‘Investors wanted cash in the hand,’ states Castello Branco. But analysts believe investors had also lost faith in Inco. Those who bought shares in Inco in 2005 might have enjoyed the 70 percent rise in share prices that being part of a bid battle and the rising world demand for nickel had prompted. But they still would have been better off putting their money in a fund tracking the Toronto stock market.
Cvrd never discussed its proposal with Inco shareholders. ‘We did not meet them,’ admits Castello Branco. ‘We had nothing to sell them, nothing. We were offering cash only. We also didn’t see the need to pay a premium because Inco shares had already gone up.’
Initially, Cvrd’s investors reacted negatively to the Brazilian company’s move, marking down its shares in the immediate aftermath. It took a round of discussions to help investors better understand the logic of the deal before the share price rallied.
‘When they realized the potential for value creation, they were very positive,’ explains Castello Branco. ‘We make assumptions to evaluate a project, and we use a hurdle rate of 15 percent. In this case, we lowered our bar because we liked the opportunity for risk management. This transaction diversified our assets geographically, because prior to this 98 percent of them were in one country: Brazil.’
Cvrd’s market capitalization fell from $66 bn on May 9, 2006 to $46 bn in August that year. It is now capitalized in excess of $90 bn. ‘Cvrd has put on almost $50 bn in market capitalization since we acquired Inco,’ says Castello Branco proudly. The debt rating agencies immedi-ately put Cvrd on credit-watch after the offer was announced, concerned its debt would climb to about $22 bn on closing the deal. ‘We showed them we had the capacity to reduce the debt we had taken on, and highlighted the synergies between the two companies,’ says Castello Branco.
‘We are very conservative when we assess deals. We had considered synergies and we believed the fit was very good: Cvrd was a specialist in open pit mining, Inco was a specialist in underground mining.’ Cvrd was eventually removed from credit watch and regained its investment grade status.
Preparing the groundwork Cvrd approached Credit Suisse, Ubs, Abn Amro and Banco Santander to arrange funding totaling $18 bn. Lending to Brazilian companies can prove problematic as the country is a sub-investment grade credit with foreign exchange regulations, so banks need to put aside capital when making plain vanilla loans.
But because Cvrd is an investment grade firm, it was much easier to raise funds and, unlike other Brazilian companies, it was not asked to extend guarantees to assuage concerns. In the event, 37 banks from Canada, Brazil, the UK, continental Europe, South Africa, Asia and the US wanted to be part of the syndicate – and up to $34 bn was made available to Cvrd.
‘We wanted to borrow for less than three years. The banks offered a bridge loan, with the option to extend its maturity,’ says Castello Branco.
‘The cost of the loan was 40 basis points over Libor for the first year, rising to 50 basis points over Libor for the second. We paid $17.7 bn for Inco, but we used $3.1 bn from cash holdings and borrowed $14.6 bn from the pool of banks. We bought US dollars to hedge against an appreciation in the Canadian dollar, and actually profited through this, which reduced the final price we paid.’
Even as Cvrd was unveiling its unsolicited approach for Inco, the Brazilian mining company was already applying for regulatory approval from Canada’s Ministry of Industry under the Investment Canada Act. ‘We had to deal with the governments of Canada and the provinces, so it was a lengthy process,’ explains Castello Branco. Cvrd also applied for approval from competition authorities in Canada, Europe and North America.
Cvrd finally received Canadian regulatory approval on October 20 after the deal was deemed of ‘net benefit’ to the country. ‘We had to make some commitments,’ concedes Castello Branco. The most significant was an agreement to maintain Inco’s headquarters in Toronto, where Cvrd’s global nickel business (Cvrd Inco) would be established with a mandate to expand its business. Cvrd also had to agree to transfer management responsibility for its interests in existing and future nickel projects, commit to invest in Canadian projects such as research and exploration, and not to cut staff for at least three years.
Other commitments related to social and environmental responsibilities, such as a pledge to boost education and training programs and to respect Inco’s existing agreements with provincial governments, trade unions and aboriginal groups, including the Innu Nation.
Winning formula
By September 5, 2006, less than one month after Cvrd launched its bid, Inco and Phelps Dodge conceded there was insufficient shareholder approval to proceed with their merger. Hand told his shareholders they should accept Cvrd’s offer. By the end of October, more than three quarters of shares had been tendered and, shortly afterwards, Cvrd set about refinancing its loan.
It issued two bonds totaling $3.75 bn, comprising a ten-year $1.25 bn transaction and a 30-year $2.5 bn deal. A three-day North American roadshow by Cvrd’s management team ensured demand almost reached $13 bn. Nonetheless, it was still the biggest debt placement in the capital markets ever made by a Latin American company.
Cvrd also launched two nonconvertible bond issues totaling BRL5.5 bn ($2.62 bn) in its domestic bond market, and the company raised $6 bn through an accord with 30 banks to support prepayment of exports. These deals, plus some smaller transactions, meant Cvrd was able to repay its bridge loan by the end of 2006.
More importantly, perhaps, Cvrd has been able to lengthen the average debt repayment period and reduce its cost of borrowing from 8.04 years and 7.15 percent as of September 30, 2006 to almost 10 years and 6.5 percent by the end of December 2006.
‘Cvrd is now a company with a very strong balance sheet with healthy cash flows, that operates in a globalized financial market and has the ability to accept capital in all regions of the world,’ says Castello Branco. The Brazilian company is in the position it is today because, says Castello Branco, it ‘faced up to its greatest challenge and had the courage to borrow billions of dollars to make its first major acquisition.
