Mining marriage a messy affair for Xstrata and Falconbridge

Mining marriage a messy affair for Xstrata and Falconbridge

By Eric Reguly, Canada Globe and Mail

Tuesday, August 23, 2005

To listen to Xstrata boss Mick Davis, you would think Xstrata and Falconbridge are a marriage made in heaven. The two companies adore one another, in spite of their exceedingly short courtship, and will do wonderful things together. It's a nice romantic story. It's also news to Falconbridge.

Xstrata is the Swiss mining group that last week snapped up 19.9 per cent of Falconbridge for $28 a share, for a total of $2-billion. Brascan sold the stake. In the conference call, Mr. Davis said "we have a very good relationship" with Falconbridge management, led by CEO Derek Pannell. He said Xstrata has the "expectation" of gaining board representation, as if it were a done deal.

Mr. Davis is calm, smooth and slick. He left the impression Falconbridge will virtually leap into Xstrata's arms should Xstrata decide to buy the 80.1 per cent of the Canadian mining and smelting group it does not already own. Good luck. This story is far from over and things probably won't go as smoothly as Mr. Davis suggests.

Brascan had been trying to unload its mining assets -- a significant minority stake in Noranda, which in turn controlled Falconbridge -- for years. China Minmetals came close to buying the Noranda-Falconbridge combo last year. After the deal fizzled, Brascan overhauled the mining companies' ownership structure to make them more palatable to prospective buyers. Noranda merged with the more attractive Falconbridge. Brascan emerged with 19.9 per cent of the enlarged company, which took the Falconbridge name.

It worked -- too well for Falconbridge, which had fantasies of an independent life as a bigger, stronger player in a hot industry. Xstrata pounced. The deal was put together only days before the Aug. 15 announcement. Brascan, whose offices in Toronto's BCE Place are one floor apart and connected by an open staircase, did not tell Falconbridge that Xstrata was coming. Mr. Pannell had no time to prepare for the news. He could not have been happy, especially since he probably would lose his job the moment Xstrata bought the rest of the company, which Xstrata strongly suggested it would do (Mr. Pannell would not comment).

Mr. Pannell and Falconbridge are suddenly in awkward and a difficult position. Brascan, which had been an ally for two decades, no longer cares an iota about Falconbridge's desire for independence. In fact, it's in Brascan's best interests to see Falconbridge sold. That's because Xstrata has agreed to pay Brascan the difference between the $28 a share Brascan has already received and any higher price it offers for the rest of Falconbridge.

Xstrata obviously hopes to get the other 80.1 per cent of Falconbridge as cheaply as possible. Mr. Pannell has a fiduciary duty to get the highest price possible. Given the opposing goals, you can bet that the Falconbridge board will not take kindly to Xstrata's requests for board representation. Xstrata may not be a hostile suitor (yet), but it's not considered friendly either.

How is Mr. Pannell to get out of the mess thrust upon him? He really has only two options, neither easy. The first is to get the share price up to the point that Xstrata and other potential suitors will take a pass on Falconbridge. The second is to recruit a white knight that will let him keep his job. Mr. Pannell is 58 -- not a young man, but too young to retire.

This is where things might get really interesting. On the other side of downtown Toronto, Inco, with no controlling shareholder and vast exposure to a high-flying metal -- nickel -- is looking vulnerable too. Why not put the two together to create an international mining powerhouse?

The idea has been around for years and was always fraught with difficulties. Together, Inco and Falconbrige might elicit rude calls from the competition authorities. It would result in big domestic job losses. In any event, it was never more than a fantasy because Brascan controlled Falconbridge (and Falconbridge's former parent Noranda).

But the world has changed in recent years. Inco and Falconbridge have victim written all over them as giants such as Anglo American, Rio Tinto and BHP pick off second-string names. If Falconbridge goes, Inco might be next and Canada's mining industry would get gutted.

The business case for putting Inco and Falconbridge together is not overwhelming. But it's far from absent. Combining the companies' Sudbury, Ont., mining and smelting operations would save a lot of money, although at the expense of jobs. Some synergies present themselves in New Caledonia, where both companies are investing billions in new nickel operations. Inco's Voisey's Bay nickel deposit, in Labrador, would be attractive to Falconbridge.

Scott Hand is the CEO of Inco. He is 63, faces retirement and wants to return to the United States, where he's from. Inco has already launched an informal search for his replacement. Is Mr. Hand willing to risk merging Inco and Falconbridge in his final years when he could just slip away to the golf course with his fortune? The effort could fail. But if it worked, he would be the hero that saved the two biggest names in Canadian mining from branch plant status.