One of the oddities of the current market is that even as the iron ore price has been falling and the discount for lower grade ore has been increasing, the share price of takeover target Aquila Resources has remained consistently above the offer price.
It’s curious because in the current climate there would appear to be only one obvious source of bidding for Aquila, given that any rival bidder would not only need to top the $1.4 billion offer made by China’s Baosteel Resources and Aurizon but would need to find at least another $4.5 billion to finance its share of the development costs of its two main projects and the port and rail infrastructure needed if Aquila’s West Pilbara Iron ore Project is to actually get any ore to market.
Since Baosteel and Aurizon launched their bid more than a month ago Aquila has been quiet and has had virtually no dialogue with the bidders, rebuffing their invitation to discuss the offer. With the offer despatched last week, Aquila now has to provide a formal response.
The performance of the share price in response to the offer of $3.40 a share – it has traded above $3.50 a share and was trading just below that level this morning – suggests the market is betting on either a rival offer or an increase in the existing bid.
If there is to be a higher offer one suspects it would come from Baosteel and Aurizon, although Aquila has limited negotiating leverage if it can’t drum up a competing bid.
One of the puzzling aspects of the bid was that it was essentially launched as a hostile offer despite Baosteel having been a very supportive shareholder in Aquila since 2009, when it effectively saved the group. Baosteel has a 19.8 per cent shareholding in Aquila, which would complicate matters for any aspiring rival.
The obvious explanation for the bid is that Baosteel was unable to agree on the terms of a funding agreement with Aquila to develop the West Pilbara project and therefore decided that the most rational course to get the project developed was to take control of Aquila.
In effect, it is saying to Aquila’s founders – chairman Tony Poli, who owns about 29 per cent of the company and Charles Bass, who owns about 11 per cent – that they can either walk away with $560 million between them or continue to own 40 per cent of a company with two core projects that it can’t afford to develop.
The key project is the West Pilbara iron ore resource, although Aquila also has a high-quality coking coal project in the Bowen Basin in a joint venture with Brazil’s Vale. Aquila has a 50 per cent interest in the iron ore project, with US commodity trader ACMI Group owning 25.5 per cent and South Korea’s Posco 24.5 per cent.
Aquila’s share of the remaining cost of developing the iron project is estimated at about $3.7 billion and its share of the coal project about $815 million. It has about $500 million of cash in its balance sheet which is earmarked for the Eagle Downs coal project.
The iron ore project can’t be developed without the associated new rail and port infrastructure which Aurizon hopes to develop on an open-access basis that would open up the West Pilbara iron ore province.
In fact, in the current environment for iron ore, with supply now beginning to outstrip demand and an outlook is which there is a growing and substantial structural surplus emerging over the next few years, it is doubtful that anyone but a Chinese steel mill would be keen to invest the sums required to open up a new iron ore region.
There are obvious strategic reasons for Baosteel to want to get direct access to iron ore and to diversify its supply away from the three big seaborne iron ore producers, Rio Tinto, BHP Billiton and Vale.
The lower iron ore prices and bigger discount for lesser quality ores hasn’t deterred them from ramping up their own production, which ought to drive higher-cost and lower-quality producers out of the market and ultimately give them more influence within the market. That’s not something the Chinese steel mills would want to allow to happen.
If the current bid were to succeed, Aurizon would achieve its ambition of breaking into the West Australia market to diversify its activities away from Queensland and New South Wales. It would own 15 per cent of Aquila and have a year of exclusivity to agree the terms of an infrastructure deal with Baosteel, ACMI and Posco. It would plan to bring third-party investors into the infrastructure project while retaining majority ownership.
Thus the nature of the joint bidders provides a solution to the impasse frustrating development of the West Pilbara project.
Whether there is another combination out there that could provide something similar is unlikely, but is no doubt something that Aquila will be exploring, along with the possibility of extracting something more from the bidders that it does have.