Chinese grant Alumina a sparkling new year

The decision by state-owned Chinese giant CITIC Resources to take a strategic stake in Australia's Alumina will protect the latter from an Alcoa takeover as well as provide a much-needed share price surge.

Short-sellers are having a bad week. First JB Hi-Fi blind-sided them with a better-than-expected result and now Alumina has belted them by announcing a completely unanticipated $452 million placement to China’s CITIC Resources at a premium to the price at which Alumina shares had been trading.

Not surprisingly, Alumina shares shot up sharply today, although that wouldn’t be entirely due to the scramble by the shorts to cover their positions. The CITIC investment is a big vote of confidence in Alumina and in the prospects of at least the bauxite and alumina segments of the aluminium industry.

The placement of 15 per cent of its pre-existing capital translates to a shareholding of 13 per cent. CITIC has the right to move to 15 per cent, so there may well be some on-market buying by the group to provide a floor under the Alumina price for some time.

With the western aluminium industry under pressure from the structural changes that have occurred as China has emerged as the world’s biggest producer – changes that have cost Rio Tinto $US29 billion of the $US38 billion it paid for Alcan – and alumina prices still loosely linked to aluminium metal prices, Alumina’s shares have languished.

From the middle of last year until last month they had traded below $1, indeed at times significantly lower, touching 65 cents at one point compared to the $1.235 a share CITIC has paid and the $1.35 or so level the shares hit after today’s announcement.

CITIC is an astute and long-term investor with a lengthy history in this market. One of the most notable investments it had was its 25 per cent stake in Macarthur Coal, for which it reluctantly accepted about $1.25 billion when it belatedly accepted the Peabody Coal bid in 2011.

It has, moreover, had a long history of involvement with the Alcoa Worldwide Alumina and Chemicals joint venture with Alcoa of the US, in which Alumina holds a 40 per cent interest.

CITIC has a 22.5 per cent stake in AWAC’s Portland aluminium smelter. The origins of that interest date back to the mid-1980s, when CITIC participated in the sale of the Victorian government’s Aluvic, which then owned 25 per cent of the smelter.

Alumina’s John Bevan would be delighted with CITIC’s endorsement of his company for at least two reasons.

The first is the obvious message of confidence one of China’s bigger state-controlled enterprises has demonstrated in the future of bauxite and alumina. The other is that it would complicate, and probably frustrate, any attempt by Alumina’s partner, Alcoa, to move to full ownership of AWAC on the cheap.

While both aluminium and alumina prices have been depressed for some time, the fundamentals for bauxite and alumina are stronger than for aluminium, where Chinese and Middle Eastern producers have created an oversupply of the metal despite continuing strong growth in demand, mainly from China itself.

So China is long aluminium but has to import about a third of its bauxite and alumina requirements. It has bauxite resources of its own but they are of poor quality.

Alumina has traditionally been priced off the aluminium price but in recent years the net short position that China and other developing economies have in bauxite and alumina has been reflected in some divergence of aluminium and alumina prices, and a shift from contract pricing to market pricing, with alumina increasing on its own supply-demand relationship.

That ought to make Alumina an attractive way for a strategic resources investor to get an exposure to a commodity with long-term upside. CITIC would have a deep understanding of China’s likely demand – which might also be valuable to Alumina itself. CITIC’s vice-chairman and chief executive, Chen Zeng (a long-time resident in Australia) will join its board.

With the proceeds being devoted to reducing Alumina’s debt from $US681 million to about $US216 million, the placement will also make it possible for Alumina to flow more cash from AWAC through to its shareholders.

The strategic dimension to the placement is quite significant. While CITIC has the ability to move to 15 per cent of Alumina, it can’t increase or sell its interest without the Alumina board’s approval for the next two years. After that it has the ability to lift the stake to 19.9 per cent.

If Alcoa hadn’t been immersed in its own problems last year the 65 cents a share level to which Alumina traded down to might have proven irresistible.

Alcoa has long harboured the ambition of acquiring the 40 per cent of AWAC held by Alumina, indeed Alumina was created in response to that ambition.

The AWAC interest was originally part of Western Mining. In 2001 Alcoa made an approach to Western Mining, offering to make an offer if its board supported it.

Western Mining's Hugh Morgan was concerned that Alcoa’s rights over Western Mining's AWAC interest meant it was the only bidder for his group and that, with about $7 billion of value (at the time) tied up in non-AWAC assets that Alcoa would want to sell, and $1 billion of capital gains on those assets that would become taxable in the event of a sale, there was no prospect of realising full value for Western Mining.

His response was a de-merger that separated those assets within two vehicles, WMC Resources (subsequently acquired by BHP Billiton, which outbid Xstrata) and Alumina.

It was thought at the time that Alcoa would almost certainly move to acquire Alumina but for whatever reason (some say wounded pride that its initial attempt had failed) it didn’t bid. Still, there has been an expectation that once Alcoa had got its own post-crisis affairs in order (which it appears to have almost done) it would eventually have another go.

CITIC is a long-term investor and, as it showed in the Macarthur Coal bid, a reluctant seller of its interests. A 15 per cent shareholding, let alone an eventual 19.9 per cent interest, would make it near-impossible for anyone to achieve 100 per cent ownership of Alumina without paying a very full price.

Moreover, having a strategic shareholder would give the Alumina board leverage in the event Alcoa were to make another attempt to clean up AWAC, particularly within the next two years, given CITIC would require its approval to sell its shares.

From Alumina’s perspective bringing CITIC onto its register brings with it a range of positive impacts. One suspects, however, that Alcoa won’t be quite as enthusiastic about the reshaped Alumina share register as Alumina.

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