Now this is a deal worth talking about…
Earlier this month, Brazil’s mining powerhouse Vale ADR (NYSE: VALE, Stock Forum) and Norway’s Norsk Hydro ADR (OTO: NHYDY, Stock Forum) struck a golden bargain.
Norsk, Europe’s third-largest aluminum maker, agreed to buy Vale’s aluminum assets for $4.9 billion. Paying $1.1 billion in cash and assuming $700 million in net debt, it will pay the rest in new shares.
When all is said and done, it will own 22% of Norsk Hydro. That makes it a significant shareholder, second only to the Norwegian government’s 34.5%.
While Norsk seems to benefit the most from the transaction at first glance, both companies are set to gain exactly what they need in the end.
As Norsk enjoys higher aluminum prices & rising demand…
Thanks to higher aluminum prices and rising demand, Norsk has enjoyed a good ride as of late.
It expects demand in both its upstream and downstream markets to grow about 12% this year. And its stock has surged over 50% in the last 12 months, as the global economy recovers from the financial crisis.
Furthermore, Norsk has easy access to Norway’s plentiful hydroelectric power supplies. That gives it a competitive advantage in an industry where energy accounts for about a third of costs.
The company only lacks reliable supplies of bauxite and alumina, its most important raw materials.
Fortunately, the Vale-Norsk deal rectifies that problem. It gives Norsk:
- Control of Paragominas, the world’s third-largest bauxite mine
- Control of Alunorte, the world’s biggest alumina refinery
- An 81% of another alumina refinery still in the developmental stage
- 51% of the Albras aluminum production facility in Brazil
All told, those businesses produced nearly $3 billion in income back in 2008. And going forward, they offer Norsk cost-efficient supplies for the next century.
Vale’s equally profitable, but not so obvious, side of the story
Vale benefits too, just not quite so obviously.
Its aluminum business was its third largest in terms of revenue. In fact, it invested $4 billion into the Alunorte alumina refinery alone.
So at first glance, investors might wonder how they benefit at all, especially considering that they sold the entire kit and caboodle for a mere $4.9 billion.
Believe it or not though, Vale had very good reason for divesting itself of those assets.
The company has publicly complained about Brazil’s rising energy costs for some time. Those fees made a serious dent in Vale’s bottom line, considering how much energy aluminum processing requires.
Electricity should be relatively cheap in Brazil, considering that it ranks second in hydroelectric production. But it also imposes heavy distribution charges and taxes on generation. Even businesses that produce their own energy have to pay their part and make it available to the national grid.
In addition, Brazil’s energy sector is slowly shifting in favor of solar, wind and nuclear plants. That move away from hydroelectric power is good for the country, considering its sometimes undependable rainfall. But it also means electricity costs could rise even higher in the near future.
The bottom line
Vale sold out because it couldn’t compete globally in the energy-intensive aluminum business. Brazil’s high electricity tariffs saw to that.
Besides, its aluminum division has always been a weak performer in comparison to its iron ore division. The deal frees up capital that can now go towards developing more lucrative iron ore assets.
Vale still believes in aluminum, which is why it asked for payment primarily in Norsk shares. That way, it exits the industry as an operator. But it retains exposure to the entire aluminum chain, from bauxite to finished products.
Ricardo Carvalho, Vale’s aluminum director, summed up the deal perfectly: “This is a strategic reposition in which Vale stops being an operator and becomes a major partner of a global aluminum company.” And that, he stressed, “makes [Norsk Hydro] much more competitive in the future.”
So in the end, both companies make out very well. And so can investors, through this new way to play the industry.