Too big to fail. Too big to succeed. It sounds like a contradiction but events in Europe overnight confirmed a growing suspicion that the world’s biggest mining companies, including BHP Billiton and Rio Tinto, will struggle to grow by acquisition in the future.
Worse than that, because they have become important sources of tax revenue the big miners risk becoming “government hostages”, trapped between growth restrictions and tax demands.
The latest problem with size came in the form of a warning from the European Commission to the giant commodities trader, Glencore, that it has serious doubts about the merits of its proposed merger with Xstrata.
The core issue is potential dominance in the supply of zinc to European customers, such as steel mills and car makers.
Glencore, the world’s biggest zinc trader, has responded by saying it is prepared to sell some of its zinc assets, or change the way it does business.
While the offer to sell assets might appease anti-monopoly regulators this latest spat with government reveals how the big miners have hit a growth ceiling.
Two years ago, BHP Billiton suffered an even more significant setback when its attempt to buy Potash Corporation was rejected by the Canadian Government.
The Canadians were concerned that BHP Billiton could dominate that country’s potash industry, a curious reaction given that it was deal which simply transferred ownership from a business already controlled by U.S.-based investors to a wider international investor base.
Whatever the logic behind the Potash Corporation rejection, a message was sent to the world’s biggest mining companies that governments were deeply concerned about monopolistic tendencies in the supply of basic raw materials such as minerals, metals and fertilisers.
China has expressed similar concerns about the supply of iron ore which is essentially in the hands of three big miners, Vale of Brazil and the two big Australian exporters, BHP Billiton and Rio Tinto.
What worries governments, the ability of a small group of suppliers to dominate a market and therefore control prices, should also worry investors because government interference has the potential to severely limit the growth of companies.
In effect, the big miners are becoming a poor choice for investors because they are easy targets for government seeking additional tax revenue, and equally easy targets for governments seeking to limit their growth by acquisition.
It’s stretching the point, but with so much government interference in their operations the big miners risk being treated as government agencies, delivering essential tax revenue which already exceeds what shareholders are paid in dividends, but limited in their growth options by the regulatory ceiling.
The miners have effectively become too big to fail because government wants to tax revenue, and too big to succeed because their expansion options are limited.
Glencore’s problem with zinc has so far resulted in a preliminary warning from the European Commission that it might launch a full-scale probe into the proposed merger with Xstrata, a process which could last six months, or more.
To avoid being drawn into a long-running investigation, Glencore has made a pre-emptive offer to sell zinc assets.
The concession is bigger than it might seem because zinc has been named by Glencore management as one of its preferred future investments because of a forecast shortfall in supply after the closure in the next few years of the Cannington mine in Queensland.
Glencore zinc assets likely to be offered for sale include a shareholding in Nyrstar, the world’s biggest zinc refiner, and possibly some of the 19 zinc mines in which it, or Xstrata, have an interest in around the world.
Exactly what Glencore does to get its merger with Xstrata through the regulatory process is irrelevant when considering the bigger question of how the mega-miners can expand via acquisition in the future with multiple layers of government watching their every move – while also taxing every dollar they earn.
At some point, institutional investors and investment banks will look at the government tax and regulatory stranglehold and ask the question management at the big miners dreads – would they be better investments if broken up into smaller units?
The answer in today’s difficult trading conditions, where diversification yields balanced revenue flows, is that a break up is probably not the best reaction.
But, when the global economy recovers and mineral demand rises the question of break-ups will return because smaller, nimbler, companies have more growth options than monster organisations – and present a smaller target for government.