04/08/2014 - 13:24

US calling for resources capital flow

04/08/2014 - 13:24


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Western Australia is once again the key player in a money flood, though this time it’s outgoing rather than incoming.

US calling for resources capital flow
Perth central business district skyline

A combination of factors is behind an imminent flood of money out of WA.

Western Australia is once again the key player in a money flood, though this time it’s outgoing rather than incoming.

There are two factors driving the funds exodus – US activist investors demanding the sale of Australian assets, and two of the biggest miners preparing to return money earned in WA to their interstate and overseas shareholders.

The activist push is being led by New York-based hedge fund managers who want US resources companies to quit Australia and bring the capital home, because profit margins in the US are much higher than Australia.

The latest example of the US activist push is an attack on Cliffs Natural Resources by Casablanca Capital, a hedge fund that owns just 5.2 per cent of Cliffs but has attracted wider support for one of its aims, which is the sale of the Koolyanobbing iron ore mine near Southern Cross.

A separate attack, but one closely related in principle, is an move by another New York-based hedge fund, Jana Partners, on Apache Corporation, which has extensive oil and gas interests in WA, including a 13 per cent stake in the Chevron-led Gorgon LNG project. Jana wants the Gorgon stake sold, and a review of all international assets.

A similar attack was mounted last year on Hess Corporation, another US petroleum company with WA interests. Elliott Management demanded extensive changes at Hess and a refocus by the US mid-tier oil producer on its US assets.

Other examples of international investors retreating from Australia in the aftermath of the commodities boom include Peabody Energy of the US attempting to sell coal assets in Queensland, and two Japanese companies – Itochu and Sumitomo – also trying to sell Australian coal assets.

But the three deals that directly affect WA are those being led by international fund managers keen to sell assets here and then repatriate the capital to the US for reinvestment in assets capable of generating higher returns (thanks largely to lower US costs).

That trend is the exact reverse of what happened at the start of the resources boom, when hedge fund money was flowing into WA, helping fund new mines such as those built by Fortescue Metals Group.

The other example of money being taken out of the state is the likelihood of both BHP Billiton and Rio Tinto launching big capital management programs, probably in the form of share buy-backs or a direct return of capital to shareholders.

WA investors will share in whatever the two resources companies decide to do, but they are very much a minority group on the share registers of the world’s two biggest miners.

In BHP Billiton’s case there is speculation that a share buy-back totalling $US3 billion will be launched, with the company’s profit announcement scheduled for August 19.

What a buy-back essentially means is that management has run out of investment ideas and is bowing to investor demands for the return of capital, a large portion of which might one day have been invested in a resources-rich location such as WA.

In BHP Billiton’s case it could be argued that a return of capital could be the result of the company selling its BHP Billiton Nickel West business, with the funds raised being shipped off to international investors rather than reinvested in WA.

It is, of course, never that simple, but the proposed Nickel West sale dovetails neatly with the expected share buy-back, or some other form of capital return or enhanced reward for the company’s shareholders.

Rio Tinto is unlikely to move as quickly in boosting shareholder returns because it is less certain about the outlook, and is more heavily exposed to a single commodity – iron ore.

Current thinking among investment banks is that a capital management program is unlikely to be launched by Rio Tinto before 2016, and only then if the iron ore price stabilises (or, preferably, rises) and even then the amount of capital returned would depend on the success of ongoing cost-cutting operations.

In Rio Tinto’s case the effect on WA is not so much one of capital being extracted from the state and sent elsewhere as it is of local job losses from cost cutting to boost conventional dividends to international investors.

Analysed whichever way you like, the net effect of what’s happening – either US activist investors demanding the sale of WA assets, or big miners switching their focus from investing in WA to extracting money from WA – the result is the same.

Cash out, not cash in.

China bounce

ON a more positive note the latest economic news from China will be greatly appreciated by the WA mining sector, which is plugged directly into that country’s growth rate and its demand for basic raw materials.

Not widely reported, and certainly not well understood, what happened is that China’s industrial production (or IP as it is sometimes called) rose from an annualised growth rate of 8.8 per cent in May to 9.2 per cent in June.

While hgher rates of IP flow directly into demand for raw materials, more important than China’s June IP level is the overall recovery in global economic growth, which has rebounded over the first half of 2014 to reach its highest rate of growth since the year 2000.

The recovery in IP is in contrast to the bad news flowing out of trouble spots such as Ukraine, Russia and Gaza.

What appears to be happening is that while the trouble spots dominate headlines, the real economy is simply getting on with business – producing and consuming.

Tax breaks

ANOTHER example of the way business is pursuing profits rather than wasting time worrying about politics is in the latest tax-dodge trend emerging in the US, where international takeovers have been a nifty way of avoiding high domestic tax rates.

A series of recent pharmaceutical takeovers are seen as ‘inversion’ deals, with a US company buying a foreign rival and then shifting its domicile and tax base to the foreign country.

Ireland, which has ultra-low corporate tax rates, has been a favoured destination, with US-based companies Medtronic paying $US43 billion for Covidien, and AbbVie paying $US54 billion for Shire. Covidien and Shire are both Irish based.

There’s nothing new in tax-driven investing but the values in the current outbreak are huge, and worrying the US government.


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