AS A YOUNG EXECUTIVE AT NERCO Minerals Co. in the 1980s, Tom Albanese was part of a team that took advantage of the prevailing wave of mineral divestments by big oil companies to expand the small Alaskan company through a series of acquisitions.
Two decades later, only the size of his appetite has changed. Just two months after taking over as CEO of London-based Rio Tinto, Albanese put his M&A skills to work by making an agreed, $38.1 billion takeover offer for the Canadian aluminum producer Alcan. The deal, which beat a hostile bid from Alcoa and is scheduled to be completed in the fourth quarter, is the largest ever in the metals and mining sector and will make Rio Tinto a global colossus, with pro forma revenues of $49 billion and earnings before interest, taxes, depreciation and amortization of $16.5 billion, rivaling industry leader BHP Billiton.
Rapid growth in China and other emerging markets is driving up commodity prices and providing a boon for mining companies like Rio Tinto. Prices of copper and iron ore, which generated 90 percent of the company’s earnings in the first half of this year, have more than doubled over the past three years.
The Alcan acquisition will vault Rio Tinto past Alcoa and Russia’s United Co. Rusal to make it the world’s largest producer of aluminum. The metal will account for 32 percent of the enlarged group’s ebitda, compared with 10 percent currently. Some analysts, however, have questioned the logic of the deal, pointing out that aluminum prices have risen less than those of other metals because of massive production increases in China. Rio Tinto’s London-listed shares fell 25 percent in the five weeks after the deal was announced but have since more than recovered to stand at £42.28 ($86.26) at the end of last month.
Albanese expects aluminum demand to grow by 15 percent a year and notes that Beijing recently announced measures to restrain output to curb the country’s appetite for electricity. The executive also regards Alcan’s access to Quebec’s hydroelectric power as a competitive advantage in the energy-intensive aluminum business, especially at a time when climate-change concerns are increasing the likelihood that governments will take steps to limit carbon emissions.
Keeping control of costs may be an even bigger challenge. Net income fell 14 percent in the first half, to $3.25 billion, despite a 15 percent rise in sales, to $13.93 billion. The price of everything from capital equipment to drilling rights to skilled personnel is rising fast in the industry. Albanese aims to cut $600 million after the merger with Alcan, but he points out that some increase in spending is inevitable if the company is to meet growing demand for metals.
The 49-year-old New Jersey native, who went to the University of Alaska to study mineral economics and mining engineering, has experience with much of the world’s mining activity. After Rio Tinto acquired Nerco in 1993, he ran the group’s Alaskan gold and silver operations, worked on a Russian joint venture with Norilsk Nickel and oversaw mining operations in Mongolia, Peru, Utah and Australia. Last December he was named CEO-designate and succeeded the retiring Leigh Clifford in May. He spoke recently with Institutional Investor International Editor Tom Buerkle.
We’ve seen a very strong bull market in commodities the past few years. How long can this continue?
We are beginning to see a number of developing and emerging countries moving quite quickly up a variety of intensity curves, if you measure metal usage or energy usage on a per capita basis. China accounts for somewhere between 25 and 35 percent, or even more, of global consumption of steel, copper and aluminum, and they’re growing that consumption at well over 15 percent annually. That is a tremendous strain on the industry when for the most part, the sectors we’re in have been undercapitalized for five or ten years. As a consequence, supply is not meeting demand; we’re seeing stronger prices. Is that a permanent situation? No. There is still such a thing as a business cycle. It’s just a matter of time before the bottlenecks to the system are overwhelmed by sheer incentive prices.
What is the bigger risk for you, a U.S. recession that curbs demand for these commodities or price levels that attract greater investment and reduce prices and profit margins?
Both at the same time. It is important to recognize that while the U.S. is the largest economy in the world, it’s sufficiently mature that its consumption of many of these materials will not be as high as some of these new areas. You can have a significant slowdown in the U.S. housing sector, but you’ve got several hundred million people who want to move into apartments for the first time in China.
Why did you buy Alcan, and why now?
We’ve looked at Alcan as a possible opportunity since early 2006. It is an extremely attractive business in terms of the quality of its production stream from bauxite to aluminum metal, and the hydro component of its power mix. Alcan was very much minded to stay independent. When Alcoa made its hostile bid, the dynamics changed and we were quite well-positioned to come out on top.
Some analysts see aluminum as less geared to the growth of emerging markets than copper and iron. What do you say to those concerns?
The intensity curve for aluminum is about equivalent. You have a fair amount of aluminum that would be in packaging and consumer goods compared with copper and steel. What’s really held down prices is China’s success in ramping up its supply. In our view they’ve increasingly become the marginal producer of aluminum because of the rising cost of electricity in China, giving us a more positive view of forward prices. It just so happened that within two weeks of our [takeover] announcement, the Chinese government imposed import quotas and export duties to discourage the export of aluminum.
There has been speculation recently about a possible breakup bid for Rio Tinto from BHP Billiton. Can size become a disadvantage?
We wouldn’t comment on speculation. Generally, it’s not size so much that’s an issue as it is complexity. We’ve worked to keep ourselves less complex, which provides us the ability to grow without the burden associated with that growth. We’re going through some changes so that our corporate executive offices will have only about 50 people by the end of this year. We’ll run a company that’s a fairly global leader in the mining sector, with an office in London of about 50 people, and that’s they way we want it to be.
We’re increasingly putting together a hub-and-spoke network, setting up offices in Salt Lake City, Brisbane, Melbourne, Perth and Montreal, where we basically bundle up professional support and engineering skills that can then be provided to a range of businesses. We have a group now that basically runs the procurement for the entire organization. These are the types of things that you can do with size.
You had pretty high cost pressure in the first half. What are you doing to get that under control?
We have had cost increases above the inflation rate, and certainly that is concerning, but it’s also reflective of the fact that the industry is stretched so tight that it cannot respond to the demand pressures.
We are looking at moving from what we had previously announced, 220 million tons of iron ore by 2009, to something in the range of 320 million tons by 2013. You’ve got to drill ore bodies to do that, and all that drilling shows up as an expense. That’s a good cost. That’s an investment we’re making so we can have the option to ramp up our businesses to what we see as a strong market.
What kind of growth rate do you project?
We’ve historically talked about a 6 percent growth rate of our businesses. The Alcan transaction positions us to do better than that because they come with a quite enviable suite of brown-field and green-field growth opportunities.
What is Rio Tinto doing to show that its mining operations are environmentally sustainable?
Mining has got to live above its prior reputation. I take quite a bit of pride in the fact that Rio Tinto is seen as a leader in many of the key areas in sustainable development: worker safety and worker health, environmental issues and community engagement. And I think that very much matches with our overall thinking on global warming.
We are focusing on moving the technology in key areas, such as clean coal, with a series of projects, including FutureGen Alliance in the U.S. and our venture with BP on coal hydrogen energy, which is looking at opportunities to convert coal to hydrogen and sequester the CO2. It’s going to really depend on what governments do, both in terms of supporting these technologies and in terms of how carbon pricing is put in place to incentivize these technologies. We’re anticipating that we will begin seeing carbon-price signals, and we want to be well positioned for that.
By being the second-largest producer of uranium in the world, we’re very well positioned for a carbon-free source of energy.
