With 35 years of institutional investing and money management experience in the United States and Canada, Donald Coxe has a unique background in North American and global capital markets http://www.coxeadvisors.com This was originally written in May, 2007.
We have been asked by several Canadian clients for clarification about our strong opposition to some of the takeovers of Canadian resource companies. This is our detailed response. (The opinions contained herein are those of Donald Coxe and do not necessarily represent the opinions of BMO Capital Markets.) The material is primarily for Canadian clients, but others who were forced to tender their Inco or Falconbridge shares, or who fear being forced to sell their oil sands holdings, should find the analysis of interest.
We opposed the takeovers of Inco and Falconbridge, and have for two years expressed strong concern that Big Oil’s Reserve Life Index problems would lead to takeovers of publicly-traded oil sands companies at unrealistically low prices—because they tend to trade in line with spot oil prices.
Last September, we gave a speech to the 30th Annual Meeting of the Canadian Council of Chief Executives (whose membership includes the CEOs of Canada’s biggest companies) in which we ridiculed the prices at which Inco and Falconbridge were sold and warned that takeovers of oil sands companies would probably be next. (We had a polite exchange of views with the Brazilian Ambassador about his government’s holding in CVRD during the question period.
He complained that I had characterized it as a “government- controlled company” whereas they had floated it publicly and only maintained a minority position. I replied that I was not criticizing Brazil, and certainly not CVRD’s management, which is clearly first class. Suppose some other major company looked at the new CVRD, and said, “There’s a well-managed company that is the world’s #2 iron ore company, and that virtually stole the world’s #2 nickel company in a takeover, so I should acquire it.” They couldn’t: Your government holds the “golden shares” that preclude a takeover. There was no reciprocity in that deal.”)
We have received criticism from some clients for taking these stands. “You’re a believer in free markets, and were a strong opponent of Trudeau’s Foreign Investment Review Agency’s policies. Why not let the market price those assets?”
Are we being hypocritical?
Here is why we were so vigorous in opposing the Inco and Falconbridge deals:
1. Inco and Falconbridge were sold, respectively, to a Brazilian-government controlled company and a company that had strong historical connections to Marc Rich—at less than six times earnings. (Mr. Rich, once America’s best-known alleged lawbreaker on the lam, was accused of dodging both US income taxes and US embargoes against trading with the USSR during the Cold War, and with Saddam Hussein thereafter. He was pardoned by Bill Clinton—after a $450,000 donation to the Clinton library by his ex wife made, coincidentally, within days of Clinton’s exit from the White House. He has redeemed himself by passing management of his companies to successors, and with large-scale philanthropy in Israel.
Nevertheless, his ideas about free markets and the duties of a citizen would not pass muster with the prim, proper and punctilious Adam Smith, who considered himself a professor of moral philosophy—not an economist—and who found time for research and writing because of his stipend as a collector of customs revenues.) As we said at the time, because “Those who know it best, love it least,” the consensus about metal prices for valuing the stocks was roughly $4 for nickel and $1.50 for copper. This was, to us, like valuing Manhattan apartments today based on their prices during the 1991 recession.
2. A year before the takeover bids from CVRD and Xstrata, Inco and Falconbridge (which had just merged with another Canadian giant, Noranda) had entered into a merger agreement that would have created a global powerhouse that could have fended off the likes of Xstrata. (This was precisely the strategy we recommended in “Hard Rock Rocks,” Basic Points, August, 2005.) The merger was approved by the requisite Canadian authorities and had the support of the companies’ unions. Anti-trust authorities in Brussels and Washington took more than eight months to analyze the deals. During that time, nickel and copper prices soared, as did
the profi ts and stock prices of CVRD and Xstrata.
Due to the unconscionable pettifogging and delaying tactics of bureaucrats in the EU and Washington, the merger of two companies whose operations were overwhelmingly within Canada was tied up, allowing foreign bidders to leap in with bids for each of the partners,killing the deal and sending control abroad at pathetically low prices.
There have been widespread rumors that lobbyists in Brussels “encouraged” the Eurocrats to do what their class does best: stall. They did: they finally gave approval just in time for Xstrata’s lock-in deal with Brascan to expire. Xstrata had bought 19.9% of Falconbridge on August 15, 2005, at the then-market price. It was committed to pay Brascan whatever it paid above that price if it later bid for the rest of Falconbridge within the time of the lock-in.
Soaring prices for nickel, copper and mining stocks meant that Brascan was in for a big payday. It never came. A major Canadian company, that had held Noranda shares for roughly two decades prior to the merger with Falconbridge, was another victim of the dark side of globalization: the EU’s sympathy for European “champions.” The Free Market was put on hold until the European-based bidder was freed of its duty to pay the previous owner what it paid to everybody else. Should admirers of The Invisible Hand be putting their hands together to applaud the marriage
of mumbling bureaucrats and slick takeover artists?
3. As the Pope observed recently, Faith must be tempered with Reason. Faith in Free Markets does not imply a blind devotion to the instant operation of a particular kind of instrument of open markets. When that instrument is deployed by a government-controlled company or by one that has issues about its control and no history whatever of participation in the Canadian economy, a reasonable, even Friedmanesque, analyst of markets would not succumb to dogmatism about unfettered markets from supporters of one of the bidders.
As Scott Hand, CEO of Inco, told us after the battle was over, “Once we were in play, arbitrageurs and hedge funds controlled nearly half our stock. They couldn’t have cared less about our longer-term plans for shareholder value from our merger with Falco.” We have learned how some “activist” hedge funds engaged in takeover battles have been able to acquire voting rights to large quantities of shares they never owned. Is the Free Market a system for creating wealth and jobs over the long term, or must it be permanently at risk to a few well-funded players’ lust for instant gratification?
4. Yes, BMO’s investment banking division eventually backed Teck Cominco’s bid for Inco when stock market price action made it apparent that the endless Brussels Pout was killing the proposed merger with Falconbridge. But BMO’s support of Teck Cominco was not the foundation of our opposition to those lowball bids from offshore bidders. We personally had no desire to be forced to pay capital gains taxes on a divestiture of our long-held Inco shares. With Falconbridge also on the way out, it meant we could not take the money we had after taxes and reinvest in comparable companies with comparable reserves in a politically-secure region. We would have been content to roll our Inco stock fully into Teck Cominco on a tax-free basis, but the hot money based in such conspicuous strongholds of mining excellence and high taxation as the Cayman Islands, Virgin Islands, and Channel Islands was demanding all-cash. What particularly bothered us was that what should have been an open-market contest was being decided, in effect, by foreign bureaucracies who shouldn’t have been parties.
Only by the kind of intellectual contortions found among vexatious lawyers and over-reaching politicians and bureaucrats could there be justification for blocking this merger of two major Canadian companies with operations primarily in the same town—Sudbury. They had a record
of a century of history in Canada, and were owners of an overwhelming percentage of Canada’s total supply of irreplaceable nickel/copper assets.
Could Canada expect to block mergers of ethanol producers within Brazil because they might drive up prices of some Canadian food products? Or would the EU let Canada block proposed mergers between German and Swiss machinery manufacturers because they just might raise machinery costs for Canadian manufacturers?
As listeners to our Conference Calls are fully aware, we argued during the long struggles for Inco and Falconbridge that Canadian institutions should resist tendering their shares because there was no chance they could take the proceeds of those sales and buy comparable assets elsewhere. Apart from the former Soviet Gulag mines of Norilsk, or the Cuban nickel mines owned and developed by Freeport that were stolen by Castro (and then leased to a Canadian company), there are almost no nickel mines in the world that can be mentioned in the same breath with Sudbury or Voisey’s Bay.
Our long-standing focus on reserves in the ground colors how we view the prospect of takeover bids for the remaining publicly-traded producers in the Alberta oil sands. Where else outside Venezuela can one find 75 years of oil reserves? And if you are offered a tempting price for Suncor or Canadian Oil Sands, where do you plan to reinvest those proceeds, assuming that you like the long-term outlook for oil? Virtually all publicly-traded oil and gas companies have reserve lives of less than 16 years, and most are in single digits if you apply political risk factors to the percentage of a company’s production or reserves located in such notably investor-friendly democracies as Russia, Venezuela, Nigeria, Angola, or Venezuela.
We take no overall stand on principle against takeovers of Canadian companies who do not have long-life mining or oil reserves, no matter how large those companies may be. For example, we have lost no sleep over the prospect of a takeover of BCE, which is a transactional—not a resource—company. Indeed, the long-suffering stockholders of that company may have a claim—on the grounds of compassion—to be taken out of their misery.
Nor do we oppose foreign takeovers of Canadian companies in principle. We focus on the question of ownership of reserves in the ground. If even such a marvelous Canadian tech success as Research In Motion were taken over by a foreign firm, we wouldn’t emit a peep of protest. Nearly all tech companies have histories of acquisitions and deals, and the takeover and merger process in that dynamic industry is an expression of its own rootlessness and rapid growth.
But for companies whose principal assets are non-renewable resources in Canada, we wonder why the self-styled small “c” conservatives who hymn the sanctity of free markets aren’t interested in the Constitutional implications of leaving any possible deal analysis to Investment Canada in Ottawa.
At the moment, Ottawa seems beset by a fear of upsetting acolytes at the shrine of unfettered markets, who are apparently presumed to make up the overwhelming percentage of the population of Brussels, Brasilia, Berne, and Washington.
Here is why we think shareholders of Inco and Falconbridge who, like us, didn’t want to sell their shares, and Canadian taxpayers who benefited from owning dividend-paying shares qualifying for the dividend tax credit were not accorded the full protection the Canadian Constitution allots:
Section 92(A) of Canada’s Constitution Act of 1867 states:
(1) In each province, the legislature may exclusively make laws in relation to:
(a) exploration for non-renewable natural resources in the province;
(b) development, conservation and management of non-renewable natural resources and forestry resources in the province, including laws in relation to the rate of primary production there from; and
(c) development, conservation and management of sites and facilities in the province for the generation and production of electrical energy.
Why didn’t the managements of Inco and Falconbridge suggest that the provincial governments should have been asked for their consent, before ownership of two of the three most valuable hard-rock assets in the Canadian Shield went abroad?
Why was such a big percentage of the True North’s Strong legacy sold so Freely?
The long-standing Canadian joke is that what most divides Canadians on almost any question is, “Is this a federal or provincial responsibility?”
When the British Parliament took up (in 1867) the question of passing a Constitution for its frozen colonies in what it called “British North America” (at an evening session after debating the problem of stray dogs in London, which occasioned far more interest from the Honourable Members), the important attractions for the Mother Country were the new nation’s fisheries, minerals, forests, and beaver pelts. London believed that the American Civil War had been fought largely over the division of economy-related powers between Washington and the states, so the British government, after consulting with Canada’s Sir John A. Macdonald, was at pains to write rules that would let the widely-dispersed colonies’ economies grow.
That meant giving control over natural resources to the provinces. If there had been a battle for control of the Sudbury copper operations a century ago, (nickel was then considered a nuisance— known as “Old Nick’s Metal”—in the copper ore), the Ontario government would have been the primary adjudicator. In other words, we are talking of concepts that have been at the core of Canada’s history…however inconvenient that history may be for residents of the village of Zug, Switzerland, which includes, inter alia, the management of Xstrata and Glencore, and Marc Rich.
We have reproduced the relevant section of the Canadian Constitution in full, because it suggests to us that the bids for ownership of the unique and irreplaceable mineral reserves owned by Inco and Falconbridge should have been considered by both the bureaucracies and the requisite standing committees of the legislatures of Ontario, Manitoba, Newfoundland and Labrador for Inco, and Ontario and Quebec for Falconbridge. It also means to us that any future bids for oil sands companies should be reviewed primarily by the Alberta government, although Ottawa could also participate because the transaction would involve foreign trade.
(In retrospect, it would have been amusing to have watched the managements of Phelps Dodge and CVRD dueling with Newfoundland’s feisty premier, Danny Williams. If that had happened, Inco might still be a public company, its stock would have more than doubled, and they would still be arguing.)
Would letting bureaucrats and MPPs stick their noses into the terms of a takeover not mean annoying delays?
Although perhaps not as long as it took Brussels and Washington to approve takeovers of companies whose total assets in the US and EU might be barely enough to purchase a few pricey pensions for Eurocrats, but whose assets within Canadian provinces would be worth today—based on what has happened to prices of base metal and base metal stocks since last September—at least $90 billion.
We told the CEOs at the Canadian Council of Chief Executives that they should consider advising the managers of their own companies’ pension funds that they would not be held accountable in performance measurement evaluations if they rejected foreign takeover bids for oil sands companies.
We suggested that the large public plans, such as the CPP, Ontario Teachers’ and the Caisse should take their oil sands holdings out of their Marketable Canadian Equities accounts and put them into their private equity holdings, along with toll highways, infrastructure, water utilities and other long-term investments that are valued on a long-term rate of return basis, not according to stock market prices that are set primarily on the basis of spot prices for crude oil.
With reserve lives for companies such as Suncor and Canadian Oil Sands running toward the end of this century or beyond, it makes little sense for major institutions with long-duration liabilities to be valuing those assets according to the stock market’s current pas de deux with Fear or Greed.
What does this imply for Alcoa’s takeover bid for Alcan—wherein our firm is an advisor to the bidder?
Since the bauxite and alumina come from far outside Canada, there is no issue of reserves in Canadian ground. The Quebec government, which has always been conscious of its Constitutional rights, had already built in the kinds of guarantees it wanted long before there was talk of any takeover. To us, it means that if Quebec and Ottawa sign off, then stockholders should be free to decide whether ownership of this great Canadian company goes south.
As historians would point out, Alcan was a pre-Depression spinoff from Alcoa to comply with Canadian and US anti-trust concerns, so it’s not quite like Inco and Falconbridge—true home brews. Putting it back together again might seem odd, but it has taken a lot more time than it took to start putting AT&T back together after the biggest anti-trust divestiture of all time.
New companies are formed every day or so.
New oil sands deposits are formed every hundred million years or so.
New mining deposits are formed every billion years or so.
Free markets in stocks are obviously desirable, but the history of stock markets is that the bigger they get, the more they get regulated.
The rights to find, claim and develop Canadian mineral deposits have been provincially regulated for 139 years; in addition, securities regulation is also a matter of provincial responsibility. Why then, is control on foreign acquisition of companies owning Canadian mineral resources a federal preserve— even when it doesn’t seem interested?
Americans, it would seem, are much happier checking on the wording of their Constitution than are Canadians on theirs.
Neither the Liberals under Paul Martin nor the Conservatives under Stephen Harper chose to intervene during Inco and Falconbridge’s long agonies. They both saw this as a question of sale of control of Canadian companies, not Canadian mineral deposits. If Ottawa had any clear Constitutional role, it should have been to demand that the EU and Washington either grant speedy review of what was really an internal Canadian affair (once Falconbridge sold off its Norwegian refinery), or to indemnify Inco and Falconbridge against any claims against them by the EU or Washington if they had proceeded with their merger.
Canada could have asserted that the egregious exterritorial interventions by those governments had the effect of protecting the market power of Putin’s national champion—Norilsk, so if they really cared about free markets they should be applauding the Inco-Falco merger.
The Alberta oil sands are worth immeasurably more than all the nickel and copper in Sudbury, Raglan, Timmins, and Voisey’s Bay.
How will the Canadian business community and Canadian legislatures respond when Big Oil, facing big problems with its rapidly-shrinking Reserve Life Indices and rapidly-increasing political risks abroad, decides on taking a quick fi x in friendly little Alberta?
Expect lots of talk about the sanctity of free markets.
And, just maybe, some talk about the Canadian Constitution, future generations, and whether loss of control of the last mega-mineral assets is worth taking some time to consider.
Last observation: Suppose some Gulf State investment funds decide to diversify away from low-yielding bonds and get together to buy—at twice the quoted prices—a million acres of wheat and canola acreage in Saskatchewan and Manitoba, thereby giving (as churlish opponents might say) new meaning to the term “Arable Land.” Would Ottawa treat this as the free market in operation? Would those purists who ridicule anyone who has questioned the big mining takeovers treat this as the free market in operation?