Lex: Xstrata/Falconbridge

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Nobody wants to be gazumped twice. Having been outbid for WMC Resources this spring, mining group Xstrata is locking up its next target.

By paying $1.7bn for a 19.9 per cent stake of Falconbridge, a Canadian miner, Xstrata buys itself a valuable option.

Having secured a blocking stake, it can take its time to either launch a full bid or sell out again if it finds something better with virtually no risk of one of its bigger rivals intervening.

A takeover is the most likely option. More than half of Falconbridge's profits come from copper and zinc, which Xstrata also mines. Most of the rest are from nickel, which would further diversify the group's portfolio. Overall, Falconbridge looks like an undermanaged company with some prize assets. Once the recent merger with its Noranda subsidiary had simplified the Canadian company's ownership structure, it looked vulnerable which explains why Xstrata pounced quickly.

The investment also stacks up financially. The stake will be equity accounted; Xstrata can apply its lower tax rate to the Falconbridge earnings; and by paying mostly in cash, it will gear up its balance sheet. The combination should produce a return in excess of Xstrata's 9 per cent cost of capital from year one. There is even some downside protection. Xstrata was a proponent of a “stronger-for-longer” commodities cycle. But if the industry does turn down next year, it may at least be able to pick up the rest of Falconbridge more cheaply.

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