Equinox Minerals Ltd.'s rich, debt-financed takeover bid for Lundin Mining Corp. is drawing rare public criticism from within the acquisition-driven mining industry. And one question underpins all the doubts about the deal's merits: Just how long can this commodities boom last?
Copper, the world's most widely used metal and a barometer of economic activity, is trading just shy of a record $4.65 (U.S.) per pound reached last month. Copper prices are up by about 40 per cent since the start of 2010 as a result of rising demand from rapidly industrializing countries such as China, the world's largest copper consumer.
As a result, cash is pouring into the treasuries of companies like Equinox, whose main asset is a copper project in Zambia. But it's the belief that high prices will persist for years that is driving the Canadian-Australian company's decision to use a large amount of debt to pay for its proposed $4.8-billion acquisition of Lundin.
On Tuesday, the day after a Lundin executive denounced Equinox's hostile offer as having too much financial risk, rival miner HudBay Minerals Inc. lashed out against deals made simply to gain scale, calling them "very value destructive" - and he questioned the rosy outlook for base-metals companies.
"We are not in a super cycle, this is a cycle," HudBay's chief executive officer David Garofalo told investors. "When the central banks find religion on inflation again, the cycle will be over."
Equinox maintains the $3.2-billion (U.S.) loan it needs to buy Lundin, to create a top 10 global copper company, will be paid off in four years, based on a steady forecast for the price of its main metal.
But that high debt load for a combined company worth about $10-billion has some investors worried about a repeat of the boom-bust cycle that played out in 2008. That's when miners such as Teck Resources Ltd. and Rio Tinto PLC, swimming in cash from high commodity prices, made acquisitions backed by billions in debt.
When the global financial crisis hit, they were stuck in an uncertain lending environment and forced to make drastic cuts, sell assets and raise billions in new money to try to pay down what they owed.
The Equinox acquisition appears to be drawing out similar concerns within the mining community, based on growing skepticism of how long the current record-setting pace of commodity prices can last.
Analysts are already predicting copper will begin to slide from an annual average of $4 this year and next to about $3 by 2015 as new mines come into production and increase supply. Then there's the potential impact of a drop in demand as rising inflation begins to cool off economies around the world.
"At some point the central banks will have to raise interest rates. That will curtail demand," Mr. Garofalo said at the BMO Nesbitt Burns global mining conference in Florida.
"There will be demand destruction, the cycle will be over. And if you aren't building a sustainable business, not building it with an eye to allocation capital on a disciplined basis, you won't sustain the down part of the cycle."
HudBay is expected to close its $520-million deal for Norsemont Mining Inc. this week, which Mr. Garofalo said isn't as risky as some deals being proposed today. "We don't want to bet the company on any one transaction."
Mr. Garofalo wasn't CEO of HudBay in 2008 when its proposed merger with Lundin was killed after HudBay shareholders revolted against the proposed dilution of their stock.
At the time, Lundin was in rough financial shape, which is what has its executives worried about the amount of debt involved in a combination with Equinox.
"It has been an uncomfortable experience from 2008 and it's not something that I would like to see our assets be subjected to," Lundin CEO Phil Wright said this week in reaction to the Equinox bid.
"Our markets remain volatile. I know it has been good times, but we still live in very volatile, tough times."
Citigroup analyst Craig Sainsbury calls Equinox's proposed bid for Lundin "typical of top-of-the-cycle merger mania where the focus is on the size, rather than the quality of a [company's]assets." Equinox has defended the deal, saying it will still make sense even if copper prices plummet.