China Gets Picky
Source: Marin Katusa, Casey Research (7/18/11)
"The age of huge, blind Chinese investments is waning."
Several resource deals have faltered in recent months, indicating an increasingly choosy Chinese perspective on energy and metal acquisitions. Add to that the growing concern that the global economy is once again stumbling and that commodity prices may be near a top, and you have a Chinese deal-making market that has gone from 60–0 in no time.
On the metals side, observers are seeing a "buyer's strike," where companies are watching commodity prices from the sidelines rather than making deals. China's Minmetals Resources, for example, stepped back from its bid to acquire copper producer Equinox Minerals after Barrick Gold (NYSE.ABX, T.ABX) topped Minmetals' $6.3 billion offer with a $6.7 billion bid.
Equinox was lucky to get the higher Barrick offer; other companies, like Lundin Mining (T.LUN), have given up trying to find suitors willing to pay a fair price. In May, the company announced it couldn't find an acceptable buyer for all or part of its copper, nickel, and zinc mines that are spread across Europe and Africa, citing a gulf between its project valuations and what buyers were willing to pay.
Both stories signal that there is a limit to how much even the deep-pocketed Chinese will pay for resources, even though securing resource assets is a stated national goal.
Pricing may be at the heart of the problem. Prices for oil assets in Albertahome to the massive oil sands and a raft of light oil and natural gas playshave soared: The average price per acre has climbed from CAD$2,185 in mid-2010 to CAD$3,111 today, according to government statistics. The price increased on the back of a series of international deals: France's Total S.A. signed a CAD$1.75 billion deal with Suncor Energy to develop oil sands reserves; Malaysia's Petronas inked a CAD$1.07 billion deal for ownership stakes in some Albertan natural gas fields; and China's Sinopec spent CAD$4.6 billion for a 9% stake in Syncrude Canada.
But price isn't the impediment to new dealsthe biggest Chinese investment in Canada's oil patch to date just fell apart because the potential partners couldn't agree on how to work together. China's largest oil and gas company, PetroChina International Investment, and Canada's Encana (T.ECA) announced on June 21 that its CAD$5.4 billion deal to jointly develop Encana's Cutbank Ridge gas project had fallen apart. The companies couldn't agree on how to structure the joint operating agreement, though they did not elaborate on the specific issues.
Encana will now launch a fresh search for a new Cutbank partner. . .or perhaps partners. The PetroChina deal included stakes in gas production, reserves, acreages, pipelines and processing facilities, but Encana now says it wants to split things up, offering a variety of joint-venture opportunities for portions of the undeveloped resources and infrastructure requirements while keeping the producing acres for itself.
The PetroChina-Encana deal was a bit of a sweetheart in the industry, often cited to support arguments about China's growing interest in Canadian oil and gas. Its failure now supports the opposite stance: That China is getting pickier about what projects it supports and how that support plays out.
In the first five-and-one-half months of 2011, Canadian energy companies sold a total of 231 million barrels of oil and gas reserves, less than one-half the 482 million barrels sold in the same period in 2010. The value of those Canadian oil and gas deals came in at $11 billion, down 35% from a year earlier (excluding the failed PetroChina deal). So, there are fewer deals being made.
That may not last for long, especially given that a 34-day market slide has left valuations on the cheap side of average. According to Bloomberg, companies on the S&P 500 Index will earn 18% more this year than in 2010, but the index has fallen 6.8% since the end of April. The combination means valuations are the cheapest they've been in 26 years. The index is valued at 8.7 times cash flow, cheaper than in 81% of occasions since 1998; and it is priced at 2.1 times book value, which is lower than it has traded 90% of the time since 1995.
The challenge for a buyer right now is to actually ink a deal at current prices, because most potential targets are still valuing themselves using parameters pulled from the rich deals of 2010.
How will it all pan out? Only time will tell. If commodity prices continue to slide because of U.S. economic uncertainty, Greek default concerns, and slowing Chinese demand, deal-making will remain quiet for a whileuntil the floor is visibleas no one wants to buy a company today that will be cheaper tomorrow. If commodity prices rebound, deals will be back on the table, as no one wants to chase a rising price.
We expect the M&A world to remain fairly quiet for the next few months, as the global economic situation figures itself out. Greece has enough bailout funding to get through August without defaulting, but there are no guarantees beyond that. The U.S. Federal Reserve just lowered its growth forecast for the next two years but still remains confident that the American economy is simply going through a rough patch. As for China, there are as many analysts predicting continued double-digit growth as there are anticipating a significant, inflation-fueled slowdown.
Regardless, it seems that the age of huge, blind Chinese investments is waning. The Asian giant has become pickier in its choices and more demanding in its deals, and why shouldn't it? After all, we are all relying on China's massive population to support global economic growth. It seems reasonable that such growth should be on China's terms.
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