THE RATINGS GAME
Merrill Lynch suggests private-equity BHP bid
Broker doesn't say bid is likely, but argues it's possible
By Steve Goldstein, MarketWatch
Last Update: 5:28 AM ET May 4, 2007
LONDON (MarketWatch) -- Merrill Lynch analysts in Australia say the mining sector is looking lonely, with private-equity action all around.
The analysts said in a note they don't see why leveraged buyout firms shouldn't take a crack at buying into metals extractors, even though the likes of Kohlberg Kravis Roberts have been reticent in the past to take on a cyclical industry.
"We are believers in the 'super cycle' and expect commodity prices to stay above historic averages for years to come. Therefore, it seems to us inevitable that private equity attentions will turn to the mining sector," said a note authored by Vicky Binns and Duncan Hay.
They're quick to note that they don't see a leveraged buyout of a metals firm around the corner.
With a market capitalization of over $87 billion, a leveraged buyout of BHP Billiton would be, by far, the world's largest ever.
But Merrill's math suggests they could be bought, if buyout firms teamed with an industry partner like Xstrata or CVRD
"Private-equity investors require 6% to 8% return on equity above the highest cost of debt over three years -- we calculate a 20% internal rate of return. The returns from our scenario on a bid for BHP on our assumptions are over 30% over three years. In addition, we calculate with the single sale of (BHP's) petroleum division, a $25 billion gain on market value is achievable in a short time period," they said.
BHP's cash generation covers the pre-tax interest bill of private-equity firms, they noted.
Merrill still has a neutral rating on BHP.
"We view BHP favorably as a bottom drawer stock -- hold it and forget it through volatility to educate your children. It is a company with low cost, long life, diversified assets with growth that many of its competitors envy," the broker said.
BHP rallied in both London and Sydney trading on Friday, though rival diversified miner Rio Tinto gained even more. See London markets.
Steve Goldstein is MarketWatch's London bureau chief.