It's not the Dollars you can see that count. It's the missing trillions you need to watch for...
2006 was clearly the year of the deal. The Australian mining sector alone saw A$145 billion in deals. According to Friday’s Australian, investment banking firms did nearly 3,000 buyouts or mergers in 2006, with the top ten firms doing nearly $166 billion in deals.
So what’s next? Has all the low-hanging fruit been picked? You’d think all the obvious deals have been done by now. With the cost of capital low, any under-valued firms with reliable cash flow have already been targeted. There are only so many firms where you can cut costs, find synergies, or operate more efficiently so that you generate a 15-20% return on your investment in a few years. Now that the big fish have been taken, it’s time to look for littler fish.
It’s a bit different in the mining industry, where the M&A activity is more typical of the resource cycle we know and love. Cashed-up big firms look to acquire smaller firms in order to ad to productive capacity and the resource base as underlying commodity prices rise.
There are two questions here. Are base metals and resources prices in for a rest? And how much more M&A activity will we see in the mining sector?
To answer the first question, base metals and resources may take a breather. But don’t count on it being long. In the big, big, big picture, Chinese, Asian, and even eventually Latin American and African demand are behind the resource boom. After all, we’re talking about a revolution in the living standards of three to four billion people. That’s a long-term trend with plenty of legs.
In the short term, companies like Zinifex (ASX: ZFX) and Oxiana (ASX: OXR) may find themselves the target of foreign and domestic overtures. There will be other targets. But even with money flowing so freely, doing proper diligence and careful valuation will be more important. Mining is notorious for unpredictable cash-flows, price volatility in the underlying commodity, and heavy fixed capital costs. Those are not the attributes private equity firms typically look for, which is why most mining M&A activity will take place within the industry, by people who know what they’re doing rather than plundering pirates.
That doesn’t mean you won’t see the private equity boom tail off. But it will probably head in a different direction. Somewhere north of here in Melbourne, like Asia.
In last Friday's New York Times, Timothy Dattles of Texas Pacific Group (involved in the Qantas deal) says, “Asia clearly offers long-term potential as a private equity market.” It will be interesting to see if the money-shufflers can do anything but gamble on Asian enterprises. But give the man credit, he talks a good game about Asia’s economic future. Dattles says:
“The great enterprises of the next 100 years are being built today in some of these markets, like China and India. And there is a role for global players in private equity, who bring in the management expertise, the experience in international markets, to partner some of these companies and help them create value and realize their potential.”
Can the pirates teach Asian capitalists how to be better capitalists? Or is this simply a recipe for economic disaster? The Times article continues, “private equity firms have encountered some resistance because of a mixture of nationalist sentiment against foreign ownership, suspicions about the desirability of private equity firms as asset owners and a maze of regulations or policies affecting foreign investment in some industries.
“Texas Pacific had a taste of those difficulties this year when its bid to buy PCCW, the Hong Kong telecommunications company, was rejected because Beijing did not want a strategic asset to fall into foreign hands. The concept of private equity is not always an easy sell in Asia, where companies are often conservatively managed and where some governments see businesses primarily as vehicles for nation building. Moreover, many Asian companies are family firms committed to providing wealth for future generations."
Will 21st century Asian capitalism work the same way as 19th and 20th century Anglo-Saxon capitalism? Will Western business culture find itself in conflict with local traditions and cultures in India, China, Asia, and elsewhere?
We asked these questions after our three-month tour of Asia in preparation for writing The Bull Hunter in 2004. Our answer? There are some attributes of capitalism which have to remain the same everywhere. You need a price, a seller, and a buyer. But the virtue of an open-market is that it is supremely adaptive and can support many local variations.
The business culture that emerges in China and India will be distinct from what prevails in New York and London. But at the end of the day, it will all be about the same thing: money. And that’s where the opportunity lies for retail investors. There are more euros in circulation in the world now (around $800 billion) than Dollars. Does this mean the greenback’s day of reckoning has arrived? Not quite.
What people use for cash in real exchanges does matter, of course. The Dollar is still used in flea markets, drug deals, and strip joints all over the world, and it will take some doing before the euro replaces the Dollar as the currency of choice for derivatives transactions.
Under New Monetarism (the theory which explains the source of global Dollar demand), the strength of the Dollar is not what is seen, but what is unseen. It’s not the Dollars you can put in your wallet that matter. It’s the Dollars created from nothing in order to buy and sell derivatives and securitized assets.
Of course we don’t see any reason why you couldn’t price those assets in euros too. If you’re creating something for nothing, why not euros as well as Dollars? But for now, the Dollar is the favored currency in which financial assets are priced, by a large margin.
The Dollar’s day of doom is coming. But we’ve developed a grudging respect for the greenback in the last few years. And just because something logically should and probably will happen, doesn’t mean it will happen right away. “There is a lot of ruin in a nation,” Adam Smith wrote. There is even more ruin in a currency Empire. But that’s fine with us.
It’s just more time to buy gold and real assets.