Straight after our piece last week Trouble on the Aurizon, querying Aurizon’s exposure to the troubled mining sector, the company announced a takeover bid for mining company Aquila Resources.
Aurizon has teamed up with Baosteel, one of China’s most powerful steel producers, for the proposed $1.4bn deal. Judging from the share price move, investors didn’t view the news positively, knocking 5% or $500m from Aurizon’s market capitalisation. That’s quite a pronounced reaction when you consider there is a significant chance the deal won’t go through, and that Aurizon is a minority partner in the deal – its maximum contribution to the purchase (and maximum potential loss on the investment) will be $211m.
The market seems to be gloomy at the Aurizon’s larger strategic intentions with this transaction, which is to buy itself a stake in an iron ore development in the West Pilbara part-owned by Aquila so that it can later build and own the $4.6bn rail link. Without a detailed look at the project it’s hard to judge the merits of the investment, but it potentially could make sense. If Baosteel gets its way it will be both the owner of the project and the major customer. With its deep pockets it could guarantee steady and reliable revenue for Aurizon, and Aurizon can potentially earn additional revenue by later opening rail access to the third party miners in the area.
Australian investors, however, have been burned investing in resource projects that never earn decent returns and have turned hostile on anything mining-related that sucks away cash flow. All they want to hear from Aurizon is that it can drive costs out of the business and increase dividends to shareholders. The move into iron ore in Western Australia will require Aurizon to raise capital, take on debt or cut distributions, and shareholders are nervous about it. That’s a message Aurizon management should have heard clearly yesterday.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.