Patience in the cards for Alcan

Alcan Inc.'s directors have a strong hand to play in their high-stakes poker game with hostile bidder Alcoa Inc.

And their best card may simply be patience.

It has been more than two weeks since Alcoa made an unsolicited offer for Alcan shares. Since then, the stock market has sent a strong signal that the bid is going nowhere.

With Alcan shares trading eight to 10 per cent above the cash value of Alcoa's bid, investors are endorsing the board's view that the company is worth a lot more than the offer on the table.

They're clearly right. Given the takeover-fuelled frenzy driving the world's stock markets, it's going to take a very handsome premium to bag a company like Alcan. To understand why, you just have to look at supply and demand.

Mergers and acquisitions in the aluminum industry have taken a lot of publicly traded companies off the market in recent years, while several new entrants are not traded on North American or European capital markets.

The result for investors is fewer ways to participate in the aluminum game. The remaining publicly traded stocks are priced to reflect that scarcity.

Consider, too, the fact that equity markets are making a very strong bet on the future growth of commodity prices. Just one sign of that is the materials index on the S&P/TSX, which is up 50 per cent in less than a year

Aluminum prices can certainly be volatile, and they're not immune to a global recession. No one would claim the business cycle doesn't apply to this industry.

Even so, the outlook for aluminum looks very strong and is one more sign that Alcoa has not fully valued its prey.

As Alcan points out, the supply and demand balance has tightened in the industry over the last few years.

From 2001 to 2006, global production increased by 38 per cent while consumption rose 42 per cent, with much of the growth coming in China.

During that time, the price of aluminum on the London Metals Exchange more than doubled before falling back from a record peak last August.

There's also the fact that aluminum is gaining market share as it competes with such materials as steel, copper and plastics.

With consumption closely tied to economic growth, demand is expected to continue apace in such fast-developing countries as India, Russia and Brazil.

That bullish outlook is reflected in Alcan's stock price to a far greater extent than Alcoa's.

On a total return basis, assuming full reinvestment of dividends, Alcan shares have appreciated 96 per cent over five years, vs. a 14-per-cent gain for Alcoa's, notes the Alcan directors circular sent to shareholders this week.

On that basis alone, the so-called merger of equals proposed by Alcoa has no compelling logic.

The performance difference has a lot to do with the asset mix at the two companies.

Anyone with sufficient capital can get into the aluminum industry these days. The technology is widely available and there's no shortage of bauxite, the ore processed into aluminum.

But two factors define success: low-cost smelters and abundant, cheap power.

Alcan looks to be in an enviable position on both counts, which should make it all the more attractive to a potential acquirer.

That's why patience is the virtue of choice in a takeover scenario such as this.

Alcan chief executive Dick Evans and chairman Yves Fortier can afford to wait for a better offer and they've set the bar high for anyone wanting to buy.

There's already plenty of speculation about which of the world's metal giants will enter the fray. Private equity groups could also get involved.

"We would expect BHP Billiton, Rio Tinto, Anglo American and possibly CVRD to be part of the potential buyer group and that Alcan is probably already in talks with some or all of the potential buyers," National Bank Financial analyst Ian Howat said in a note to clients yesterday.

But one veteran of the aluminum business cautions a