Fundies froth as Alcoa shares tumble

Apparently our observation that BHP is not going to bid for Alcoa chopped about $US4 billion ($4.5 billion) from the value of America's aluminium house during Thursday's trading on Wall Street. "You have cost me a lot of money today," a New York funds manager complained. Certainly Alcoa's price was tripping along quite nicely until just before 10am New York time, hitting $US46.94 when news of BHP refusal to play by the funds manager's rules started filtering though. By 12.30pm on Wall Street, when the wire services started running hard with our story, Alcoa volumes surged and the price slipped 6 per cent, only to rally and close just under 4 per cent lower over the day. Local investors in BHP, mind you, breathed a sigh of relief. After a week of uncertainty caused by the swirling speculation that it was prepared to pay $US45 billion or so for Alcoa, BHP's share price got back on track with a 1.7 per cent increase. Mind you, the market appears to have digested Rio Tinto's success in the Alcan bid-off. After a week of dilution, Rio's price jumped 2.4 per cent, briefly tipping through the $100 a share mark during a day of buoyant trading. BHP and Rio are, amusingly enough, being rewarded for taking polar-opposite decisions on aluminium. But who cost whom over there in New York is an intriguing question. Certainly The Australian was never going to buy Alcoa and, from what we have been told, neither was BHP. So just who decided the deal was on? Alcoa was linked with BHP by analysts and the media, but it was the hedge funds who put their cash where the idea was. Alcoa, mind you, was and remains a fair-enough punt, and one which will most likely still pay good dividends given that Brazil's CVRD, the world's biggest iron ore producer, was always a more likely player in the consolidation of the North American aluminium sector than was BHP. What was really interesting about discussing the Alcoa situation with the 17 US, Asian and European-based funds managers who contacted The Australian at various hours before dawn yesterday was the fact that they remain steadfast in their view that Alcoa will fall and that BHP is still a likely buyer. The majority of the fundies facing a reality check on Alcoa's prospectivity felt that BHP would attempt to do a deal with Alain Belda, that our "source" was trying to drive down the Alcoa price to more digestible levels and that, if BHP really believes the China rhetoric, then Alcoa is a once-in-a-generation, must-buy situation. By the theory that still binds these guys to their Alcoa-BHP play, the US company's boss, Alain Belda, has been ambitiously pitching a $US60 a share price at anyone who has knocked on his New York door. Now without the support of Belda and his board, Alcoa will not fall, if only because the company is registered in Pennsylvania, a state with a peculiar set of takeover protections based on the broadest possible interpretations of interested parties. What better way to get Belda back into a realistic price ball-park that attempts to remove the takeover tension that floats the idea that the bid is off? The main reason the US metals watchers believe BHP still wants Alcoa is that they find it hard to believe the Global Australian does not want the US company's global bauxite and alumina muscle. After all, the real money in the aluminium production chain comes in raw materials, which means in bauxite and alumina. It takes 4 tonnes of bauxite to make two tonnes of alumina which in turn makes 1 tonne of aluminium. But it is in the alumina game where the real margins are retained. Even at current relatively constrained prices, alumina producers have 60 per cent margins, which sits nicely with the best margins across BHP's top-earning V8 commodities, iron ore, nickel, copper and coking coal. The attractive aspect of Alcoa then is that it is very, very long in bauxite and alumina, even though it sits much higher up the cost curve than BHP's very low cost operations. BHP could flog Alcoa's poorly performing smelters and rolling business and just go big on doing what it loves doing, digging holes and shipping refined minerals. Which is all very nice in theory. But according to our sources, BHP just doesn't want Alcoa. BHP's view is that it will only expand its aluminium footprint where it sees stranded power assets (which is not in the US), and if it wanted Alcoa's alumina assets then it might well be cheaper to get a slice of them by taking out Alumina Limited than spending so much time, management energy and US dollars on an under-performing and already premium-priced aluminium company. Alumina, remember, is a 40 per cent owner of AWAC, the joint venture that runs the bauxite and alumina operations once owned by Alcoa and WMC. Alcoa owns 60 per cent of AWAC and the agreement is that the American company, or its future owners, would conduct its raw materials business through the AWC framework. Which gives the third party owner of AWAC, Alumina, some natural upside in whatever happens to Alcoa. The super-Alcoa play would have been to go for both Alcoa and Alumina at the same time. Which isn't to say BHP might not end up with Alcoa's alumina. There is a theory that private equity might pursue Belda's business. Which would imply a massive asset sale and probable see the raw materials assets on the market. One conclusion that might be drawn though from BHP's current lack of interest in Alcoa is that the Global Australian could have a subtly different view of the resource industry consolidation than Rio. Rio's move to market leadership in aluminium says the Anglo-Australian is prepared to pay heavy numbers to gain size even when that new bulk does not necessary deliver a capacity to constrain production. On the other hand, BHP could well be taking the view that heavy hands should be played only in sectors where there is a possibility that a handful of players will be able to effectively direct the marketplace. For example, Rio and BHP are part of a troika that plays very hard against each other in the iron ore market but where the game remains relatively rational because they dominate the seaborne trade. Through this boom cycle, production has consistently lagged demand, hence we face the prospect of $US100 a tonnes iron ore prices. Consolidation has helped the copper producers manage the China Syndrome. For the first time in several generations of booms, they have not shot themselves in the foot by over-producing at the first glance of price inflation, largely because the biggest producers have maintained a rational approach to expansion. Nickel too is a commodity seriously limited in its capacity to respond to the surge in global demand. But the aluminium feed-stock cycle is a bit different. Bauxite is a very common product and alumina, for all it attracts in healthy margins, is a reasonably simple product to produce and ramp-up. Rio's deal will deliver a hell of a lot to the company. But, as big as Rio-Alcan will be, it will provide little ability to constrain global production even if Alcoa falls to either CVRD or, as the funds managers believe is still possible, to BHP. The primary reason for that is China, which is the world's biggest and least cost efficient producer of aluminium. It has massive, if high cost, bauxite reserves and it will continue to use them. So, while China's imports of alumina will grow exponentially over the next decade, its domestic reserves position give it a capacity to put some sort of cap on prices. Unlike in iron ore, where demand has reached extraordinary levels but where China has no sustainable domestic resource with which to replace imports and so its steel makers simply have to pay the market price. One of the trends to watch in China's aluminium industry is how much it allows alumina imports to grow. Because it is clear the Government would prefer that, rather than import the raw materials, it would rather buy metal. The reason for that is that, outside of the minerals itself, the biggest cost in aluminium is power (it represents about 25 per cent of the total cost). And high among the resources China is short of is electricity. On Thursday China removed a 5 per cent tax on imports of aluminium for aircraft and beverages cans and, at the same time, imposed a 15 per cent tax on exports of aluminium rods and bars. The aim, obviously, is to ensure Chinese aluminium stays in China and that more of the aluminium processing actually happens outside the country. Effectively, China does not want to export its electricity. And that is a really good thing for Alcan, which is, after all, more of a play in metal than Alcoa would ever be.