Inco-Falconbridge Merger Stymied

Early last week, in the plush surroundings of Miami's Turnberry Isle Resort and Club, two of Canada's top mining executives were preparing one of the biggest moves of their careers.

Inco-Falconbridge Merger Stymied

Early last week, in the plush surroundings of Miami's Turnberry Isle Resort and Club, two of Canada's top mining executives were preparing one of the biggest moves of their careers. Both were on the brink of what might be defining moments, not just personally but for the world's high-flying MINING industry. Scott Hand, a long- time Inco Ltd. executive, was finally on the cusp of acquiring the crosstown nickel rival in Sudbury, Falconbridge, in a $12-billion friendly deal that would place him atop the world's biggest and most powerful nickel miner. Unbeknownst to him, Donald Lindsay, the president and CEO of Teck Cominco Ltd., also had big things on his mind. After 20 years with CIBC World Markets, he now found himself at the helm of the world's biggest zinc producer, a company awash in cash and ready to expand.

On Monday, the day before they were set to take the podium at the annual Merrill Lynch mining conference, before an audience of some of the most influential industry analysts and investors, Lindsay made his move, announcing Teck Cominco was launching its own $17.8-billion hostile bid for Inco - conditional on Inco terminating its offer for Falconbridge. His triumphant moment spoiled, Hand flew back to Canada to deal with the fallout. Lindsay stayed in Miami, delivering the sales pitch of his life: a speech outlining why Inco investors should embrace Teck Cominco.

The move was a shocker, and a particularly unpleasant one for Hand. Up to that point all that was standing in the path of the Inco-Falconbridge deal was regulatory approval from the U.S. and Europe, which has been delayed over fears the combined company would be too big and hold too much sway over the nickel market. Teck's announcement threw everything up in the air, opening up countless possibilities that could see any or all of the companies merging or being taken over by other big players. It also wasn't the first time Inco, Falconbridge and Teck have crossed paths, leaving Inco, and Hand, seemingly on the wrong side of the encounter.

In the mid-'90s, both Falconbridge, which was being advised by Lindsay at CIBC, and Teck, under its chairman Norman Keevil, decided to invest in the large nickel deposit in Voisey's Bay, Labrador. Inco was also in the hunt, and already owned a small stake when Keevil made what was considered a surprise $100-million investment in Voisey's Bay in 1995, boosting the value of the find. The following year, as Inco sought to secure the rest of the mineral rights, Falconbridge launched a rival bid. Both moves significantly inflated the price Inco would eventually pay for Voisey's Bay. In 1996, Inco completed its purchase for $4.3 billion - a sum that proved to be far too high.

"There is a certain irony that Falconbridge, being advised by Don Lindsay, and Norm Keevil with Teck, were the big winners in Voisey's Bay," says Lawrence Smith, the director of metals and mining research at Blackmont Capital. "They ended up selling into the Inco bid and pocketing a lot of money, basically."

Inco's investment hung like a dark cloud over the company for nearly a decade, as nickel prices fell and Newfoundland and Labrador meddled in the terms under which mining could begin. In 2002, the company wrote down the value of Voisey's Bay by $1.5 billion, an admission of just how bad the move had been. "I would think that Scott Hand is very cognizant of the fact that he was president when that took place," says Smith. "Particularly galling must be for Scott that he thought he was going to be ending his career on a high note with the merger of Inco and Falconbridge, and now that looks like it might be taken away from him." Not surprisingly, Teck's recent offer was met with an icy response from Inco (and Falconbridge), which refused to comment publicly beyond a short, written statement.

Most analysts suspect a fourth player is also at work in last week's move to scuttle the Inco-Falconbridge merger: the Swiss-based mining conglomerate Xstrata Plc. Last year it bought a 19.9 per cent stake in Falconbridge from Brookfield Asset Management. Under the deal, it promised to pay that company any difference in share prices if it chose to make a further investment at a later date. That deal, called a top-up agreement, expires on May 15, prompting predictions that an Xstrata bid for Falconbridge is imminent. Together, Teck and Xstrata could divide and conquer Inco-Falconbridge. Last November, Teck met with Xstrata, but nothing has since followed from those talks, says Doug Horswill, a senior vice-president at Teck Cominco. Some analysts suspect the discussions of six months ago are being revisited, in light of the regulatory delays facing Inco and Falconbridge.

In the past several months, the mining industry has developed an insatiable appetite for growth. Companies have ample amounts of cash, given the high demand for minerals from places like China. Most expect the good times will not slow any time soon. "The flavour du jour right now seems to be bigger is better," says John Kinsey, a portfolio manager at Caldwell Securities Ltd. When Teck Cominco hired Lindsay, it sent a message, analysts say, that deals would follow. When Lindsay, a Harvard MBA grad, was president at CIBC World Markets, he had a hand in many of the biggest mining deals in Canada, including the merger that created Teck Cominco in 2001. The message he used to send to his investment bankers was: "Stay hungry and humble," according to an interview with the Financial Post in 2004. Last year, under Lindsay, Teck Cominco made its first foray into the oil sands, with an investment in Fort Hills. Along with zinc, the company now mines copper, coal, gold and other precious metals. "If we wanted to be a part of the important consolidation in the Canadian mining industry we had to make our position known," says Horswill about the timing of Teck's Inco bid. While the company acknowledges Inco and Falconbridge are a good fit, Horswill adds, "the great mining companies of the world will be diversified."

Last summer, Teck approached Inco about a merger. Inco, which has a long history of turning down suitors, said no. Its goal was Falconbridge. The company was finally back on track after Voisey's and, like Teck, looking to expand. "The new challenge is to meet rising demand," Hand said last year, in reference to Inco's resurrection. "Back around the Voisey's Bay time, everybody was saying they paid too much. The stock was down around $10 and the debt was a problem," says Kinsey. "They've come a long way since then."

In the aftershock of Teck's hostile bid for Inco, there is no shortage of potential endgames. Some analysts have suggested the three companies might all get together, though if past events still resonate with Inco management, that might be difficult. The prevailing wisdom is that Xstrata will bid for Falconbridge, prompting Inco to up its offer. Inco may also choose to sweeten its bid sooner to try to deter rivals. None of the options, save for sped-up approval of the Falconbridge deal, seem to offer much in Inco's favour.

Ultimately, the Inco-Falconbridge deal may well have become unravelled due to the bumbling of regulators who have drawn out the approval process, opening a window for Teck, says Kinsey. "There's a number of large mining companies that might want to get involved here. Falconbridge and Inco are great assets - they're terrific Canadian companies, and it looks like they're now in play."

Maclean's May 22, 2006