The Wall Street Journal-20080129-THE GAME- Alcoa-s Stint in the Minor Leagues

Return to: The_Wall_Street_Journal-20080129

THE GAME: Alcoa's Stint in the Minor Leagues

Full Text (877  words)

If you're nervous about America's place in the world, you should be nervous about companies like Alcoa Inc. A new group of global titans created by rising commodity prices, geographic quirk, and meddlesome home governments has made this American stalwart into a pipsqueak.

Now Alcoa faces a strategic quandary that awaits much of American industry: Is it more profitable to fight these new players, succumb to them, or hang back and hope they fail on their own?

It is telling that the answer will be decided largely outside of Alcoa's home of Pittsburgh by corporate intrigues in Melbourne, Australia; Zug, Switzerland; Rio De Janeiro and Moscow.

Riding a postwar spending boom, the Aluminum Company of America ascended into the Dow Jones Industrial Average in 1959. For decades more, Alcoa and Canadian aluminum company Alcan Inc. "had the world at their feet," says Magnus Ericsson, who monitors the metals business for Raw Materials Data in Stockholm. "Now the Russians have consolidated their business, and the Chinese will, too. I think it will be difficult for single-metal companies to survive."

Alcoa's strategic dilemma begins in the desert lands of Saudi Arabia, Oman and Dubai. A slate of new aluminum-smelting projects are under way there, developed by, among others, government-backed Chinese producers and Alcan, which was just purchased by London's Rio Tinto Group.

Making aluminum requires vast quantities of electricity, which can account for a third of aluminum's overall costs. The new smelters upend those costs by taking advantage of natural-gas fields underneath the desert. By 2015, the Middle East smelters could produce aluminum 25% cheaper than Alcoa does now, says John Tumazos, who runs a metals- research concern called Very Independent Research. "It will be very difficult for Alcoa to compete," he says.

As if that weren't enough, the world's largest aluminum producer, the newly formed United Co. Rusal of Russia, is considering a nuclear- powered smelter in Siberia as part of an $11 billion capital-spending plan.

It was against these lower-cost threats that Alcoa made its gutsy hostile takeover offer for Alcan last year. The hope was to acquire access to Alcan's vast hydropower dam network, which would help Alcoa cut its own overhead.

That bid came to a humbling end last July. While Alcoa was still offering $76 per share, Rio stepped in with a heart-stopping $101-per- share offer. Alcoa retreated, saying it wouldn't overpay.

Yet having broadcast its own weakness, Alcoa became a natural takeover target. Rumors washed over Alcoa's headquarters along the Allegheny River in Pittsburgh. The whispering was that Alcoa would be subsumed by the world's largest mining company, BHP Billiton, based in Melbourne. Another possibility was that Brazil's Vale, the world's second-largest by market cap, would make a run at Alcoa and its excellent stores of alumina, a vital component for producing aluminum.

The bold M&A steps did come -- but they didn't involve Alcoa. BHP is expected to deliver a $120 billion offer for Rio Tinto next week, while Vale is mulling its own $90 billion deal for Xstrata PLC, a Swiss holding company and metals trader. The idea is that these unfathomably large companies can better absorb the costs of exotic mining projects while also forcing higher prices on customers.

Size pays. In 2002, Alcoa was valued at $32.5 billion, while BHP was valued at $59 billion. Today, Alcoa's valuation has sagged to $26 billion, despite just posting its most-profitable year on record. BHP is pegged at about $185 billion.

Left out of the action, Alcoa is trying to figure out how it became a relative bit player in this, the final stages of mining's Great Game. Its best strategic choice to survive as a stand-alone may be to do nothing.

There is the possibility that aluminum prices, and the entire commodity cycle, might hit a sharp downturn as the U.S. economy touches off a global recession. If that's the case, the winners could be those companies that shied from costly and dilutive acquisitions.

Otherwise, it's wait and hope. A person familiar with Alcoa's operations says the company is hoping a Rio-BHP deal -- and its attendant divestitures -- might come together. The expectation is that Alcoa could then acquire some of the Alcan assets it had coveted last year.

"Alcoa just completed the most-profitable year in its 120-year history," an Alcoa spokesman said. "Our markets and businesses are very strong, and we have great prospects for growth."

Alcoa could also choose to go on the offensive again, perhaps making a play for the aluminum assets of Norway's Norsk Hydro. But that could be blocked by the Norwegian government. A deal with Rusal seems impossible, given that the U.S. government won't even let one of the company's owners into this country.

Investment bankers have another plan in mind: Splitting Alcoa into different units, with shareholders perhaps receiving stock in a mining company, a smelting company, an aluminum-sheet-rolling business and a more-advanced engineered-products division. Eventually, these parts would be gobbled up by different competitors both domestic and foreign. Alcoa would simply sink back into the earth and disappear.

Here in the global marketplace of the early 21st century, some American icons are becoming someone else's mop-up work.

---

Email [email protected]. Visit wsj.com/deals for breaking news and commentary on deals and deal makers.