The Wall Street Journal-20080212-The Game- Proposed Mining Megadeal Could Make the Earth Move

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The Game: Proposed Mining Megadeal Could Make the Earth Move

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Yahoo-Microsoft? Small potatoes. It's time to talk about how the potential formation of the second-largest public company on the planet could affect your life.

If you want to understand how the great flows of people and material will shape our future, it's essential to understand BHP Billiton's $132 billion unsolicited offer for Rio Tinto. The Anglo-Australian mining companies are the world's first- and third-largest by market capitalization, which combined would have a firm hand in iron ore, coal and copper, pulled across 154 separate mines from Madagascar to Michigan.

History is littered with Malthusian predictions of shortages. And yet companies like BHP, and countries like China, are putting up hard cash -- at huge valuations -- to secure their positions in tomorrow's flow of natural resources. In the 19th century, countries were prone to dispatch navies to secure a flow of goods. Today, they send investment bankers.

If the offer is successful, the new $350 billion company would be larger than General Electric and behind only Exxon Mobil, pulling out nearly double the profit of Microsoft and 45 times the profit of Yahoo. It would create a company so geographically dispersed, and so politically influential that it would become almost a country unto itself.

BHP's offer for Rio bares the fact that "there is not enough to go around," says BMO Capital Markets mining analyst Tony Robson. "There are very limited opportunities to develop mines. You have to buy what's already there." Feeding Chinese skyscrapers, Indian bridges and copper-wired hybrid Priuses, BHP and Rio saw quarterly revenue grow at 15% and 13%, respectively, from the year earlier. By comparison, a nominal growth stock like Yahoo saw its revenue rise over 7%.

This world-wide demand has created its own perils, as companies push to develop more complicated projects. As BHP would argue, these elaborate extractions require ever bigger capital commitments, deployed inside ever-more threatening political theaters like the Congo. For BHP, a Rio Tinto deal would give it the capital base to pursue these massive new projects, without putting the company at mortal risk.

The coupling would nonetheless be unprecedented, giving it control over 40% of the world's seaborne iron-ore supply and over one of every three pounds of uranium, says Mr. Robson. When the two companies discussed merging their iron-ore operations back in 1999, one official in Western Australia snapped that the two were "essentially monopolizing the production of iron ore."

Who has the resources to challenge the power of this new quasi- country? Only a real country. It's called China. On Feb. 1, state- backed aluminum company Aluminum Corp. of China staged a "dawn raid" to purchase nearly 10% of Rio Tinto's shares in the open market, along with Alcoa of the U.S. China's intentions still remain inscrutable. It's possible that it hopes to squeeze assets from a successful BHP- Rio combination. It may hope to use its blocking stake as a tool for negotiating commodity prices.

Whatever the case, the unprecedented move signals how important the flow and pricing of natural resources have become to governments.

"Access to raw materials is probably the biggest thing facing China now, in terms of its economy," says Doug Guthrie, professor of management at New York University's Stern School who studies Chinese business. "We put focus on the trade deficit and goods at Wal-Mart. We often forget these issues are going to have a bigger impact on people."

That's on display at an empty lot near the Ground Zero site in lower Manhattan. Local and state authorities just pulled a plan to develop an elegant $1.2 billion transit hub there, citing rising steel, concrete and cement prices as one reason.

Research from Ernst & Young also takes mining-sector analysts to task, saying they've remained too conservative in their forecasts. The market "is undervaluing mining assets by not fully appreciating how long demand will outstrip supply." Mining's merger wave suggests that price levels -- especially after the fall of the mineral-rich Soviet Union -- were artificially depressed, and that current prices are sustainable, Ernst & Young says.

If that's the case, a BHP-Rio deal would be but an opening act in a world-wide competition for resources for which there are few precedents. And that will matter a lot more to you and your family than whether Microsoft or Yahoo appears on your screen in the morning.

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