Dec '07/Jan '08

MAC Economic Commentary

Foreign acquisitions in Canadian mining — good, bad, or indifferent?

By P. Stothart

In recent years, the theme of foreign direct investment has commanded more attention than any other Canadian economic policy issue. And no sector has been more centrally involved in this issue than the mining industry. The international fight for control of the prominent and century-old Canadian mining companies Inco and Falconbridge in 2006 served to highlight a number of fascinating strategic and policy issues for observers of the global mining industry —as did the acquisition of business icon Alcan by Rio Tinto in 2007.

At its core, as a business strategy issue, a handful of large companies are battling to control global supply of key base metals and related assets. These global players include BHP Billiton, Rio Tinto, Anglo American, CVRD Inco and Xstrata, with other companies like Freeport McMoRan, Norilsk and Rusal knocking at the door of this elite club. These firms are generally aiming to raise their in-house ore ratio (the amount procured from affiliated mines) and they are operating under the premise that a constrained base-metal mineral reserves situation, combined with strong global economic growth and infrastructure development in China and India, is a potent combination — an equation that means strong mineral prices for many years to come. Simply put, we are moving towards a world with more municipal infrastructure, more autos, more medical equipment, more housing and more iPods — this means we need more minerals.

Having reached this supply/ demand/price conclusion, the objective of the global companies has become one of acquiring reserves and landholdings and broadening their technical ability to find more deposits. Canadian firms and their assets have become prime targets in this respect and, interestingly, given its long-time position as a global leader, Canada has emerged, for the most part, as a seller rather than a buyer in this battle.

Beyond the business strategy, one of the interesting public policy debates related to this issue revolves around whether the location of a head office matters. Does it matter if CVRD Inco or Xstrata Nickel have head offices in Canada? Conversely, does it matter if a foreign takeover results in a head office being shifted — or in key decision makers being transferred — to, say, Texas, London, Australia or Switzerland? Does this affect levels of procurement from Canadian suppliers of equipment or engineering or financial services, for example? These questions are broadly relevant in Canada, as leading companies in other sectors, such as Dofasco, Algoma, Four Seasons Hotels, Molson’s, and Hudson’s Bay, have also fallen under varying levels of foreign control in recent years.

Normally, one would expect Canadian sovereignty groups and activists — the Maude Barlows and Mel Hurtigs — to be prominent on this issue. Their line of argument was most strongly held in past decades — particularly through the 1960s and 1970s, when initiatives such as the national energy program and the foreign investment review agency were designed to encourage domestic control or to enhance domestic benefits from foreign takeovers. An October 2007 survey by the Canadian Council of Chief Executives highlighted the ironic fact that business executives themselves now have concerns on this front — four out of five CEOs believe Canada should impose new restrictions guarding against certain types of takeovers. These restrictions would ostensibly be applied against “state-controlled entities,” although this path could easily turn into a slippery slope. This kind of sentiment is also being reflected globally. According to the United Nations Conference on Trade and Development, there were 90 regulatory changes worldwide hindering foreign direct investment in the 12 years up to 2002 — in the three years between 2003 and 2005, there have been 101 and in all likelihood this acceleration of regulatory change has continued since 2005.

In the Canadian mining context, it is difficult to describe the experience in the year since the Inco/Falconbridge acquisitions as having been negative. On the contrary, the two acquisitions have broadened the global reach of the Canadian operations. In the case of Xstrata, the company’s huge global nickel operations have been headquartered in Canada, under the direction of a Canadian chief executive. The copper and zinc operations have been integrated within a global network. The case of CVRD Inco differs slightly, as CVRD had narrower global operations than Xstrata, and less structural change has been made to the Canadian operations. Nonetheless, the company’s commitment towards Canada remains strong — as employment and investment have increased since the acquisition and Canadian expertise and know-how is helping drive the globalization of this company. The pro-investment school of thought — that foreign investment enhances Canadian access to new technologies, ideas and markets — appears to have held true in these instances.

Trade and investment liberalization agreements of the 1970s and 1980s have translated into less support for the “domestic control” school of thought. This is doubly true in the mining sector, where levels of Canadian investment abroad have for many years been roughly double the value of the stock of foreign investment in Canada. In 1995, Canada had $25 billion invested abroad in mining versus foreign firms having $10 billion invested in Canada. As of the end of 2006, Canadian mining companies had $62 billion in direct investment abroad, while foreign firms had $38 billion invested in Canada. Overall, in all sectors, outward stocks were $523 billion and inward stocks were $449 billion as of the end of 2006.

It is delicate, if not hypocritical, to call for tough rules limiting foreign investment in Canada when our own companies such as Barrick, Goldcorp, Teck Cominco, Cameco, Kinross and many others are actively investing and acquiring assets in foreign countries. Ironically, one of the factors that made Alcan such an attractive target in 2007 was the foreign acquisition of France’s Pechiney that it itself undertook in 2003. The potential hypocrisy of tighter Canadian controls would also become evident in examining junior “mineral exploration” type investments in this sector. An estimated 62 per cent of the world’s exploration companies (with annual budgets over $100,000) are Canadian — these companies explore and appraise minerals in countries throughout the world.

In this current environment, there is no particular momentum behind the notion of public policy makers interfering in foreign takeovers of Canadian mining firms. There is no evident public outcry against this trend in Canada and, even if there was, it is not evident what could be done in response — the globalization train left the station a few decades ago in the aftermath of the GATT and WTO liberalizations through the 1960s and 1970s. Among Canadian political parties, neither the Conservatives nor Liberals presently have an appetite for investment barriers. It is possible that the coming years will see state-controlled entities from China become more aggressive. Similarly, large monopoly firms from Russia may also seek foreign targets. Whether such a trend would change the present levels of openness of Canada’s mining economy remains an open question for the future — or perhaps more pertinently for the Competition Policy Review Panel.

This panel was recently established by the federal Ministers of Industry and Finance to “review key elements of Canada’s competition and investment policies to ensure that they are working effectively and that Canada is positioned for continued economic competitiveness.” The panel, chaired by long-time business executive, “Red” Wilson, released a consultation paper on October 30 seeking input and submissions by January 2008. The paper (see seeks views regarding specific investment limitations (such as in uranium), as well as on general questions such as whether Canada should be concerned about foreign takeovers.

Paul Stothart
Paul Stothart is vice-president, economic affairs, at the Mining Association of Canada. He is responsible for advancing the industry’s interests regarding federal tax, trade, investment, transport and energy issues.

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