A proposed $3.2 billion tie-up of two Australian iron ore miners raises the stakes for Chinese commodities trader Sinosteel, which covets both.
China's roaring demand for steel has set the iron ore market alight, driving up prices and stirring interest in resource-rich areas.
Two of the biggest beneficiaries are Midwest Corp (MIS.AX) and Murchison Metals Ltd (MMX.AX), which are battling to lead the development of Western Australia's Yilgarn iron ore province and weaken the dominance of BHP Billiton (BHP.AX) and Rio Tinto (RIO.AX), which produce from the Pilbara region further north.
Sinosteel, looking to seize the opportunity, is bidding for Midwest. But Murchison threw a spanner in the works on Monday by negotiating a friendly tie-up with Midwest that would leave the Chinese firm, a 20 percent Midwest shareholder, with a measly 10 percent stake in a combined company.
But few market watchers think that will be the end of the story.
We believe Sinosteel will not simply abort its bid for Midwest, Stephen Gorenstein, an analyst at Goldman Sachs JBWere, said in a note to clients. Its options include coming back with a superior cash bid or waiting on the sidelines and potentially making a bid for the merged entity.
A marriage of the two leaders in the region was bound to happen, experts say, since they will share railway and port infrastructure and could cut costs by merging adjacent projects.
Midwest's shareholders will vote on the deal 28 days after a scheme of arrangement document for the merger is issued, giving Sinosteel four weeks to intervene.
IN CHINA'S SIGHTS
Murchison's move has upped the ante after it failed to snare Midwest with a A$748 million all-stock offer late last year.
Midwest then rejected a takeover proposal from Sinosteel, which turned hostile with a bid of A$5.60 a share before finally winning the recommendation of Midwest's board with an offer of A$6.38, conditional on getting 50.1 percent acceptance.
Midwest shares closed at $7.03 on Tuesday, a price that puts Sinosteel's offer in the shade and implies investors do not expect it to trump the merger terms, equivalent to A$7.36 a share at the market close on Tuesday.
A sticking point in Sinosteel's approaches to Midwest has been David Law, a Malaysian board member who holds 13.3 percent of Midwest and who, according to media reports, was keen to avoid incurring a large tax liability by selling.
The reverse takeover format of the merger proposal would overcome that objection by having Midwest absorb Murchison.
But Sinosteel cannot afford to let go. And it has an ace in its pack: a joint venture with Midwest, which has said China's investment is critical to the development of its major projects.
I struggle to see how you could execute a deal with an unhappy joint venture partner, said an investment banker who declined to be identified due to the sensitivity of the issue, referring to Sinosteel. This is a last ditch attempt by Murchison.
Another option would be for Sinosteel to bid for Murchison, in which it already owns 2.4 percent.
Sinosteel approached Australian authorities with a bid for all of Murchison earlier this year but was one of around a dozen firms that had to withdraw a takeover application as officials tightened rules on foreign investment, another banker said.
At some point, you start to develop a level of discomfort. Given the amount of deals China has done into Australia, I think we're getting there, said a Hong Kong-based investment banker, who like the other banking sources did not want to be identified for commercial reasons.
But Australia has welcomed investments that will help develop its resources and China desperately needs iron ore, leading it to put higher valuations on lower quality ores than other buyers.
Murchison thus appeared to skew its attractiveness further towards China by saying on Tuesday that its Jack Hills project had 13 percent more high-quality ore than thought but five times as much low-grade ore, making it a much bigger, but higher-cost, project.
But Jack Hills is being mined by Crosslands Resources Ltd, a joint venture between Murchison and Mitsubishi Corp (8058.T) of Japan, which is also keen to secure iron ore supplies.
This is critically poised at the moment, said one banker. Will this turn into China Inc versus Japan Inc? Who knows?
He said the deciding factors in the race to build a 30-40 million tonne producer might turn out to be neighbouring miners such as Mount Gibson Iron (MGX.AX) and Gindalbie Metals Ltd (GBG.AX), whose shares rose 10 percent on Tuesday.
Both are widely thought to be in China's takeover sights.(Additional reporting by Michael Flaherty)
© Thomson Reuters 2008. All rights reserved. Users may download and print extracts of content from this website for their own personal and non-commercial use only. Republication or redistribution of Thomson Reuters content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Reuters. Thomson Reuters and its logo are registered trademarks or trademarks of the Thomson Reuters group of companies around the world. Thomson Reuters journalists are subject to an Editorial Handbook which requires fair presentation and disclosure of relevant interests.