Digging up deals down under: M&A

Decades of consolidation in the commodities markets has left an industry of towering giants who loom over the global market. Nowhere is the process more complete than in Australia, where two goliaths, BHP Billiton and Rio Tinto now run the show.

After completing 81 and 65 deals respectively since 1980, they account for about a quarter of the market capitalization of the country's top 200 companies. BHP (nyse: BHP – news – people ), the world's largest miner, accounts for as much as 10% of the Australian Stock Exchange's market capitalization of the top 200 Australia companies and 46% of its index for materials. Rio Tinto (nyse: RTP – news – people ) has 2.5% of the 200's market cap and makes up 10% of the materials index. All told, Australia has 630 domestically listed miners.

But despite the persistent euphoria over mergers and acquisitions for miners elsewhere, the temperature has cooled significantly in Australia this year, with per-deal size declining to as little as $17 million for 162 transactions, down from the heady level of $230 million for 178 deals in 2005, according to consultancy Dealogic. Now, many analysts are declaring the end of megadeals in Australia and the beginning of the next phase of industry consolidation, one involving small- and mid-cap companies.

BHP Billiton made its key strategic move to grow in size in 2001 when it acquired the UK's BHP for $15.6 billion before buying a smaller domestic rival, WMC Resources in 2005 for $7.7 billion. The deals rank as the two largest acquisitions in Australia's mining history, according to data provider Thomson Financial.

Rio Tinto took its current form much earlier, mainly during the industry downturn in 2000, when it bought two Australian counterparts, North and Ashton Mining. The latest acquisition this month by Rio Tinto, a strategic stake in Canada's Ivanhoe Mines (nyse: IVN – news – people ), is aimed at securing development rights on the ground for copper and gold reserves in Mongolia rather than an empire-building attempt.

It may be a sign of things to come. With the value of commodity assets rising across the board, BHP and Rio Tinto are shifting their focus to organic growth, preferring to expand on existing operations or through global joint ventures rather than through the voracious acquisition strategy of recent years.

BHP Billiton and Rio Tinto have both pursued a diversified strategy, reaching into different segments of the world's base metals and commodity industry. BHP made 34% of its first-half EBITA (earnings before interest, taxes, amortization) from base metals, 29% from iron ore, 19% from petroleum, 5.5% from nickel and 2% from coal, whereas Rio earned 48% of its first-half EBITA from copper, 28% from iron ore, 10% from aluminum, 10% from coal and 3% from diamonds. "The real difference between BHP and Rio is that Rio does not have exposure to petroleum," says Martin Petch, a senior analyst at Commonwealth Bank of Australia.

ABN Amro's analyst Rob Clifford reckons that the current rally of commodity prices still shows no signs of slacking, despite climbing off from a peak in May. He says prices for copper, zinc and iron ore still stand at five times, 4.5 times, and 2.5 times respectively over those achieved at the downturn of 2003, with nickel trading at a historic high.

This may fuel a new, albeit smaller, round of deals with mining companies in sectors such as coal and gold, uranium or some base metals. As before, Clifford says, the next stage will be supported by companies looking for ways to deploy surplus capital accumulated from the current run.

One analyst, Jonathan Barratt, managing director of Commodity Broking Services in Australia, is particularly keen to see similar consolidation extend to the gold mining sector, a segment ruled by some mid-cap players, who are by far immune from outside buying interests due to the relative long time needed to confirm proven reserves.

Indeed, momentum for consolidati