Caterpillar Leaps to the Top of Mining Equipment

Wow! Caterpillar Inc. announced it will purchase Bucyrus Intl. Inc. (BII) for $7.6 billion cash plus assumption of $1 billion of BII debt for a total transaction price of $8.6 billion or $92 per share, a 32% premium to the BII closing price the day before. The deal is expected to close in mid-2011.

This year BII will have revenues of approximately $3.75, which are all mining related. Caterpillar’s estimated 2010 mining related revenues are $3.9 billion. With only one possibly redundant product category between the two companies (electric-drive trucks, where Cat products are still in development), it is reasonable to add revenues from both companies totaling $7.65 billion in mining equipment sales if they were one company today.

More than 18% of Caterpillar’s revenues would be from mining, making Caterpillar far and away the largest manufacturer of mining equipment worldwide. Komatsu is expected to have 2010 mining equipment revenues of $4.8 billion and BII’s direct competitor, Joy Global (P&H Mining Equipment and Joy Mining Machinery), will have 2010 revenues of approximately $3.4 billion.

What Bucyrus gains.

Massive worldwide distribution for sales, and product support. Caterpillar and BII will have to work out which products will be sold through the Caterpillar dealer network and which ones will be retained for direct sales. Most of Caterpillar’s products are sold through its dealer network but one candidate for direct sales will probably be draglines, some of which cost $100 million.

Manufacturing technology and Caterpillar purchasing power. Many of BII’s products are built as one-off units and would benefit from the Caterpillar Production System expertise as well as Caterpillar’s purchasing power, especially for steel and components. Caterpillar will eventually be able to supply its diesel engines and drive train components for use in BII machines as well.

Caterpillar’s engineering support. Caterpillar has a huge engineering and research budget some of which could easily be repurposed to assist BII with its products.

Sales advantages. The mining industry has become extremely concentrated in the past 10 years. Both BII and Caterpillar management commented that their customers want fewer suppliers and would like to work with one that can offer an entire mine system.

Financing. Caterpillar Financial will be able to offer financing to mining customers. The division recently financed a complete spread of equipment for a start-up iron ore company in Scandinavia.

BII shareholders will receive an attractive price for their shares compared with other companies in the industry.

What does Caterpillar gain?

BII products in the field. Caterpillar estimated the installed BII base has a replacement value of $40 billion. Cat dealers will be able to improve after-sale support for those machines. BII’s revenues are divided 49% new equipment and 51% parts.

One-stop shopping for mines. Both Caterpillar and BII management have said their customers are asking for this.

Terex (O&K) hydraulic shovels. Caterpillar dealers have sold about 30% of the $500 million in annual sales of the O&K machines; the rest has been sold mostly manufacturer direct. Availability of the shovels to the rest of the Caterpillar network will undoubtedly result in bonus business for Caterpillar. The O&K excavators have been among the most successful in the marketplace, and the machine population is probably among the highest in the business, having been sold for nearly 30 years.

More-credible mine planning. Until it can offer all alternatives, Caterpillar may favor, or be perceived as favoring, the type of loading or hauling machines it builds. That risk is mitigated when company mine planners can recommend either an electric drive truck or a mechanical drive truck; cable shovels or hydraulic shovels.

Redeployment of assets. Assets Caterpillar was preparing to spend developing hydraulic shovels to be built in their plant in Aurora, Ill., can now be used elsewhere. It will be interesting to see if Cat decides to build the O&K machines in Aurora and in Germany.

Underground mining opportunities. Underground mining is becoming increasingly important as mineral commodity prices have risen and made going underground a good alternative to deeper and deeper surface mines. The BII underground products, which it added in 2007 with its acquisition of DBT, combined with Caterpillar's Australia-built offering will provide customers with a good alternative as well.

Caterpillar expects to be able to trim $400 million of expenses from the combined business. Most of those savings will start in 2012. But this acquisition will not be simple for either company.

The huge population of BII products is both an amazing opportunity and a problem. Parts for the 25 or 30 year old BII legacy products usually have to be made to order; they’re not sitting in a warehouse.

BII management said in their joint Wall Street call with Caterpillar management that they did not offer to sell the company to any other companies. I would not be surprised to see a shareholder class action lawsuit about this despite the fact that the $92 per share values BII at a 17.8 times earnings per share multiple compared with Caterpillar which is selling for approximately 15 times expected 2011 earnings.

The truck product lines are the only ones where it could be argued there is a product overlap between the two companies. BII (Terex) builds its electric mining trucks in China and sells them mostly in the Asia/Pacific region. Caterpillar management was careful to say that they sell mechanical drive trucks and that their electric mining trucks are still in development. Nevertheless, the purchase by Caterpillar would remove a competitor from the market, which regulatory agencies might find objectionable.

Caterpillar is placing a big bet on the long term viability of the mining industry. As we all know, mineral commodity prices can be very cyclical. The company is essentially betting on China and India’s determination to greatly improve the standard of living of its people. Those countries are growing their GDP at 8% to 10% per year and consuming huge quantities of iron, copper, aluminum and coal. Time to manufacture BII’s big ticket products can sometimes be a year or more. Long lead times to build the equipment, the expense to develop a mine, and the size of the expenditure made by mine operators will insulate Caterpillar from some but not all of that cyclicality. A sudden bump in the road to prosperity could cause unexpected drops that could be hard for a combined Caterpillar/BII to deal with.

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