Hegarty runs hard in Oxiana play

THE latest commodity price and share market fall does not alter the long-term strategy of Owen Hegarty. Like most in the resources industry, he believes there is a long-term underlying shortage of metals such as copper and zinc that will keep prices at very profitable levels for low-cost producers.

The former RTZ executive now has a new goal: double Oxiana's production of base metals and gold to make it a $10 billion company by 2010.

It would then be Australia's second-largest Australian mining house.

Hegarty has already converted Oxiana from a $10 million minnow to a $3.5 billion Australian Stock Exchange top-100 company in less than 10 years.

To achieve the Oxiana long-term goal three events need to take place.

First, because Oxiana does not sell metals forward, he needs to be right that the latest price falls are a short-term correction, multiplied by hedge fund selling, and that the underlying shortages will cause metals to stay firm in the longer term.

Second, Oxiana's expansion programs and new projects have to be completed without a major hitch.

Oxiana needs another small acquisition or an exploration breakthrough to reach its production targets, and this fall in the market will give it the chance to do that, because of the cash bonanza the company has enjoyed over the last year

Third, he must escape the clutches of Xstrata or other raiders who prey on middle-ranking miners when they show any sign of weakness.

The odds are stacked against him.

Nevertheless, Hegarty's success in building an ASX 100 company is an inspiration to all those who aspire to create a big company.

Hegarty succeeded because he made two or three correct calls that put him in a position to take advantage of the good luck that came his way.

He spent the first 25 years of his working life with CRA.

When the Londoners took control after the merger with Rio Tinto, Hegarty saw an opportunity.

The Londoners did not share the CRA executives' belief in the potential of Laos as a major copper-gold province that would extend into neighbouring countries including China.

The Australians at CRA believed that the only way to develop this potential was to start small in Laos and then build.

The merged company was only interested in copper mines that started as a major undertaking.

And so Rio was happy to sell the Sepon gold-copper project in Laos to Hegarty and take a small stake in his new public company, Oxiana.

Hegarty then followed the original CRA plan of first developing a gold mine and then extending it into a 60,000 tonne copper metal plant. And in the next three years it will double to 120,000 tonnes.

He used the knowledge gained to widen Oxiana's exploration net through Laos and into the neighbouring countries, including China.

What nobody could have forecast was that just as Oxiana commissioned its Sepon copper metal production, the copper price exploded.

He also gained control of the Prominent Hill copper-gold prospect in South Australia, which was originally part of the BHP camp but was shed because it was thought to be too small.

And again just before the zinc price trebled, Newmont sold its Golden Grove zinc operation because it was not part of the company's gold strategy.

While the timing of these three events was good luck, Hegarty believed with a passion that base metal prices would boom because the world's mining houses simply didn't have the capacity to produce enough metal to meet demand.

He still believes that while there will be price corrections, shortages will continue for at least another decade, and possibly 20 years. This belief underpins the Oxiana strategy to 2010 and beyond.

For example, Hegarty does not forward sell Oxiana production, which means that when metal prices are rising Oxiana shares soar.

When they fall the shares are punished.

A few years ago the ANZ bank forced him to take out put options on gold so that he had the right to sell at least part of the group's output at what seemed at the time a high price.

The option expired because the gold price rose and it further entrenched the Hegarty view.

Of course, thanks to the recent high copper and zinc prices, Oxiana now has about $270 million in the bank, which goes a long way to cover its $US273 million ($367 million) in borrowing.

Hegarty says ambitious mining companies have to go through three trials before they become major players. Using an Australian Football League analogy he divides those trials into four quarters.

In the first quarter a small company brings together promising assets.

Oxiana has done that and is now playing in the second quarter, where these assets are developed and their range and number are expanded by exploration and small acquisitions. In the third quarter it is all about expanding the base that has been created, usually by large acquisitions or developing big discoveries.

In the fourth quarter the company becomes a major mining house and is usually immune from takeover.

By 2009 Oxiana expects to be at the end of the second quarter with a series of fully developed projects and a production of at least 400,000 tonnes of base metals (mainly copper and zinc) and 400,000 ounces of precious metal (gold and silver). Hegarty's target is to add another 25 per cent to those production levels by 2009, which will require an acquisition or exploration success.

Then Oxiana will be in the third quarter, using its large base for large acquisitions to reach the size required to be a true major company.

In recent times, four Australian miners have reached the end of the second quarter: MIM, WMC, Normandy and North's.

On each occasion the boards succumbed to what are now seen to be very low takeover bids. Only North's put up a real fight.

In the next three years Oxiana plans to spend more than $1 billion on four projects: lift its copper production at Sepon from 60,000 to 120,000 tonnes; increase Sepon gold production from 200,000 to 300,000 ounces; develop Prominent Hill (by 2008) to produce around 120,000 tonnes of copper; and incrementally lift Golden Grove's production to around 150,000 tonnes of zinc and around 100,000 ounces of gold and silver.

The risks of so much construction activity are obvious.

So far Oxiana has commissioned its projects on time and on budget, but if at any stage it stumbles it will be vulnerable to takeover.

A few weeks ago analysts expected Oxiana to earn $400 million in the current year to December 31, or 28c a share.

That will be now downgraded because, as Oxiana sells metal unhedged, profits can move sharply with metal prices.

But whatever way the sums are done Oxiana's price-earnings ratio is well below BHP and other leaders.

Hegarty knows this makes him vulnerable to takeover and with some emotion he says: "What we have to do is keep running as fast as our fat little legs will carry us and keep powering into the second quarter.''

Oxiana is planning to virtually double production, and despite lower metal prices a substantial amount of the investment cash will come from operations because the company has low costs and very little net borrowing.

That will put Oxiana into a very strong financial position to undertake the expansion.

And, with cash in its pocket, it is also looking around for acquisitions.

I put two suggestions to Hegarty and naturally he had little to say on either.

The first was Pan Australian Resources, which is also developing a copper mine in Laos. When I asked the question his quick response was: "I don't think so, not today.''

The "today'' was just before the big share fall which could create an underwriting shortfall in Pan Australia's four-for-five issue.

Pan Aust is backed by ANZ bank, which is also a major supporter of Oxiana.

My second long-term suggestion was a merger with Zinnifex, which is larger than Oxiana.

Hegarty gave the standard no comment.

Lots of companies have looked to takeover or merge with Zinnifex, but are nervous because the company is dominated by zinc and has many old smelters with pollution problems. On the other hand, Zinnifex has lots of cash, which it has begun to return to shareholders.

If Hegarty can complete the projects he is planning, then he will have a base for what he calls "the third quarter'', a period of rapid expansion by acquisition.

Xstrata is just completing this third-quarter process with a takeover bid for Falconbridge.

Once you have hit the final quarter you are of true size and the market will forgive you if you make a mistake, as we saw with BHP.

But if you make a mistake in the second or third quarters then you simply become bait for takeover.

Oxiana has got this far without stumbling, but its belief in the long-term outlook for commodities is now being tested.

If Oxiana can maintain its momentum until 2010 – a big challenge – then the odds will then favour Hegarty creating a second Australian mining house.

But he will need to run very fast.