Core Transformation

Brazil's CVRD may be one of the world's biggest mining companies, but its cost of capital is higher than its rivals.

Cia. Vale do Rio Doce (CVRD) is transforming itself from an iron ore producer operating mainly at home in Brazil into a global multi-product mining giant. Fuelled by robust cashflow, prudent debt management and a well-planned acquisition strategy, CVRD's market capitalization has surged to $41.2 billion at the end of 2005 from $8.7 billion in 2000. CVRD now ranks as the world's third-largest mining company, behind first-ranked BHP Billiton in Australia and No.2 Rio Tinto, based in London. CVRD became the first Brazilian company to win an investment grade rating from Moody's last July and from Standard & Poor's in October.

CVRD's assured and generally very successful approach to the capital markets is a key factor in its development into a world-class company, earning it LatinFinance's award for Best Corporate Issuer of 2005. Today, it can access the market at will. But only five years ago, CVRD had to use its own iron-ore export receivables as collateral to back a $300 million bond issue. That was Latin America's first future flow export securitization, structured to mitigate currency and country risk. The transaction won LatinFinance's structured finance Deal of the Year prize in 2000. Nowadays, the company is focused on replacing these collateralized bonds with plain vanilla issues.

Fábio Barbosa, CVRD's finance director, says the company bought back about $170 million in asset-backed bonds last year. "We decided to clear the market of non-pure CVRD instruments and provide investors with a clear benchmark of pure CVRD risk," he says. CVRD set out to build a yield curve of plain vanilla bonds in August 2003 with a $300 million, 10-year issue led by Deutsche Bank and Morgan Stanley. Last year it issued a landmark $500 million, 30-year plain vanilla bond, led by Merrill Lynch. CVRD reopened that issue to raise another $300 million in October 2005. The reopening of its 2034 issue had a 7.65% yield to maturity with a spread of 286 basis points over US Treasuries – no less than 50 basis points fewer than the original bond.

But CVRD complains that markets are still setting its cost of capital too high. In October, CVRD aborted an attempt to sell a 40-year plain vanilla bond through ABN Amro and HSBC. Barbosa says it made sense to concentrate liquidity on existing plain vanilla bonds rather than rush to add new bonds. "The spreads on the 2034s continue to tighten in connection to the increased liquidity. We should continue to look at structures that enhance liquidity and capture hidden savings," he says.

However, CVRD has not used the commodity bull market to go on a debt binge. In September it had $4.27 billion in gross debt, close to its historical high of $4.75 billion in December 2003. However, its ratios have improved dramatically. By September, gross debt-to-equity had fallen to 36.5% – the lowest since December 1996. The average maturity on CVRD's debt at the end of September was 6.89 years and nearly half of its debt is fixed-rate, compared to 30% last year.

Barbosa says CVRD has accepted that it can only close the financing gap with its peers by evolving into a diversified global mining company. CVRD pays about 100 basis points more for its bonds than its peers. Barbosa says: "We are perceived as a single country company, with 95% of our operations in Brazil. The simple fact is our concentration in one country attributes to our higher cost of capital." He adds: "We want to diversify away from iron ore into new industries and with this in mind we are investing in new products like copper, nickel and coal, so CVRD will be perceived as a global, diversified mining company."

CVRD will continue to focus on lowering its cost of capital by retiring, exchanging and refinancing debt and will use its formidable cash flow to fund an aggressive investment program and robust dividend payments. But don't expect a flood of acquisitions. Says Barbosa: "Organic growth is CVRD's priority. Acquisitions may complement our strategy but they are not core to our growth strategy."