Vale: Global Expansion in the Challenging World of Mining

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Vale: Global Expansion in the Challenging World of Mining

The second largest producer of Iron ore and minerals in the world, Vale Corporation, had been facing significant pressures after the 2008 global financial crisis. The government of Brazil help equity share and golden shares in Vale after its privatization which gave the company veto power to influence the decisions of the company. Moreover, the government of the company was also turning to take a more aggressive strategic turn for intervening in the strategic sectors of the country. The President of Brazil, Luiz Inacio da Silva, Lula, was pressurizing the CEO of Vale, Roger Agnelli to invest in its home country as the company had not done much to help the economy of Brazil recover from the shocks of the global financial crisis. The relationship between Vale and the government of Brazil was also politically sensitive and this was because the privatization of the company in the year 197 has not come easily. On the other hand, the company was a major exporter of China for iron ore and was looking to invest in Chinamax Vessel for minimizing its shipping costs and compete with its other competitors from Australia. The contract prices of the company were already low but the shipping costs were high which killed the margins of the company. Therefore, Agnelli has to come to a decision now and explain the benefits and rationale of its proposal of shipping to Lula for disusing some of the political pressure. Lula was insisting Vale to invest in a steel mill in the Para state of China. After considering a range of options for Agnelli and the financial rewards of the Chinamax vessel project which would make Vale more competitive, it is recommended for Roger Agnelli to accommodate for instance by investing in s steel mill also. The company already had a diversification strategy in place therefore; the stock markets would not perceive this in negative way. Vale should invest in Chinamax Vessel but at the same time make contributions for its home country by either accommodating or increasing its royalties or support Brazil economy with iron ore export tax or 5%. This would be the best way out for the sustainable growth and continued support of Brazilian government for Vale in the long term.

Vale, a Brazilian diversified management company, which is also the largest iron ore producer in the world, was facing pressure from two different sides. On one the other hand, the company was facing the pressure from the government of the country and it’s President of Brazil, Lula for investing in integrated still mills in Brazil. Lula, who was also a former union leader, was pressurizing Vale through its minority interests and the golden shares held in the company to invest in integrated still mills in Brazil because since the 2008 financial crisis, and the layoff of its employees as a result of that, the company had moved far away from Brazil.

Roger Agnelli, the CEO for Vale Company, was facing significant political pressures from Lula and as a result, both of them decided to meet for finding a solution to this problem in October 2009. This report attempts to analyze the core issues, current position of Vale and analyze the range of options for Agnelli and then recommend a the best strategy to Agnelli for dealing with the political pressures at home and deciding about the investment of the large vessels for shipping the iron ores to Asia especially China.

The analysis for this case emphasizes on a range of issues. First we begin with the evaluation of the performance of Vale after its privatization in 1997.

The privatization of Vale in 1997 made sense because of the instable economy, hyper inflation and the high budget deficits. Therefore, it made less sense to finance the government of the country. The Brazilians had alsoalso supported the less intervention of the government in the economy. However, when Vale was included in the privatization program, it was faced with criticism and protests, because Vale was considered as the national symbol by the left wing parties. HoweverNonetheless, despite these criticisms, the supporters of the privatization stated that the operations of vale required no important technology therefore,; the intervention of the government did not make sense.

As a result, Vale was privatized in 1997 with the highest bid by the pension fund, SOE and government development bank, BNDES. They togetherTogether they held a voting equity of 41.73% of Vale. Despite the privatization of the company, the government had kept important voting right through its equity in Vale. The golden shares were also held by the company which gave many voting rights to the government to make decisions such as changing company name, its objectives and missions. However, later this shareholding had reduced to only 11% in 2009 as seen in exhibit 2.

The privatization has proved to be a success for the company. If we look in exhibit 3 of the case, then we can see that the revenues, net profit and the net profit/net worth ratio of the company had increaseds significantly for Vale after the privatization of the company. This was because of the aggressive diversification strategy of the company which it was not able to implement before privatization. The growth of investments after privatization in exhibit 3 provides evidence for this. The iron ore production also increased significantly along with the exports to other countries. Therefore, the privatization of Vale in 1997 proved to be successful for the company.

The shareholding of all the major shareholders in October 2009 of Vale, after the privatization of Vale, could be seen in the bar and the pie charts in the appendix attached to this report. The total shareholding held by the Brazilian government is 11.51% through BNDES Par. BNDES Par is the holding company which managed the equity holdings of the National Bank of Economics and Social Development. This could be seen in exhibit 1, 2 and 3 attached in appendices. The equity held by the government through BNDES Par and some other pension funds could influence some of the decisions of Vale. For example, Banco do Brasil, which is a government owned bank, also participated in the selection of the Previ executives.

The executive director of Previ was the former member of the City Council in Sao Paulo, since 2003. His name was Silva Rosa and he became the president of the board of directors for Vale in 2009. Therefore, the government had the power to influence Vale’s decisions through him. Apart from this, the Brazilian government also held 12 golden shares which gave a veto power to the government for any proposed action relative to the objectives of the company, the location of the mining and the change in the name of the company. Through this veto power, the company can also veto any decisions for winding up the company and influence merging decisions.

The global external environment has changed significantly since the privatization of Vale in 1997. Mineral ores haves become one of the five largest export sectors in Brazil. Moreover, the emerging markets were becoming less dependent on Europe and the US as export destinations. After the financial crisis, China has becomebecame the most important source for Brazilian exports. This was mainly due to the rapid increase in the US interest rates and this has impacted negativelynegatively affected on the demand of the iron ore exports from Brazil. Moreover, the external environment has also changed from technological perspectives.

The technology has dramatically changed which has increased the demand for complex alloys and rare minerals especially in the emerging economies such as China . The demand for iron ore had increased significantly in China where 98% of the iron ore volume sold went to the steel production. The supply for iron ores and minerals was lagged behind the demand therefore, the prices soared. Overall, these external environment changes made a significant contribution for Vale pursuing a global diversification strategy and exporting to emerging economies.

Number 1 Player in Iron Ore Industry: There are many strengths of the company which had made it a the number 1 player in the iron ore industry. First of all, Roger Agnelli was an experienced bank executive and had served on many boards of major energy companies such as Petrobas and CSN. The infrastructure of Vale was also strong which supported the mining operations around the globe. The construction of the distribution centers also provided Vale with an added advantage which strengthened its shipping capabilities in Asia. As Vale had become the second largest metals and mining company, the company was the largest producer of iron ore and other minerals such as kaolin, manganese ore, aluminum, potassium and coal. This also added to the strengths of the company. It was the largest exporterd of iron ore, minerals and metals such as nickel in 2009, which made it the number 1 player among the five major players in iron ore industry in 2009. The long term contracts and the benchmark pricing system also strengthened the position of Vale against its competitors, Rio Tinto and BHP Bhilliton.

Value Proposition: The international diversification strategy was the core component of the customer’s value proposition of Valve. The diversification of Vale in emerging economies such as China where the consumption of minerals had spurred between 2002 and 2009 had created a value proposition for the customers of the company . The company has always capitalized on its opportunities for international diversifications and achieved this through strategic acquisitions and development of logistics solutions around the world. The company has mineral exploration efforts in 22 countries. The value proposition of Vale lies not about being only in Brazil but expanding and diversifying its core business or iron ore and minerals around the world.

Sustainable Competitive Advantage: Vale was the largest producer of the iron ore in the world and in 2009, the mineral ores had become one of the five largest export centers in Brazil. Therefore, the core business of the company which was the iron ore business with a business model based on bulk volumes handled by the integrated platforms and logistics of the company is the sustainable competitive advantage of the company . Despite rapid diversification around the world, the iron ore business remains the biggest business of the company where the key success factors for Vale depend upon. Steel companies on the other hand were also dependent on the supply of iron ore and Vale had a sustainable advantage based upon the mines of the company which yielded highest grade of iron ore. Secondly, the company was also able to supply its iron ore products at a relatively low price due to its advanced technology, open pit mines and the less complex logistics network. Finally, the rapid boost in the consumption of the minerals and the iron ore in the major emerging economies such as China has boosted from 30% to 50% of the worldwide sales. These all factors had created a sustainable competitive advantage for Vale.

The assessment of the three options available to Roger Agnelli is shown below:

The first option available to Agnelli is to fight back with the government and to go ahead for entering shipping for China. However, this option is not a sensible option given the current equity stake and golden shares held by the Brazilian government.

Accommodating the pressures of the government in the global strategy of the company makes sense for Vale at this point of time. For instance, Agnelli could look forward to develop steel mills with its partnerships with China’s Baosteel and the Korean Steel Company Posco. The issues with the project such as land irregularities should be resolved. Equally important is the global expansion of Vale in the global economy. Therefore, accommodating the global strategy with the home country government pressures seemed seems to be a good option for Angelli. However, this might prove to be quite difficult to be achieved due to lack of public support and immense political pressures from Brazil government due to recent financial crisis. On the other hand, Agnelli could explain all the economic and financial benefits from its export business with China which would also boost the Brazilian economy.

The third option for Vale was to implement both the strategies simultaneously if it had the required capital, resources and time. For instance, Agnelli could go ahead with the development of the steel mills in Brazil and also purchase the iron ore vessels for overcoming the shipping issues in China. Another alternative here for Agnelli is to create a partnership with any of its two competitors for the shipping of its iron ore products to China. However, looking at the current competitive landscapeenvironment, this option did not seemed feasible and possible for the three mining giants.

The financial analysis for the Chinamax Vessel has been performed in the excel spreadsheet. The calculations are attached in exhibit 4 of in appendix. Agnelli should encourage the small producers of China to buy at the minimum ships of about 200,000 tons At this point,; the company can achieve average freight costs of $ 20 per ton which would be $ 10 lower than the freight costs of the Australian competitors. With an average contract price per ton of $ 59.06, Vale can make a contribution of $39 per ton. Similarly, the contribution for the Chinamax vessel with a shipping capacity of 400,000 would be $78.12 . The breakeven point for Vale would be 1.792 million tons of iron ore, which would cover all the shopping costs . The breakeven point covers all the freight costs and represents only 0.61% of total production of Vale.

The NPV analysis also shows that Chinamax investment is profitable with a positive NPV of $1066 million . Therefore, it is recommended for Vale to enter shipping. The purchase of the Chinmax vessels should be explained to Lula by adopting the Option 2 above. Agnelli should explain all the financial rewards of Chinamax project, the importance of export business with emerging economies and diversification strategy of Vale . He should explain to Lula that Vale had knowledge, which others didn’t have and Vale had competitive advantages in running large projects. Agnelli could should also consider the alternative of increasing the percentage of royalties or iron ore export tax of 5%. In this way, Vale can play an important role in adding more value to Brazil and capitalizing on China exports.

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