Consolidation has been brewing in the aluminum industry since early this year. But it wasn't mining companies BHP Billiton, Xstrata or Rio Tinto going after Alcoa of the U.S.; instead, Alcoa made an unsolicited $28 billion did for Alcan of Canada. In effect, Alcoa is seeking to become the world's largest aluminum producer. The new combined company would have dual headquarters in New York and Montreal.

Naturally, Alcan's board of directors are urging shareholders to reject the Alcoa bid, claiming that the offer is too low. “This was entirely expected,” says independent metals analyst Charles Bradford in New York. So, it's no surprise that Alcan has told the U.S. Securities and Exchange Commission that it is negotiating with third parties, presumably seeking a better deal.

Demand for aluminum, the light metals used in everything from airplanes to cars to packaging to consumer products of all stripes, is expected to grow about 7% this year, fueled mostly by China's growing appetite, and may double by 2020 to 60 million metric tons of production, according to Alcoa's estimates.

The Alcan buyout proposal comes at a time when aluminum ingots, which are heated and rolled into aluminum sheets, bars and other products, are selling for about $2,850 a metric ton on the London Metal Exchange. Though down from their record in July 2006, prices remain at historically high levels, partly due to strong demand from emerging markets, and are double what they were a few years ago.

Carol Levenson, director of research at Gimme Credit, an independent research firm on corporate bonds a New York, says in a note to clients that “Alcan is unlikely to go quietly,” adding she wouldn't be surprised to see the company make stock-leveraging defensive moves—“perhaps even a Pac-Man defense of going after Alcoa.” This anti-takeover tactic first gained currency in the 1980s, when it was dubbed the Pac-Man Defense after the popular video game in which players could change roles and go after their pursuers.

According to Securities and Exchange Commission filings, the companies had engaged in merger discussions in 2005 and 2006 and were near a deal until last December, when the companies couldn't agree on several points. That's when Alcan's directors and executives walked away from the deal, mush to the dismay of Alcoa CEO Alain Belda. “I'm thinking the Alcoa management did this as a defensive move” to short-circuit a possible reverse bid by Alcan, says Wayne Atwell, a former metals analyst at Morgan Stanley who now is involved in a hedge fund.

Alcoa has said the deal to reunite the two companies (once split up for anti-trust reasons) is necessary as companies in emerging markets are gaining clout. Companies such as Rusal in Russia, China Aluminum and Dubai Aluminum are expanding aluminum production in places where energy is better priced. “We are facing an increasingly competitive global aluminum industry,” says Alcoa's Belda, pointing to the emerging market competitors during a conference call with analysts and investors.

“These two companies were once one company before anti-trust authorities required the divestment of Alcan by Alcoa,” writes Bradford of Soleil Securities. “However, we believe that conditions in the industry have changed with the formation of a very large aluminum company in Russia (claiming to be the largest in the world) and the huge growth of aluminum output in China, nearly a 12 million ton annual rate in April. This is substantially larger than a combined capacity at Alcan and Alcoa of nearly 7.8 million metric tons.”

The “merger transaction makes a lot of sense because it would put the Alcoa-Alcan firm on a larger scale to compete in the global market,” Kirk Schmitt, who helps manage $1.1 billion at Victory Capital Management in Cleveland, tells the Bloomberg News Service. He says Alcoa would gain an edge over competitors by securing more supplies of Alcan's cheap electricity, which is a major cost for aluminum smelters. “As long as you have an electricity advantage, you should be able to compete with the Chinese, and Alcan gets a lot of its power from hydroelectricity, which is the cheapest,” Schmitt says.

Alcoa has said a combined company would create an aluminum giant with annual revenue of about $54 billion and 188,000 employees. Together, the companies would have significant mining, refining and smelting assets, including 48 aluminum smelters on six continents with capacity to make about 7.78 million metric tons of aluminum each year, about 20% of global capacity.

“The Alcoa proposal doesn't adequately reflect the value of Alcan's extremely attractive assets, strategic capabilities and growth prospects, does not offer an appropriate premium for control of Alcan, and is highly conditional and uncertain,” according to Alcan chairman Yves Fortier in a statement. “Our offer is full, fair and balanced,” Alcoa CFO Charles McLane told the Reuters Global Mining and Steel Summit in New York.

Asked what the company would do if the Alcan deal was unsuccessful, McLane says: “We have other directions, but I'm not at liberty to talk about what those may be. We're not going to take our eyes off this one specific transaction. This one makes the most sense to us.” He says Alcoa executives have met with some Alcan and Alcoa shareholders and “without exception...we have had no negative feedback. Zero.” He says they mostly asked, “Why now?” and his reply was “Why not?” He admits that takeover proposal “came as a bit of a surprise” to some Alcoa shareholder—because there had been many previous rumors that Alcoa would likely become a takeover target.

A recent Wall Street Journal analysis says that Alcoa's “audacious bid for rival Alcan escalates the buyout frenzy in the commodity world, where buyers are running out of prime assets to acquire.” The marriage proposal also raises tough questions for antitrust regulators about how big is too big in an increasingly global market. Alcoa CEO Disk Evans insists regulatory hurdles in Canada, Europe and the U.S. could drag on and threaten the value of the deal.

In an interview with Toronto-based Globe and Mail newspaper, Alcan's Evans insists that all options are being considered, and he refuses to rule out any scenario—including one in which Alcan would turn the tables by launching its own bid for Alcoa.

Bradford says that “Alcan could make an offer to buy Alcoa, the so called Pac-man defense, but we believe that since Alcoa is a Pennsylvania corporation, a hostile takeover is difficult and, thus, not likely.” He believes Alcan is looking for a “white knight” with a better offer. “Alcoa could raise its offer price and Canadian politicians could get involved since nearly all the major Canadian metals and mining companies have been bought by foreign interests,” says Bradford. “For this deal to go though, not only is approval needed from the anti-trust authorities, but also from Investment Canada.”

“At this point, we are looking at all alternatives,” Evans tells reporters in Canada, “which include both internal and external alternatives. We are in ongoing discussions with third parties about various other transactions.” He has declined to identify the third parties, but sources suggest that BHP Billiton, the world's largest miner, has begun talks with Alcan. BHP approached the company about a possible union late last year, but was rebuffed. Rio Tinto also has been cited by several industry observers as another logical suitor for Alcan.

Analyst John Tumazos of Prudential Equity Group in New York in a note to clients says “Canadians are not unpopular in the world these days.” Thus, he suggests, not only would the Quebec government likely prefer that a Canadian company hold long-term water rights now ceded to Alcan, new deals in the Middle East and elsewhere might evolve more smoothly. “Also, simpler regulatory issues in Europe might sidestep anti-Americanism if Alcan were the buyer,” he adds.

Alcoa says it probably would divest certain overlapping assets, most likely plants that make aluminum plate and other products for the aerospace industry—to satisfy concerns that the combined company would control too much of that market. A Reuters News Service report says the targeted divestitures include a handful of specific plants from Alcan, primarily in Europe, that make products for aerospace companies such as Boeing and Airbus, and that make brazing sheets, which are used in automotive applications. Brazing sheet is material made of two alloys that is used to create a bond in heat exchangers for automotive applications.

Alcoa also makes products for the packaging, building and construction, transportation and industrial markets.