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Aurizon Holdings Ltd set to enter the mining industry. Should investors be concerned?

Aurizon Holdings Ltd (ASX: AZJ) announced in early May, that it was part of an off-market takeover bid with China’s Baosteel, for WA-based iron ore miner Aquila Resources Limited (ASX: AQA).

Aurizon is, and has always been, a rail freight operator with assets in Queensland, New South Wales and Western Australia. In Western Australia, it operates the largest independent iron ore haulage operation outside of the Pilbara, which services a number of mid-tier iron ore miners. The Aquila purchase is expected to increase the company’s network in the state and appears to be the main driver of Aurizon’s interest in the venture.

The Asset

Aurizon and Baosteel will be purchasing Aquila’s 50% stake in the West Pilbara Iron Ore and Eagle Downs Coking Coal projects, which come with the option to develop a railway and multi-user port near Karratha. The rail system, which could service a host of small and mid-tier miners, is the main interest for Aurizon.

Increased Risk

If the deal goes ahead, analysts expect Aurizon to take up to 15% of the joint venture and outlay in excess of $200 million for its share of the purchase price. Once investment for the development on related mining and transport infrastructure is completed, this number could increase to over $1.5 billion and introduces a significant amount of risk into the Aurizon business.

The company is already exposed to weakness in the iron ore and coal export prices through its existing network. Taking ownership of Aquila’s mining assets and the related rail infrastructure, will expose Aurizon, to a more significant risk for smaller companies, that are unable to absorb lower prices and continue shipping coal.

Management History

Investors concerned about the purchase should consider the track record of Aurizon’s management. Since listing in 2010, revenue has increased by 27% and profit has increased by 125%. The company has also started signing up customers to long-term contracts between 5 and 12 years in length, with 95% of customers expected to be on the new contracts by 2017. Investment in new infrastructure in NSW and increased freight prices, are expected to see revenue and profit continue to grow strongly in the coming years.

Should you be concerned?

Aurizon’s management team has done a great job so far in its short life as a listed company. This purchase is difficult to assess and certainly analysts are more than sceptical about its merits. Should the iron ore price and negotiations with nearby mines go to plan, the planned rail infrastructure could provide Aurizon with a decent profit boost in the medium term.

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Motley Fool contributor Andrew Mudie does not own shares in any companies mentioned. You can find Andrew on Twitter @andrewmudie

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