labels: M&A
Chinalco-Rio Tinto deal may run into rough weather news
14 February 2009

Chinalco's $19.5 billion investment deal with Rio Tinto may run into a storm with the Australian government, a shareholder of Rio and arch rival BHP Billiton both seething in anger. BHP is pulling out all stops to scuttle the deal in Canberra.

Yesterday, the debt ridden Australian miner, announced that it had closed a deal with China's biggest aluminum company, Chinalco, whereby the Chinese firm will take stakes worth $12.3 billion in several mines of Rio Tinto such as Escondida, the world's largest copper mine and a further $7.2 billion in convertible bonds issued by the miner.

The bonds will be converted into shares in seven years, which would raise Chinalco's stake in Rio from the present 9 per cent to 18 per cent. (See: Chinalco invests $19.5 billion in Rio Tinto to raise stake to 18 per cent)

The deal, which has to be approved by shareholders of both the companies and the Australian government, has already been undermined by politicians, industry experts and Rio Tinto's arch rival, BHP Billiton.

Opposition likely from Australian government: Just minutes before Rio Tinto made the announcement of the deal, the Australian government amended the foreign acquisitions and takeovers act of 1975, where it made convertible debt to be treated as equity with the change coming into effect immediately.

This means that Chinalco's stake will go up to 18 per cent immediately rather than the normal waiting period of seven years required for the convertible bonds to be converted into shares and hence will require regulatory approval as any foreign company investing in Australia requires regulatory approval if the stake crosses the threshold level of 14.99 per cent and 11.6 per cent if the investment is coming from a state owned company.

Chinalco will be free to transfer its share of Rio to any other Chinese state-owned company in the future without requiring shareholders approval is the most disturbing part of the deal, which will raise the heckles of the Australian regulators.

Briefing investors in London, Rio Tinto chief executive Tom Albanese extolled the advantages of its deal with Chinalco. "I believe this transaction is not only good for Rio Tinto, I think it is also good for the Australian economy also,'' he said.

"Just this transaction alone preserves 2,000 jobs which otherwise would be at risk in any other scenario we have," he added.

But the Australian government has said that job losses will not be a factor for approving or disapproving the deal.

The Australian government will also not like its strategic mineral reserves being cornered by the Chinese, although it may find it difficult not to approve the deal. there is also a past instance when it had blocked Royal Dutch Shell's acquisition of Woodside Petroleum for $6.5 billion in 2001 citing national interest.

But Rio Tinto's chief executive Tom Albanese and Chinalco president Xiao Yaqing expressed their confidence in the deal and said that it would be approved by the Australian government.

Shareholders/investors angry: Apart from the government, many investors and shareholders are furious and voiced their opposition to the deal and said they will not let the deal go through as they felt that the miner had rejected BHP Billiton's takeover offer worth more than $147 billion at prices prevailing at the time (See: BHP Billiton raises offer for Rio Tinto to $147 billion) but has now sold some of its best assets to Chinalco at bottom of the market prices in order to pay off its huge debt of $39.1 billion.

Rio justified the deal saying that it had "extensively considered" other options but Chinalco offer was of "superior" value and offered "greater medium-term certainty and long-term value" for its shareholders.

Even some analysts have commented that it was wrong for the Rio board to conclude that the Chinese deal at a lower price was better than the offer of BHP Billiton for its shareholders, which many consider, as far superior to Chinalco.

Even chairman designate Jim Lang, who resigned last week, has reportedly left after disagreements with Rio's chief executive Tom Albanese and certain board members, on the company perusing the Chinalco deal rather than looking at a rights issue option. (See: Corus chairman quits Rio Tinto's board; rules out joining it)

After having bungled in overpaying for Alcan and acquiring a mountain of debt in the process and refusing to entertain the lucrative takeover offer by BHP Billiton, there is a strong possibility that investors and shareholders may call for a meeting to oust the present board headed by the out going chairman, Paul Skinner.

With shareholders airing their opposition to the deal, shares in mining giant Rio Tinto fell Friday by as much as 4.7 per cent.

Analysts believe that Rio could have done the same what Xstrata did recently, when it announced that it would raise $5.9 billion through a rights issue. Rio could have paid off its immediate debts of $8.9 billion due in October 2009 and another $10 billion due the following year, had it taken the route of rights issue, where it could have easily raised $10 billion and mustered an additional $5 billion from savings in capital expenditures, which it recently announced and the billions of dollars it just received from some asset sales. 

But Paul Skinner told analysts on Thursday that although his company would not have been able to raise $20 billion from a rights issue, which Chinalco has offered.

But some analysts have said that Chinalco has undervalued some of the prize assets they were buying stakes in, as according to the analyst, the combined value of Chinalco's stake in the Escondida copper mine, Hamersley Iron, Yarwun refinery and Weipa bauxite mine is approx $21 billion, while they were paying only $12.3 billion.

Chinese strategy: As far as China is concerned, it has ensured a minimum level of long-term supplies of iron ore and bauxite, but more importantly it will be privy to all information of the company and by holding dual positions one as a consumer and the other as a stake holder, will give it enormous advantage on the actual cost of the ore and may be able to manipulate pricing.

Although the Chinese have taught BHP on how to conduct big deals, BHP has been opposing the deal from the beginning, since it is also a supplier to Chinalco and the Chinese will now prefer to make bulk of their purchases from Rio as well as they may be forced to reduce prices if Rio does the same on Chinalco's influence.

To make matters worse for Rio, the secretary-general of the China Iron and Steel Association, Shan Shanghua is reported to have told Bloomberg in an interview that the duopoly enjoyed by the Australians in supplying iron ore will be broken by China over a period of time and the investment of $19.5 billion might be too early to affect the 2009 price negotiations.

This is definitely not in BHP Billiton interest and it will not hesitate to influence the Australian government in scuttling the deal by letting Rio or Chinalco undermine its long-term interest.

The BHP-Rio merger was a threat to the Chinese as it feared that BHP would have a near monopoly on iron ore and other minerals and Chinalco picked up a 9 per cent stake in Rio last year to thwart the deal and also asked the EU regulatory authorities to reject the merger. (See: China calls for Europe to reject BHP Billiton - Rio Tinto merger)

Chinalco is said to have hired the services of the Australian lobbying firm, Hawker Britton, who reportedly is in good books with Australia's ruling Labor party and may play a vital role in getting the deal through.


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Chinalco-Rio Tinto deal may run into rough weather