Rio Tinto up **** Creek Without a Paddle
BHP Billiton has been weighing up a bid for Rio for years, as the two companies have highly complementary assets, especially in iron ore, coal, copper and diamonds. Chip Goodyear, former BHP chief executive, and Don Argus, chairman, pitched a friendly deal to their Rio counterparts in April last year but were rebuffed.
Mr. Goodyear was succeeded by Mr. Kloppers in October last year and within weeks BHP launched a hostile all-share bid for Rio worth $141bn (£91bn), a deal that would have been the second-largest corporate takeover in history after Vodafone’s acquisition of Mannesmann.
But it appears that BHP’s top team underestimated the severity of the crisis. Only last month, Marius Kloppers and his team, led by Alberto Calderon, chief commercial officer, were still sounding confident. Base metals prices had been dropping since July as the US economic slowdown intensified, but the real eye opener came in mid-October, when mining executives realised that Chinese demand – their only hope for a recovery in the short-term – was also tumbling. Industrial metals prices have tumbled 55 per cent since their March peak, according to the Goldman Sachs Commodity Index.
The deal began unravelling as the credit crisis made investors sceptical, and funding obligations for such a deal would have been difficult to meet. Rio Tinto’s shares plunged some 37.5 per cent since its suitor BHP Billiton abandoned its hostile takeover, ironically on the same day the World Bank cut its 2009 Chinese growth forecast to 7.5 per cent from 9.2 per cent. BHP was quick to blame falling commodity prices, a lack of demand and lackluster capital markets as the main reason for the deal falling apart. BHP’s shares rallied 7 per cent on the news.
Though BHP cited falling demand from its number one market as the main reason for abandoning its bid, the proposed merger had already received both US and Australian regulatory approval, European regulatory approval of the proposal in its current form was not forthcoming and any green light from the EU competition commission would have required the merged entity to have made some divestment of specific units which the acquiring company would have been none too keen on. Or at the very best would not be able to secure a price consistent with its own internal valuation on today’s markets
Last week BHP and its executives were still saying they were confident of reaching a “manageable solution”. But as the deadline for submitting suggestions for asset sales loomed, BHP got cold feet. “We were getting to a point with the European Commission where conversations were about divestments,” said BHP on Tuesday.
It quickly became clear to BHP that it would struggle to sell assets at a price it would be happy with, given the gridlocked financing markets and the havoc that would play with potential buyers’ ability to bid.“What may have been manageable before was not manageable now,” said BHP, indicating that companies, such as Xstrata and Anglo American, that might normally have been obvious acquirers of iron ore mines, were no longer interested
BHP has had to swallow or write down US$ 450 million in expenses related to the deal so far. Rio Tinto’s strategic investor, the state owned Chinalco said it was considering whether to increase its stake in the company to just under 15 per cent.
Chinalco owns part of a 9 per cent stake in Rio that it purchased together in tandem with Alcoa, that stake was largely meant to be a defensive position since Chinese steel manufacturers were not keen to see so much of the Iron ore reserves controlled by a single entity such as a potentially merged Rio an BHP.
BHP initially approached Rio Tinto in November 2007, but the board rejected the offer as opportunistic. BHP then sweetened the deal in February this year, upping its offer to 3.4 BHP shares for each one of Rio. This was again rejected as too low.
Now it seems that Rio’s lack of interest was indeed a blessing in disguise for BHP. Clearly commodity markets peaked at some point during 2008 and credit markets all but ceased to function in September this year with Lehman’s going into insolvency.
Rio has around US$ 44 billion in debt to service which it picked up during the acquisition of Canadian Aluminum miner Alcan. Had BHP managed to seal the deal then the structure of the deal they were proposing would have ultimately meant a share swap and the combined company assuming the debt.
In an environment where Chinese demand at least in the foreseeable future is waning, credit is scarce and extremely expensive BHP made the extremely wise choice of abandoning the bid altogether. At this point the tide turned for Rio Tinto, with a bid fallen by the wayside, there was very little price support left for the stock which investors feel is over leveraged and will struggle to meets its obligations in this kind of dear credit environment. Such a situation really in this day and age is the financial equivalent of leprosy. As a result the stock has tanked by a third, and traders and investors have begun talking about a potential rights issue to strengthen the group’s balance sheet.
A Rio spokesman told The Daily Telegraph that an equity issue was definitely not being considered. Rio has to refinance $9bn next year and $10bn in 2010. The company expects to service this refinancing from cash flow and existing banking facilities. Rio also has around $10bn in planned disposals, but these could prove difficult in the current environment
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