The meaning of Rio Tinto's capitulation

Finally, tacit admission that the USD 38bn cash purchase of Alcan in 2007 was one of the most appallingly overvalued transactions in mining history.

JOHANNESBURG - 

Transnational mining group Rio Tinto has finally capitulated to multiple pressures, in abandoning its posed near-USD 20bn deal with smaller rival Chinalco, in announcing a rights issue to raise the equivalent of USD 15.2bn, and agreeing a USD 116bn joint venture with BHP Billiton over the two companies' West Australian iron ore assets. 

The capitulation is also final admission, albeit covert, that Rio Tinto's 2007 gigantic USD 38bn cash acquisition of Alcan, trumping an earlier bid from Alcoa, comprises one of the most value-destructive transactions in the history of mining. Rio Tinto finished up 2008 with USD 38.17bn in debt, ranking it as the world's most indebted mining company, and one of the most indebted companies of any kind. 

Rio Tinto and Alcoa, and also Rusal, also one of the world's most indebted mining companies, have each variously claimed to be the world's biggest aluminium entity, when in fact Chinese producers, not least Chinalco's Chalco, have grown exponentially over the past few years  and now dominate the global game. BHP Billiton, one of the world's lowest cost aluminium producers, recently showed in a frank and convincing presentation how China has become the world's biggest country producer of aluminium (by far) over the past five years. 

The dynamics in China include low capital construction costs, the ability to bring new power stations on stream on time, and strong domestic demand. Given that China's focus is on self-sufficiency in aluminium, along with China's growing requirement to import alumina or bauxite to meet domestic metal demands, one of BHP Billiton's "key messages" is that its growth options and project pipeline are aligned to this view, viz., to feed the emerging seaborne bauxite/alumina market. The primary aluminium chain comprises quarried bauxite, which is refined into aluminium oxide (alumina), which is smelted at huge cost into aluminium. 

The costs of the Alcan acquisition are proving to be dear. Rio Tinto is offering new shares at GBP 14.00 a share, compared to current trading levels of GBP 30.21 a share, and at AUD 28.29 a share, compared to current trades around AUD 72.49 a share. As a result, Rio Tinto's net debt will be reduced to about USD 23.2bn, exceeding, states Rio Tinto "the commitment made in December 2008 to reduce net debt by USD 10bn by the end of 2009". It is not clear whether this includes the USD 5.8bn BHP Billiton will pay Rio Tinto for equity type interests to take BHP Billiton's interest in the iron ore joint venture from 45% to 50%, valuing the venture as a whole at USD 116bn. 

Rio Tinto has indicated that its net debt was USD 37.9bn on 31 March 2009, suggesting that the anticipated reduction of net debt to USD 23.2bn includes the proceeds of the proposed rights issue, but excludes the anticipated payment from BHP Billiton. However, even if the USD 5.8bn due from BHP Billiton is further deducted from net debt, Rio Tinto retains its ranking as the world's most indebted mining company.

So far this year, mining companies have raised at least USD 65bn outside any banking system, by selling fresh equity, convertible bonds, and more rarely, corporate bonds. This year has seen Rio Tinto sell USD 3.5bn in bonds, at fairly expensive coupons over five and ten years. 

In terms of size, the biggest capital raising transaction would have been Rio Tinto's previously proposed raising of USD 12.3bn from Chinalco by selling equity stakes in some of Rio Tinto's most prized aluminium, copper and iron ore assets. Chinalco, an arm of the Chinese government, holds 38.6% of listed Chalco, and also 26.6% of listed Yunnan Copper. 

Rio Tinto also wanted to sell convertibles worth USD 7.2bn to Chinalco; if the now-abandoned hybrid debt-equity instruments were indeed sold and one day converted, Chinalco's stake in Rio Tinto would have increased to 18%. The afterburners of Rio Tinto's flirtations with, and abandonment of, Chinalco are as clear as mud. 

Alcoa, the US-based aluminium producer, and, like Rio Tinto, also somewhat challenged by debt issues, in February jointly announced with Chinalco that the duo "intend to explore opportunities to expand their commercial relationship by identifying strategic ventures that will benefit from the companies' complementary strengths in bauxite, alumina, aluminum and fabricated products". Rio Tinto will now pay Chinalco the agreed break fee of USD 195m. 

In further bids to shore up it balance sheet after the Alcan experience, Rio Tinto has in 2009 sold some fine assets, separately to the proposed Chinalco deal: Jacobs Ranch for USD 761m; potash assets for USD 850m, and certain iron ore assets for USD 750m. Rio Tinto's apparent escape from potential catastrophe has left a legacy of note. In its 2008 annual report released in mid-March, erstwhile chairman Paul Skinner stated that after the termination of BHP Billiton's offer for Rio Tinto in November 2008, "I felt this was the right time to step down after five and a half years as chairman". 

The identification of a successor started in late 2008; Jim Leng was appointed chairman designate in January 2009, but threw in the idea and quit within three weeks. It took many weeks before Rio Tinto announced the appointment of Jan du Plessis, currently chairman of British American Tobacco, as its new chairman. 

BHP Billiton's offer to take over Rio Tinto was always a paper one, at 3.4 BHP Billiton shares for each Rio Tinto share. Were the offer still in the market today, the offer would value Rio Tinto at USD 87bn, compared to Rio Tinto's current market value of USD 70bn. The combined group, had it merged, would have been valued at USD 229bn at this point in time.

Meanwhile, aluminium still has its head deep in the sand. During the so-called commodities super cycle from early 2002 to mid-2008, aluminium prices increased the least in percentage terms, within the base metals complex. By the same token, aluminium has shown the smallest percentage in price recoveries since multi year lows around five months ago.

Rio Tinto Alcan Bauxite and Alumina president Steve Hodgson was quoted in April this year as saying that "despite major industry wide production cutbacks", aluminium stocks continue to increase. "Even with alumina industry capacity cuts equivalent to 21m tonnes per year since the beginning of the crisis, including cuts of 12m tonnes made since January, there is still little improvement in the alumina price. At current prices around 70% of the industry is currently operating at a financial loss".

Of the USD 8bn included in Rio Tinto's impairment charges for 2008, USD 7.3bn related to the group's aluminium businesses. During the first quarter of 2009, Rio Tinto's aluminium operations - including the Alcan assets - posted underlying losses of USD 481m (compared to USD 330m in underlying profits for the first quarter of 2008), a savage indictment on the tens of billions of dollars paid in cash for Alcan. 

For years, if not decades, Rio Tinto carried the reputation of world class management running world class assets. Rio Tinto CEO Tom Albanese, who was loud in praising the Alcan acquisition, and equally loud in rejecting BHP Billiton's takeover tunes, has a career of note. It may still have time to run, and that time may allow Rio Tinto's sullied reputation some healing. For the meantime, it's been iron ore that's saved Rio Tinto's bacon, but that's a story for another day.

Disclaimer

MINEWEB is an interactive publication, with rolling deadlines through each day, commencing in the Sydney morning,  and concluding, 24 hours later,  in the Vancouver evening.  If you believe your side of an issue deserves inclusion, but has failed to meet one of our deadlines, you are invited to notify the Editor in Chief in Johannesburg, and we will include you in our editing and expanding on our stories. Email him at alechogg@gmail.com

Print story      Email story      Subscribe to free newsletter

Related Links ARTILCES:  Stunning Pilbara iron ore pact a relief for Australian Government  Rio's Chinalco deal dead as goes for iron ore jv with BHP and rights issue  Now it's Chinalco seeking to amend Rio terms  Chinalco is considering changes to the Rio deal  Rio Tinto reports weaker aluminum, iron ore production  Rio Tinto may sell more assets if Chinalco falls through  Australia weighs diplomatic consequences of saying 'no' to Chinalco  OTHER PAGES:  MINING FINANCE / INVESTMENT AFRICA

Back

 

responses to this article

Name
Subject
Comment