June 06,2009

Chinalco Drops the (Iron) Ball

By CT Johnson

Sweeping aside the overwhelming advantages of ready cash, a dominant equity position, and access to the world's largest steel market, Chinalco today managed to lose its bid for Rio Tinto (Rio), the largest overseas acquisition ever attempted by a Chinese company.  "Chinalco stuffed up (from the start," said one industry expert.  "Had the agreement been less complex, it would have been far less controversial."

In a major blow to China's steel industry and the Chinese government, Rio rejected Chinalco's bid to increase its stake in the Australia mining giant.  The Chinese have made every possible effort to derail a tie-up between the two Australian miners since 2007, when BHP made a bid of over $150 billion for Rio.  Chinalco's foray into the Rio deal was an effort to support China's steel industry in its ongoing negotiations with major iron-ore producers, and to keep BHP and Rio separate over the long term.  This appears to be the end of China's efforts to prevent a "conspiracy" among iron ore supplier to keep the price high.

"Regrettably the Chinalco transaction did not proceed," said Tom Albanese, Rio Tinto's American-born chief executive officer, speaking in Melbourne yesterday.  Instead, Rio announced a fully subscribed $15 billion share issuance that enjoyed the support of shareholders and the board of directors.  For good measure, Rio announced a joint venture with rival BHP Billiton, forming one of the world's largest iron-ore enterprises.

Rio and BHP shares rose 10.0% and 6.8%, respectively, on the news.

Rio was quick to emphasize the advantages of abandoning negotiations with Chinalco and opting instead for a share issuance.  "The Rights Issue will enable the Group to meet its Alcan facility debt repayment obligations," the company said in a press release.  "As a result, net debt will be reduced to approximately US$23.2 billion by the end of 2009."  The press release continued, "The Rights Issues and debt repayments will strengthen the Group's financial position in a period of continuing uncertainty and allow it to take advantage of future value creating opportunities."

The Chinalco statement was far more downbeat.  "It is with great regret that we are confirming the announcement made by Rio Tinto," it said.  "We are very disappointed with this outcome."  This came despite a 10% rise in Chinalco's share price following the announcement.

Rio was even more effusive in its praise of the deal with its once-hated rival BHP.  "The joint venture will establish and unrivalled iron ore business with world class assets and infrastructure.  We believe it represents great value for shareholders and will create a business combination able to serve growing international markets with unparalleled efficiency."  Albanese added, "We have long recognized the natural fit of our two iron ore businesses and the industrial logic for bringing them together in order to unlock substantial synergies.  We are very pleased that we have been able to realize the vision which offers value to both companies."

The significance of the deal with BHP was not lost on Chinalco.  Xiong Weiping, the company's president, commented, "We note the announcement of the joint venture [with BHP] and will continue to monitor developments in relation to this project."

BHP "played their hand pretty well," said Peter Arden, analyst for Ord Minnett Ltd, a subsidiary of JPMorgan Chase & Co. "It’s a neat solution for both companies at a time of falling commodity prices. To be able to unlock this kind of value is extraordinary."

These developments pose a major challenge to the China Iron & Steel Association (CISA), which is currently locked in negotiations with Rio and BHP over the price of iron ore.  CISA has demanded a 45% reduction in ore prices, rejecting a 33% reduction agreed to by Japanese and South Korean steelmakers.  Some of China's state-run media have portrayed the negotiation as a battle between the forces that would make China great and those that would hold her down, labeling the Australians?negotiating tactics a "conspiracy."

CISA's latest rejection of Rio and BHP’s price demands may be short-lived.  CISA admits that its members hold only a 2 month supply of iron ore inventory.  Once this is depleted, the world's largest steelmakers will be forced to cut back on production, leaving Chinese producers at the mercy of the Australian conglomerate.  According to Goldman Sachs JBWere Pty., the combined Rio-BHP joint venture may supply as much as 75% of China's iron ore imports this year. 

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