Controversial Chinalco deal faces hurdles
A proposed deal for China to invest US$19.5 billion in Rio Tinto would be value-accretive, should it receive approval, but raises a few concerns
The controversial deal is said to be the largest overseas investment by the Chinese and although it is widely-deemed to significantly alleviate Rio’s debt worries, if not eradicate them, there are concerns that it could give China the power to manipulate prices and that the political implications could make it tricky to gain regulatory approval.
News of the deal overshadowed Rio’s full year results, also released this morning, in which the group revealed underlying earnings before interest, taxation, depreciation and amortization (EBITDA) grew by 60% over the year to US$22.3 billion. Underlying earnings increased by 38% year-on-year to US$10.3 billion but net earnings fell by 50% to US$3.7 billion. In light of the cash injection on its way from China, Rio has opted to maintain its full-year dividend payment at US$1.36 per share—some analysts had pondered the possibility that the group cut its dividend to boost its balance sheet—but capital expenditure is to be cut by around US$4 billion in 2009 from US$8.5 billion in the previous year.
Net debt was reduced by US$6.5 billion to US$38.7 billion by the end of 2008, and the Chinalco deal “provides additional flexibility in addressing the group's commitment to reduce net debt by a further US$10 billion by end of 2009,” Rio said in a statement today.
The deal reveals how desperate for cash Rio has become, Andrew Turnbull, Senior Sales Manager at ODL Securities said. “I doubt [chief executive] Tom Albanese would have even considered selling a stake to one of its largest consumers even a year ago and the sheer size of this deal, although positive for the share price, does give you the impression that there will be further deals like this over the coming months as the global slowdown deepens.
The fund-raising will see the Chinese group invest US$12.3 billion in some of Rio’s aluminium, copper and iron ore assets, including 49.75% of its Escondida venture, as well as subscribe to a new US$7.20 billion convertible bond, which, if converted, would enable Chinalco to increase its existing 9% stake to 18%. For all of this, Chinalco will hand over aggregate cash proceeds of US$19.5 billion.
But there are a few hurdles to overcome before the deal is done and dusted. The two groups need to secure regulatory approval, which could be a long drawn-out process according to analysts, and Australian authorities have in the past rejected the Chinese. In addition, chief executive of former bidder BHP Billiton, Marius Kloppers, has previously stated that BHP is interested in buying assets from Rio, particularly its Escondida venture. BHP is currently mulling a counter-bid for some of Rio’s mine stakes offered to Chinalco, according to press reports this morning.
The proposed deal would add value for Rio’s shareholders, according to analysts’ initial calculations, but should the deal fail to get approval—from either the authorities or shareholders—there is still the risk that the global miner will have to go ahead with a discounted rights issue, a move that would be highly dilutive for the shares.
At 9.15am, Rio’s shares were 1% weaker at 1,950p , outperforming the wider sector and having see-sawed in early deals, while peer BHP lost 3.1% at 1,254p. The FTSE 100 index was down 1.5% at 4,169.2.
