Rio Tinto's short-term focus is unfortunate
"It takes 20 years to build a reputation and five minutes to ruin it," or so says Warren Buffett
To justify its proposed US$19.5 billion strategic partnership with Chinese aluminum major Chinalco, Rio says the deal will strengthen its ability to deliver its strategy of maximizing shareholder value. We don't remember the board saying its abilities were lacking while it cold-shouldered BHP. Nor have previous Rio boards had any problems independently executing and delivering value to shareholders. Surely BHP's skill sets would have been eminently more useful, not to mention the cost savings and superior value offered to Rio shareholders.
Now Rio sees value in a deal that sells portions of its best assets to a competitor, unlocking the door to the inner circle to a customer. The company has agreed to issue Chinalco US$7.2 billion in convertible bonds and US$12.3 billion in asset sales across major divisions. These are core assets--a departure from Rio's long-held strategy. Asset sale prices are comparatively good in the current market and paying down debt removes balance-sheet risk. But the terms of the convertible bond--arguably a 60-year call option for Chinalco (an unbelievable maturity period) and the fact that at US$45 per share, the first tranche is almost in the money and the second not far from it--is scandalous.
The only conclusion one can draw is that Rio is hardly being run in the best interests of shareholders. Jim Leng may well have been absolutely right in telling the rest of the board it was "unanimously wrong." Chinalco will have board representation and a shareholding potentially increased from 9% to 18% upon bond conversion. There will be those who cheer Rio's de-stressed balance sheet and those who decry selling distressed stakes in crown jewels, particularly to a major customer. We fall within the latter category. We would prefer a rights issue, a takeover by BHP, or a better offer from the Future Fund! That said, Rio regardless remains undervalued.
Underlying fiscal year 2008 earnings rose 38% to US$10.3 billion, a touch below expectations. Pleasingly the result exceeded expectations at the cash level. This was in part due to higher-than-expected prices, particularly for aluminum where there is a lag effect to falling spot. The headline result fell 49.7% to US$3.7 billion including US$6.6 billion of exceptional items. Significantly these included a US$7.6 billion impairment charge--largely Alcan--partially offset by US$1.5 billion profits on asset sales.
Mark Taylor is a Morningstar Equity Analyst based in Australia.
