Deal or no deal for Rio Tinto?
There are various rumours circulating the miner at the moment, several of which would present a better deal for shareholders than its current plan
The Rio Tinto/Chinalco memorandum of understanding was signed mid-February and has since gained Chinese finance approval, Australian Competition and Consumer Commission clearance, and German and US antitrust clearance. However, the two most serious hurdles remain. The Australian Foreign Investment Review Board (FIRB) will hand down its decision in mid-June, to be followed by Rio Tinto shareholder approval in June/July. We believe there are strong arguments for FIRB rejection on national interest grounds. However, if passed, shareholders may prove an even tougher nut to crack. There has been an ongoing undercurrent of dissatisfaction, increased with more recent improvement in equity markets and a swath of successful rights issues by other companies. Why should Chinalco, a major customer, be given an open-ended, discounted entrée in preference to existing shareholders and be paid a 9%-plus coupon for the privilege? It's a dream deal cooked up when markets were at their most nightmarish.
There's persistent talk that major UK institutions already on the register want to underwrite a Rio Tinto rights issue. BHP Billiton is also posited as a potential underwriter possibly in conjunction with a joint venture deal on Western Australia iron ore, including a cash injection. Action in Rio Tinto's shares seems to suggest that there might be smoke and fire. An iron ore JV makes excellent sense, with well-discussed synergies in sharing infrastructure. Either of these deals makes more sense for shareholders--assuming they participate in any new raising--compared to being diluted by Chinalco. Our Rio Tinto valuation fell on the most conservative assumption that Chinalco gets up. If a rights issue replaces the Chinalco proposal, and shareholders participate, they could expect a reinstatement in relative value, not to mention a reduction in business risk by hopping out of Chinalco's bed.
Rio Tinto has promised to pay down $10 billion of debt by the end of 2009. A one-for-five entitlement issue might just about do it, given $2.5 billion in asset sales already completed this year. More sales have been flagged, and we've highlighted Rio Tinto's 68% stake in uranium miner ERA as a prime candidate. It could unlock considerable value with limited impact to near-term earnings.
