Crunching the numbers on Rio's recapitalisation
We drill down into the Anglo-Australian miner's favourable recapitalisation and joint-venture proposals
Second, Rio Tinto reported adjusted first-quarter 2009 earnings of $976 million. This was considerably below our forecasts--chiefly because of a higher proportion of iron ore sold into low spot prices. The impact on valuation is negligible but our fiscal 2009 earnings forecast is clipped. Headline first-quarter profit of $1,604 million included a $797 million gain on the sale of potash assets and a $39 million unrealised hedge gain, partially offset by $208 million of Alcan and other impairment losses. Rio doesn't normally report quarterly earnings but added clarity was required under the exceptional circumstances.
The third event is the 50/50 iron ore joint venture with BHP. Although we view this tie-up as logical and good for both parties, most of the immediate benefit goes to BHP. Rio has the better assets, and BHP's $5.8 billion equalisation payment, for bringing only 45% of the goods to the party, does no more than just compensate for its share of the venture. That said there doesn't need to be much value added for it to be eminently better for Rio than the value-detracting alternative of selling down to Chinalco. Further as is often the case, unforeseen benefits from the tie-up could accrue in the fullness of time.
Up to this point in our valuation exercises--pre-entitlement issue--the wash-up is our Rio valuation increases 7% to $91 per share ($364 per ADR). This is the number that matters, unclouded by dilution from the entitlement offer.
However, the fourth event is a 21-for-40 entitlement issue raising $15.2 billion--for all intents and purposes a deeply discounted 1-for-2 offer--proceeds of which will pay down debt. Pro forma gearing falls from 158% to 50%, and net debt falls from $38 billion to $23 billion. Leaving off from our third point above the entitlement issue results in a 27% reduction in our valuation to $66 per share ($265 per ADR).
Here is what this all means. An existing shareholder with two shares worth $91 each based on our valuation is entitled to one new share at $22.94. The average value of the holding post offer will be $66 per share. The holder clearly must subscribe for the new share or sell the entitlement on market to avoid being diluted. Buying new shares on market is also attractive. Every two shares bought on-market prior to the ex-entitlement date of June 17 entitles the holder to one new share at $22.94 per share. At the market price of $58 per share at time of writing, the weighted average cost of the three shares ultimately held would be $46 per share. This is an attractive 30% discount to our post-issue valuation of $66 per share. Further we think Rio shares will climb higher following entitlement issue completion.
Mark Taylor is a Morningstar equity analyst based in Australia.
