It was like an O’Henry short story for BHP after the European Commission early last month presented a Statement of Objections to the Anglo-Australian mining giant’s $62bn hostile bid for rival Rio Tinto and called for divestments in iron ore and coal operations as a condition for approving the deal.
Rio’s vast iron ore operation was one of the main prizes of the deal for BHP – as it made clear when it pulled the bid today, citing demands for asset sales from European regulators and deteriorating market conditions.
Well, market conditions, including commodities prices, have been “deteriorating” for some time, and that did not seem to have deterred BHP, which signalled as recently as last week it fully intended to proceed with the bid.
And on the upside of the market downturn, it’s worth noting that when BHP first announced its interest in Rio just over a year ago, the potential deal – the largest ever considered in the mining sector and one of the biggest in corporate history – was worth $140bn. The value of the planned bid had fallen to just $62bn this month as the value of both groups’ shares fell.
In response to the Commission’s objections, which were understood to focus on BHP and Rio’s leading positions in iron ore and also the coking coal market, BHP said last week it would outline by late November which iron ore mines it could spin off to win Commission approval.
And just the preceding week, shortly after news of Brussels’ objections, BHP’s chief commercial officer Alberto Calderon told a Deutsche Bank conference in London: “We still think we can come to a manageable agreement with them… We’re really in the last stages of the EU process, just a little longer.”
So what went wrong?
As The Australian’s business editor Andrew Main suggested on Tuesday, BHP’s top team saw the light – suddenly and all too clearly.
De-leveraging is the name of the game now and cutting Rio’s of debt would have meant the disposal of some of Rio’s Alcan aluminium assets at lousy prices, if the bid had gone ahead. Any failure to shift the assets at a good price would create a vicious spiral.
Yes, it is “embarrassing” for Marius Kloppers, BHP’s chief executive, and Don Argus, its chairman, to “haul their juggernaut of a Rio bid to a standstill, particularly after road-showing the merits of the bid to eye-glazing level for so many months”, as Main puts it. “But they’ve seen the way this market’s treating any debt-laden structure – horribly – and they know that won’t change in a hurry.”
Kloppers not only staked his reputation on what he saw as the “compelling logic” of combining the two companies – there probably hasn’t been one night in the past year when he was not thinking, breathing and living the bid. He reportedly told people last week he was working on possible proposed asset sales or spin-offs to remedy the Commission’s anti-trust objections.
So the reality check must have come swiftly and absolutely.
On Tuesday, he noted in a statement that “recent global events and associated falls in commodity prices” had “altered risk dimensions”.
He added that BHP was very focused on balance sheet strength, and the greater debt exposure of the two groups combined with the difficult conditions to divest assets had meant the planned deal had elevated risk to an “unacceptable level”.
Perhaps, as some suggested, the Commission’s objections, based on an exhaustive investigation including industry submissions, were the final straw.
There was some very heated debate last week, we gather, within BHP’s executive conference rooms in Melbourne.
Another complication for BHP, as the FT noted last week, was the steadily weakening demand for iron ore, which would normally lead to cuts in production, as seen at Rio and Vale of Brazil.
BHP is understood to have been strongly opposed to cutting its iron ore output, in the belief this would undermine its argument that a combination with Rio would lead to more iron ore coming on to the market.
But BHP admitted earlier this month that Chinese steelmakers had asked for iron ore shipments to be deferred, partly in response to difficulties obtaining credit to pay for raw materials, which could result in 2008 sales being $600m lower than expected. The group now faces the prospect of a wave of profit downgrades after Macquarie Research on Tuesday sliced 31 per cent off its current year estimate due to a likely sharp drop in sales of iron ore and coking coal.
Macquarie, which also cut its 2009-10 profit estimate by 50 per cent, said the “speed and degree of deterioration” in the operating environment for minerals and energy producers had been surprising.
Drawing a broader bow on BHP’s “lost year”, newly installed Reuters columnist John Kemp said in a note on Tuesday that BHP’s failure to obtain clearance from European regulators for the proposed takeover marks a significant turning point for global competition policy:
After nearly two decades of progressively more relaxed merger clearance standards, we have probably reached the limits of what regulators in the EU, US and Japan are prepared to tolerate in terms of increasing industry concentration. With the EU taking a tougher line, and an incoming Obama administration likely to treat mergers more sceptically as well, the new Gilded Age may be drawing to a close.
In the end, though, says The Australian’s Main, for Kloppers and Argus, the embarrassment of changing course “is nothing to the sense of power they’ll get from standing on a mountain of cash. The double whammy is that their share price, which they can use as part of any new acquisition, is rising too. The vendors are probably lining up already.” Besides, he adds:
Kloppers and Argus will be able to walk into the annual meeting on Thursday in Melbourne with a brand new script about what else they’d like to buy. Since cash is king, they could stamp themselves each a tin crown and keep a straight face as they explain what else they’re looking to pick up with the monumental cash flow that they’re guaranteed until the iron ore and coal price contract prices change for the worse next April.
The final response, perhaps, should go to investors who signalled their opinon in morning trade in London – when at one point, Rio shares were down 40 per cent while BHP was up 12 per cent and cruising.
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