Single mining company, 103 years young, seeks genuine life partner for romantic strategic off-sites, walks on the beach and candle-lit board meetings (to reduce carbon footprint). Ideal partner is someone who will love me for who I am, although if you want to change me – well, that’s okay too. But you will have to accept my neurotic family of bankers, including the weekly Sunday roast.
I have an unfortunate condition known as DLC Bipolar Syndrome as well as chronic indigestion from swallowing too much aluminium last year. However, a small amount of nursing aside, I will be a desperately loyal spouse. Happy to learn Mandarin.
After BHP Billiton’s shock abandonment of its $66bn bid for Rio Tinto, the next big story on that front will focus on how Rio deals with the consequences – including repayment of $38bn of debt used to buy Canadian aluminium producer Alcan last year and a sliding share price which has brought its market value to just $36bn.
Rio shares plunged 34 per cent to A$42.01 in Sydney on Wednesday - catching up with the earlier slide in London - as Moody’s warned it may cut Rio’s credit ratings, citing the slump in prices for metals and raw materials and Rio’s high debt level.
Two things are clear from the collapse of the deal, says Business Spectator’s Alah Kohler:
1. BHP has changed its view about commodity prices from positive to negative – it now believes they will fall further; and 2. Rio Tinto is overvalued and set to decline further than it has already today. It is certainly not a buy yet.
Kohler’s colleague Robert Gotteliebsen, meanwhile points out Rio has two big legacies from the bid:
First, it would argue that, but for the BHP bid, it would have made an equity issue much earlier and would not be in its current position where the value of assets has slumped and US$40bn is still owed. Second, the BHP bid thrust Rio Tinto much closer to the Chinese than they had ever been before.
Indeed, Chinalco - Aluminium Corp of China - on Wednesday flagged its intention to buy up more of Rio, as Reuters reports, saying it planned to lift its stake to 14.99 per cent from the 9 per cent it purchased jointly with Alcoa in January.
Furthermore, noted Chinalco vice-president Lu Youquing, Chinalco might even consider seeking as much as 49.99 per cent of Rio although, he added, that was an idea that had been suggested by investment bankers and was not the company’s policy.
His remarks sparked a flurry of damage control from Chinalco, which hastily issued a statement saying it had “not made any decision in respect of its investment options in Rio Tinto, including the possibility of increasing its holding above 15 per cent”.
But the logic is clear: Rio has the world’s best iron ore and aluminium business. But, warns Gottliebsen, “there is a risk that as Rio goes to the Chinese to help solve its debt problem it will be forced to sell huge chunks of equity to its customers (or to friends of its customers) at very low prices. If this happens, the response of the Australian government to such a significant foreign investment will be critical”.
Well before it gets to that stage, the immediate post-BHP issue for Rio is its refinancing obligations of $9bn next year. Breakingviews believes it should be able to meet these obligations through cash flows and existing short-term facilities.
But Rio’s chairman Paul Skinner on Wednesday was at pains to reassure investors he was confident the miner could sell billions of dollars in assets to pay down massive debt, despite concerns about a lack of buyers.
Speaking at a scheduled business breakfast, he said the group was “comfortable” with its financial position, remained committed to increasing its dividend, and dismissed market speculation Rio would now need to raise equity. He said it would make asset sales in the next few months, possibly including a major packaging business, aluminium products, its US coal business, an Australian copper mine and its US Sweetwater uranium mine.
“We now move on, we have a very strong company,” Skinner told reporters. “We are confident with our financial position. We have other ways of managing our debt.”
It all sounded eerily similar to the reassurances spouted by some investment bank chief executives we all know. And similarly, Skinner’s optimistic remarks seemed to fall flat - not least because Rio has so far failed to get away the A$10bn or so of asset sales it planned before year-end as part of a A$15bn debt-reduction programme. And now it faces increasingly dismal valuations of miners and their various assets.
Moody’s immediately signalled a possible downgrade to Rio’s high-investment-grade A3 rating, noting that asset sales would be a key focus of its rating review.
As Breakingviews noted, if commodity prices keep falling – aluminium has plunged a third in three months – Rio will look increasingly uncomfortable.
With the deal scrapped, both sides have questions to answer. But those fired at Rio chief executive Tom Albanese may be the tougher. Albanese was spared a drubbing for his $38bn splurge on Alcan by a subsequent spike in the aluminium price, and the distraction of a bid from BHP. He has now lost both shields. By leaving its biggest rival in such a tight spot, BHP may have pulled off a sort of victory after all.
Quite possibly a sweet moment for BHP. But at the same time, its chief executive Marius Kloppers – having devoted a year to the pursuit of Rio - is under intensifying pressure to come up with a new strategy.
S&P said Wednesday it would most likely keep BHP’s credit rating outlook as “negative” until a review of its strategy after dropping the Rio bid, reports Bloomberg. “To revert the outlook to ‘stable,’ we will assess management’s near-term capital-management needs in the near term and its appetite for acquisition opportunities that may arise in the current market downturn,” it said.
As Business Spectator’s Gottliebsen says, the BHP challenge is harder to quantify “because it is not as easy to see”. The danger, he says, is that BHP will not recognise the long-term problems it now faces until it’s too late.
First is the depth of antagonism that BHP has created among both its Japanese and Chinese customers with its pursuit of Rio. Kloppers’ biggest task is to repair those relationships.
Second, when it comes to iron ore expansion, the next big project will be Rio Tinto’s because it has the best port. The BHP port requires a substantial investment, which makes sense when iron ore prices are high but no sense at all at current prices. BHP is now in danger of being the number two iron ore player with bad relations with its customers. Not a good scene.
It is hardly surprising, then, that the broad consensus emerging from the tidal wave of commentary on the failed deal suggests that BHP, going into a cheap asset cycle with low gearing, should move - fast - acquire some of the increasingly depressed miners at well below cost.
While Rio might need a more meaningful relationship, BHP may be better off preparing for a round of high-octane speed-dating.
Related links:
BHP: Altered risk dimensions - FT
Markets Live, Nov 25 2008 - FT Alphaville
Rio Tinto under pressure on asset sales - Reuters
