Underwhelmed.
That’s probably the best way of summing up the market’s initial reaction to Rio Tinto’s $19bn deal Pioneering Strategic Partnership with Chinalco, China’s biggest aluminium maker.
Shares in Rio are 24p lower at £19.43 in early trading on Thursday.
In summary, Rio is selling big stakes in some of its most important assets for prices which are less than spectacular. On top of that, the terms attached to the $7.2bn of convertible bonds (which could see Chinalco’s holding in Rio rise to 18 per cent) are not particularly attractive and the Chinese get to appoint two directors to the Rio board.
Here’s the early reaction from the City.
Cazenove:
Our initial reaction is, to say mildly and with emotions in check, disappointment on both levels of economic interests being sold and the value attached. Chinalco have gone straight for the ultra tier one assets within the stable — Weipa, Hamersley Iron and Escondida along with the other tier one and important businesses of Kennecott Holdings (Bingham Canyon), Yarwun, Grasberg and the La Granja copper project. In addition they have bought stakes in Boyne and Gladstone Power Station. No coal though and sadly no downstream aluminium packaging assets. The stakes range from 15% to 50% versus market speculation of 10-20%.
The convertible does not look particularly attractive for Rio Tinto either (the coupons are 9 and 9.5% respectively) and with two Chinalco nominated directors on the board of the company comes conflicting interest from the world’s hungriest consumer of commodities. Furthermore the two companies have entered into various strategic alliances that give Chinalco even greater levels of control in the underlying businesses.
It feels as if these transactions were struck under the duress of the BHP Billiton offer post the Lehman failure and complete credit seizure in Q3 last year. Conditions have changed and the market’s appetite for a rights issue with it.
Indeed!
UBS:
On an intitial view, RIO receives US$12.34bn from asset sales, while our estimated NPV for what was sold is roughly US$10.8bn. This prima facie represents a 14% premium although we need to analysis the sales in greater detail. Potentially the market is likely to view the removal of debt overhang as favourable, however may be dissapointed by the modest premium to our valuations, given previous asset sales have been achieved at larger premiums.
and Merrill Lynch:
Our initial reaction: this will be taken positively first thing as balance sheet/debt
service overhang removed and conversion price on bonds well above current
share price (in case of plc) BUT rally should be sold given rights issue preferable
(in our opinion), regulatory hurdles etc.
Little wonder chairman designate Jim Leng resigned earlier this week.
The good news for shareholders at least, is that they can vote this deal down – it needs 50 per cent +1 to go through. There is a $195m break fee, but this is not payable if investors decided to vote against the transaction.
So it’s make your mind up time for institutions here and in Australia.
Do they want to sell at the bottom of the market and give away the upside when commodity prices rally? Do they want to lose their ability to charge premium prices for their products (for China is Rio’s biggest customer)?
Fortunately, the timetable on this deal is fairly lengthy – the EGM is likely to be held in May/June.
Over to you shareholders. Deal or no deal?
Here’s what Cazenove thinks:
While we recongnise that the price paid in terms of earnings multiples looks relatively attractive
against current trading metrics, we find it difficult to reconcile the rationale for this deal with Rio Tinto’s history of long term value creation for its shareholders. We believe the market reaction will hinge on three inter-related decisions. Firstly, do shareholders believe that strengthening the company’s ties to one of its major customers is positive or negative? Secondly, does the magnitude of asset sales appropriately reflect the benefit of the tie-up? Finally, are shareholders comfortable that the proposed deal is a better alternative than raising money through more traditional means?
Related links:
Pioneering Strategic Partnership – Rio Tinto
Hold Tight for a might Rio row – The Guardian
Chinalco deal raises tough questions for Rio Tinto – FT.com
Rio Tinto and its new masters – FT Alphaville