Rio Scraps Chinalco Deal for $21 Billion Offering, BHP Venture

Rio Scraps Chinalco Deal for $21 Billion Offering, BHP Venture


June 5 (Bloomberg) -- Rio Tinto Group, the world’s third- largest mining company, scrapped an investment from Aluminum Corp. of China in favor of raising $21 billion from a share sale and an iron ore venture with BHP Billiton Ltd.

The new shares will be sold at 1,400 pence each, 49 percent below yesterday’s close in London, raising $15.2 billion, the company said today in a statement. Shares of Rio and BHP both surged in Sydney trading.

Today’s deals allow Rio to reduce $38.9 billion in debt without selling bonds and stakes in its largest mines to Chinalco, defusing a backlash from shareholders and politicians. The collapse of the China accord is a setback for the nation’s plan to secure supplies of materials to drive economic growth.

“The ability of Rio to put away the deal and not have to rely on Chinese financing is a huge positive in terms of the dynamics of the market today and in the future,” said Tim Schroeders, who helps manage $1 billion at Pengana Capital Ltd. in Melbourne. “You could say the Chinese ability to divide and conquer producers, and to have control over the market, has been lessened.”

Rio rose as much as 13 percent in Sydney for their biggest gain since November 2007. They traded at A$72.99 at 3:06 p.m. Sydney time on the Australian stock exchange. BHP rose as much as 10 percent, its biggest gain since it abandoned a hostile bid for Rio, partly because of concern over its debt levels. Rio will cut its debt to about $23.2 billion, the company said today.

‘Wrong Deal’

The deal Rio Chief Executive Officer Tom Albanese, 51, brokered with Chinalco, as the Chinese company is known, was criticized by Legal & General Group Plc, the third-largest investor, and the Association of British Insurers, for not giving them the option to participate in the fund-raising. His Chinalco accord also spurred a Senate inquiry in Australia.

“The Chinalco deal was wrong in a strategic sense,” said Prasad Patkar, who helps manage about $1 billion at Platypus Asset Management in Sydney. “The market was right in marking the management and board down for trying to jam it down shareholders’ throats. But you have to give Rio’s new Chairman Jan Du Plessis due credit for listening and pursuing alternatives.”

Rio dropped the deal with Chinalco, which was agreed in February, after the improvement in financial markets, du Plessis said in a statement. “The financial terms of the Chinalco deal became markedly less valuable” and “our ability to raise a level of equity appropriate for our needs on attractive terms has improved considerably,” he said.

‘Very Disappointed’

Chinalco is “very disappointed” with the failure of its investment plan, President Xiong Weiping said today in a statement. Today’s deal replaces the planned $19.5 billion investment from Chinalco, China’s biggest aluminum producer. The company, Rio’s biggest shareholder, will monitor the iron ore joint venture announced today by Rio and BHP, Xiong said.

“The global capital financial market has stabilized and individual companies now can get back to the stock market to raise equity or bonds to strengthen their balance sheets,” said Winson Fong, who helps manage about $2 billion at SG Asset Management H.K. Ltd., adding that Rio’s decision won’t stop future Chinese investment overseas. “They’re no longer desperate to find strategic investors.”

BHP agreed to pay Rio $5.8 billion to create the 50-50 venture, the two companies said today in a separate statement. The two companies may save more than $10 billion by combining their iron-ore assets in the Pilbara region of Western Australia, they said. The two will continue to sell their ore independently through their own marketing groups.

Falling Prices

BHP “played their hand pretty well,” said Peter Arden, resource analyst at Ord Minnett Ltd., an affiliate of JPMorgan Chase & Co. “It’s a neat solution for both companies at a time of falling commodity prices. To be able to unlock this kind of value is extraordinary.”

Rio and Melbourne-based BHP may supply 75 percent of China’s imports of iron ore this year, according to Goldman Sachs JBWere Pty. China is the biggest steelmaker. Brazil’s Vale SA is the largest iron ore producer. Rio last month agreed a 33 percent drop in contract prices with steelmakers in Japan and South Korea.

“While this deal has been more than 10 years in the making, I believe it has been worth the wait,” Marius Kloppers, 46, chief executive officer of BHP, said on a call with reporters, adding he had initiated talks for the venture with Rio. “If we combine these we can get very, very substantial production, development and financial synergies.

A Pilbara joint venture had been studied in 1999 and was a key driver behind BHP’s hostile takeover bid for Rio, Citigroup Inc. said in a report last month. Kloppers dropped the planned acquisition in November last year, citing turmoil in global markets, slumping demand for commodities and Rio’s debt.

Deal Savings

‘‘The synergies are there,” Chris Weston, an institutional dealer at IG Markets in Melbourne said by phone. He didn’t foresee any competition concerns because BHP won approval in October last year from the Australian Competition and Consumer Commission for its hostile takeover of Rio. The regulator said the proposed acquisition wouldn’t be likely to substantially lessen competition in any market.

The cost of protecting Rio’s debt plunged. Credit-default swaps on Rio fell 125 basis points to 180 as of 11:15 a.m. in Sydney, according to National Australia Bank Ltd. The contracts, which decline as investor perceptions of credit quality improve, have fallen 82 percent since January, CMA DataVision prices show.

“Perversely the best outcome for bondholders was if the Chinalco deal failed,” said Mark Bayley, an independent credit credit strategist based in Sydney. “A capital injection is a significant improvement for bondholders over the Chinalco convertible and asset sale option as it means there will be no additional debt.”

Rio is cutting jobs and trying to sell assets to repay $10 billion of debt this year. It has total borrowings of $38.9 billion, incurred mainly through the 2007 purchase of Alcan Inc.

Earnings Decline

At $15.2 billion, the rights offering would be the second- biggest this year after HSBC Holdings Plc, which sold $18.3 billion of stock in April. Rio will offer 21 Sydney-traded shares for every 40 already held at A$28.29. That’s a discount of 57.7 percent to the last traded price, it said.

Credit Suisse Group AG, J.P. Morgan Cazenove Ltd. and Macquarie Capital Ltd. are acting as joint global coordinators on the rights issue.

Rio joins companies including Xstrata Plc, the world’s fourth-largest copper producer, that have sold $45.2 billion of stock to existing investors, data compiled by Bloomberg show.

The trading outlook for the rest of the year remains “uncertain,” du Plessis said today in a letter to shareholders. It reported a 45 percent drop in first quarter earnings, down to $1.6 billion.

Under the plan announced Feb. 12, Chinalco had agreed to buy $7.2 billion of convertible debt and pay $12.3 billion for stakes in some Rio projects. Rio said today it will pay Chinalco a $195 million break fee.

BLOOMBERG