Rio Tinto Scraps Chinalco Deal

It was not a good day for China’s steelmakers. What BHP Billiton couldn’t accomplish in iron ore by buying all of Rio Tinto, it will now accomplish in a 50/50 mining joint venture between the two companies. As a result of its new agreement with BHP, Rio Tinto decided to scrap the proposed $19.5 billion investment by Chinalco into the company. Instead, Rio Tinto will use the $5.8 billion of proceeds it expects to receive from BHP as part of the joint venture agreement, plus $15.2 billion from a rights issue and a skipped dividend to cover its cash requirements.

The new joint venture will own the prized iron ore assets in the Pilbara region of Western Australia of both miners, and will topple Brazil’s Vale as the world’s largest iron ore producer. Because RioTinto’s contribution to last year’s aggregate output was 55 percent, a $5.8bn investment from BHP is required to even things up between the two partners. The effect of this joint venture is to reduce the number of major global iron ore producers from three—BHP, Rio Tinto and Vale—to two—the BHP/Rio Tinto joint venture and Vale.

Even before the deal with BHP was announced, fireworks had already started between the miners and China, their biggest customer. Last week, China’s top steel negotiators formally rejected iron ore price cuts negotiated between Rio Tinto and Japanese and South Korean steel mills, signaling a showdown between Beijing and the miners. Look for tough negotiations between China’s steelmakers and the miners in the months ahead.

In the aftermath of the announcement, Australia’s prime minister sought to reassure China, the country’s biggest two-way trading partner, that the failed tie-up between Rio Tinto and Chinalco did not represent a change in attitude from his government towards foreign investment. While there was political resistance in Australia to the proposed Chinalco investment in some quarters, shareholder resistance was the primary reason why the deal was ultimately scuttled. Rio Tinto shareholders have been upset with the company for some time. An ill-timed purchase of Alcan in 2007, which saddled Rio Tinto with a high level of debt, the rejection of BHP’s $147 billion takeover bid in 2008, and the proposed sale of convertible bonds and assets at seemingly bargain basement prices to Chinalco have not sat well with Rio Tinto’s large shareholders.

From the point of view of Rio Tinto’s shareholders, scrapping the Chinalco deal in favor of the joint venture with Rio Tinto and a rights offering makes sense. In terms of global competition for resources that are becoming increasingly dear as China, India and other emerging countries industrialize, however, it’s anything but a positive development. The world’s supply of iron ore, one of the most basic building blocks in an industrial economy, will now be in the hands of a powerful duopoly, one in the Western Hemisphere and the other in the eastern part of the world. Consumers everywhere will pay the price.

2 Responses to “Rio Tinto Scraps Chinalco Deal”

  1. Hi Jack, I was curious…given the spate of unfortunate mining accidents in China, you’d have thought the Chinalco deal would be trumpeted for the stellar safety standards Rio Tinto would bring to the bargaining table. I’m sure the PR people were all over this one.

    The optics on this deal looked enticing from other another perspective besides a strict evaluation of the financials. I’d like to think China is serious about putting its money where its mouth is in terms of the national desire to clean up their environmental act. So much for the stimulus heralding the advent of a new era.

    You mention nothing about the rash of mine cave-ins…what’s your position on these, out of curiosity?

  2. As far as I could tell, there was no agreement that Rio Tinto would bring their mining technology to China in the Chinalco deal. That was simply an investment by Chinalco that would have maintained three strong players in the iron ore industry.

    Unfortunately, the high demand for raw materials of all type have encouraged marginal players in the mining industry to ramp up production. Cutting corners on safety usually leads to mining incidents and loss of lie. There’s nothing that I can say other than to express my deep sympathy for the victims and their families. Tighter regulation of safety standards by local officials would go a long way.

    I agree that China has much to do on the environment. As a Beijinger, though, I can attest to the fact that the government is taking action. See my recent post on “Blue Sky Days in Beijing.”