Rio Tinto on Friday cancelled a pending deal with Chinese state-owned enterprise Aluminum Corporation of China (Chinalco), preferring to launch a $15.2 billion rights issue and enter a joint venture with Australian miner BHP Billiton.
The size of the rights issue coupled with the fact that it is fully-underwritten in two jurisdictions has resulted in a role for a number of banks. Credit Suisse, J.P. Morgan Cazenove and Macquarie are joint global co-ordinators -- a selection which likely reflects both the willingness and ability of the said firms to provide underwriting. Deutsche Bank, Morgan Stanley, RBS and Société Générale are also playing a role.
Rio Tinto simultaneously announced a 50:50 joint venture with BHP Billiton covering both companies' iron ore assets in the Pilbara region of Western Australia. The two firms said they estimate the net present value of future synergies from the JV at $10 billion. BHP will pay Rio Tinto $5.8 billion at financial close to increase its equity ownership of the JV from 45% to 50%. On the JV, BHP was advised by Goldman Sachs and Gresham Partners, while Morgan Stanley advised Rio Tinto.
Following the announcements on Friday morning, Fitch Ratings affirmed Rio Tinto's BBB+ rating and removed it from a watch status, instead assigning a positive outlook.
Rio Tinto is offering investors 21 new shares for every 40 existing shares held at £14 ($22.37) per share, or A$28.29 per share for its Australian shareholders, totalling $15.2 billion of gross proceeds. Rio Tinto maintains a dual listing with 23% of its share capital floated on the Australian Securities Exchange and the balance 77% held through a London listing.
The issue price represents a discount of approximately 38% to the theoretical ex-rights price (Terp) of £22.65 and a 47% discount to the Terp of A$53.61 per share. It also marks a discount of 48.5% to the closing price on the London Stock Exchange on June 4 and a discount of 57.7% to the closing price on the ASX on the same date.
Rio Tinto gained 10% on Friday to £30, as shareholders endorsed the new deal, while BHP gained 6.8% to £15.50.
Proceeds from the rights issue will allow Rio Tinto to repay its 2009 debt obligations in full and a substantial portion of its 2010 obligations, the firm added in a statement. Rio Tinto will reduce its net debt by $23.2 billion, exceeding the commitment the company made in December 2008 to reduce net debt by $10 billion by the end of 2009. Fitch said Rio Tinto's debt obligations of $7.2 billion and $8.1 billion in October 2009 and 2010 could now be met and Rio Tinto's next major debt maturity of $10 billion will fall due in late 2012.
The new deals mark the end of Chinalco's attempt to make the biggest-ever investment overseas by a Chinese company. Rio Tinto said it "remains interested in potential future collaboration with Chinalco and continues to recognise the importance of China and building strong relationships there".
On February 12, Chinalco, which is the parent company of Hong Kong-listed Aluminum Corporation of China Ltd (Chalco), agreed to invest $19.5 billion in Rio Tinto, split between $12.3 billion in aluminium, copper and iron ore joint ventures and $7.2 billion in two tranches of convertible bonds. Chinalco also negotiated the right to nominate two directors to the Rio Tinto board as long as it owned at least 14.9% of Rio Tinto, and one director if its ownership was between 9.9% and 14.9%. Chinalco's stake in the joint ventures would have ranged from a 15% stake in an iron ore project to a 50% ownership in an aluminium project. In total, Chinalco was to take a stake in nine different projects.
The coupon-bearing convertible bonds would have increased Chinalco's shareholding in the Rio Tinto Group to 18% upon conversion. The bonds were convertible at any time from 41 days after closing with $3.1 billion of the bonds converting at a price of $45 per share, and the balance $4.1 billion converting at $60 per share. The conversion prices were negotiated when Rio Tinto had traded down to lower levels than where it is currently at. Rio Tinto shares were trading at A$42.15 on the ASX on January 30 before news of the Chinalco investment leaked into the market, but by the time details of the deal were announced on February 11, the share price had rebounded to A$49.40.
In a written statement, Rio Tinto chairman Jan du Plessis explained that the improvement in financial markets since Rio Tinto announced the deal with Chinalco made the financial terms of the Chinalco investment less attractive and also increased the ability of Rio Tinto to raise the equity it needed. The rights issue coupled with the BHP joint venture were also preferred by Rio Tinto shareholders, du Plessis said, albeit obliquely.
One of the criticisms of the Chinalco investment that has been voiced by Rio Tinto shareholders and the Australian media was that the Chinese firm did not pay a control premium for the fact that it was acquiring a substantial strategic stake and board representation. Rio Tinto's chief executive officer, Tom Albanese, said in February that the price being paid by Chinalco and the amount being committed by the SOE would have been difficult to raise from the capital markets amid the then prevailing market conditions.
Ironically, it is demand from markets such as China, one of Rio Tinto's largest customers, which is driving up prices of natural resources and improving the outlook for Rio Tinto. Du Plessis also referred in his statement to unsuccessful attempts made by Rio Tinto to re-negotiate the deal it entered with Chinalco.
For Chinalco, the deal was a follow-up to its January 2008 initial investment in Rio Tinto when the SOE spent $14 billion to buy a 9% stake. At the time, Chinalco paid £60 per share, a hefty 21% premium to the then prevailing share price. One of the factors driving Chinalco's 2008 investment in Rio Tinto was a pending merger between Rio Tinto and BHP, which was then outstanding. Chinalco's investment coupled with Rio Tinto's rebuffs succeeded in driving BHP away.
With its second investment in Rio Tinto, Chinalco would have been seeking to average out its acquisition cost and gain some management control. Chinalco was advised on the investment by Nomura, J.P. Morgan and Blackstone, while Rio Tinto was advised by Credit Suisse and Morgan Stanley. The line-up of advisers for the BHP JV and the rights issue sees Nomura left out in the cold.
The appetite of China in general and Chinalco specifically to secure a supply of natural resources is unabated. And with China willing to direct its banks to finance such ambitions -- China Development Bank was providing debt to Chinalco for the Rio Tinto investment -- Nomura will no doubt win other business from this client. Also, Chinalco remains Rio Tinto's single largest shareholder, a point stressed by the Chinese company in a written statement on Friday in which it announced that the proposed investment in Rio Tinto was aborted.
The timing of the announcement by Rio Tinto is unlikely to be coincidental. The Chinalco investment was under review by Australia's Foreign Investment Review Board and the deadline for FIRB to announce a decision was fast-approaching. Mandarin-speaking Australian prime minister Kevin Rudd was walking a tightrope between offending China, a country with whom he has worked hard to forge closer ties, and managing the opposition mounting in Australia to having Chinese government-owned companies acquire even partial control over valuable natural resources assets in the country.
China may have been saved the embarrassment of a rejection or large-scale renegotiation of the deal, but it is still likely to be smarting from the rebuff and the $195 million break fee it will receive from Rio Tinto will not do much to alleviate this. Chinalco said in the statement that it had worked constructively to amend the transaction terms and was "very disappointed with this outcome".
China has a lot at stake if the BHP-Rio Tinto combine starts to flex its muscle on iron ore pricing. With the amount it was willing to invest, Chinalco is likely to go shopping for other targets to prevent such a situation. It may, however, choose to find them in countries where China's capital is more welcome.
