If the gut-wrenching scale of Rio Tinto’s writedowns of the value of its aluminium business can be attributed to flaws in Rio’s strategic thinking, the $US3 billion impairment charge against its Mozambique coal project that was announced on Friday appears to have been more about a fundamental failing in a core competency.
That may be why the Rio board saw the writedown in the value of an asset acquired only about 18 months ago as the final straw for chief executive Tom Albanese and a career-ending event for the executive who had carriage of the Riversdale Mining acquisition, Doug Ritchie.
The Alcan acquisition, which has so far resulted in losses of $US29 billion of value on a $US38 billion acquisition was, as discussed previously (The aluminium atrocity that ravaged Rio Tinto, January 18), a deal struck when Rio was trying to escape BHP Billiton’s clutches and was predicated on two big assumptions that have proven to be wrong.
One was that the aluminium price would rise in line with rising Chinese demand and the rising costs of China’s domestic producers and the other was that Alcan’s mainly hydro-based power would give Rio a significant advantage in an environment where carbon would carry an increasing cost.
Couple those mistakes in reasoning with a more prosaic mistake – Rio simply paid way too much – and the scale of the writedown is understandable, if no less traumatic.
In that sense it is analogous to BHP’s big disastrous takeover, the 1995 acquisition of Magma Copper at a moment when the copper price was at record levels.
A scandal involving a rogue trader at Sumitomo undermined the copper price, the Asian financial crisis finished it off – it halved. BHP ended up incurring losses of about $4 billion to bury an acquisition that cost it $3.2 billion and ultimately that deal resulted in the purging of its board and management. BHP, like Rio, got the big picture very wrong.
Subsequently BHP disclosed that its due diligence on Magma had been conducted by the same investment bank that had promoted the acquisition to it; something BHP said it would never allow to happen again.
The Riversdale write-off, Rio said last week, came after it realised that the development of infrastructure to support the coal assets was more challenging than originally anticipated and it had also revised down estimates of recoverable coal on the Riversdale tenements, which had led to a reassessment of the overall scale and ramp-up schedule for the project – and the $US3 billion of losses on a $US4 billion acquisition.
Rio had planned to move the coal by barge along the Zambezi River, a concept that wasn’t supported by the Mozambique government. With less coal of lower quality that Rio had thought, building rail infrastructure to get the coal to a port wasn’t a viable option.
Riversdale was Rio’s first significant acquisition after the Alcan debacle so one could have expected it would have gone to great lengths to assure itself that it understood precisely what it was buying.
The bid was an agreed offer and the bid implementation agreement makes reference to a virtual data room and due diligence, so Rio presumably did have access to non-public information on the Riversdale projects – but it appears self-evident that the quality of that information was not as good as Rio thought it was.
Big miners have access to an enormous amount of technical expertise so the combination of the misconceived plan for shipping the coal and the overestimation of the resource itself represent a failure of what should be Rio’s core capabilities. It isn’t surprising that the board’s response was brutal.
It is no coincidence that big miners tend not to make hostile takeover offers for juniors or that they generally make even agreed offers only after exhaustive due diligence. They are well aware that the quality of the data generated by smaller companies isn’t necessarily as solid as their own.
The risks are lower if the target is a large established company where there is a lot of public information available and a lengthy track record – Rio’s most successful takeover was probably its $2 billion acquisition of North Ltd in 2000, which gave it more producing iron ore mines in the Pilbara and a second port in Western Australia.
That was an acquisition of a long-established company in its own backyard with assets Rio knew very well, similar to BHP’s $US7.3 billion acquisition of WMC Resources in 2005.
One suspects that Rio will be gun-shy about acquisitions, whether agreed or otherwise, for quite some time after the bruising Riversdale experience and that for the foreseeable future it will confine itself to assets that it knows well and to development of what it has within its existing portfolio. The Riversdale lesson won’t be lost on the other big miners either.
The Alcan and Riversdale losses mean Rio can’t afford another slip up without risking being completely destabilised.
With the giant Simandou project in Guinea now apparently on the slow burner that makes it imperative that Rio’s ramp up of the Oyu Tolgoi copper-gold project in Mongolia goes smoothly, given that the those two projects are regarded as the flagships for Rio’s strategy under Albanese of adding developing world assets to its traditional portfolio of tier one assets in first world jurisdictions.
Despite some tensions with the Mongolian parliament over the size of the state’s interest in the project, it appears to be on track. It needs to remain so. At least, unlike Riversdale, Rio can be confident that it knows the resource and understands the development plan intimately.
Mining must learn from Rio's Riversdale flop
Although not as large as the Alcan loss, the Riversdale writedown was more damning on the company's leadership. It's a mistake that will instil acquisition caution in Rio Tinto and the other giants.
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