Rio deal hits use-by date
Stronger equity markets and a strict approach from the regulators are rendering Chinalco's Rio Tinto proposal increasingly unattractive. It's possible that the best time to complete the deal has passed us by.
Over the weekend HSBC raised almost $25 billion through a deeply-discounted rights issue. Apart from the significance of the event for the globe's ailing banking system, it signals that there is some depth to the rebound in equity markets in the past few weeks. That adds a new dimension to the controversial $US19.5 billion package of proposed dealings between Rio Tinto and Chinalco.
The strongest argument for the proposed deal has been that Rio had no viable alternative that would completely and comprehensively deal with the threat posed by the debt it took on for the ill-timed takeover of Alcan.
It has argued that it needs something close to $US20 billion to de-leverage its balance sheet and give it the capacity to repay the $US19 billion mountain of debt that matures this year and next.
In the circumstances that prevailed earlier this year, when markets were volatile and still trending down, Chinalco represented the only option for fixing the Rio balance sheet in an instant – although Rio's institutional shareholders weren't quite as convinced.
They still aren't. Rio has been constantly engaged with its London and Australian institutional shareholders since it announced the Chinalco deal in February and would be aware that they are still agitated. This month's annual meeting could produce some fireworks.
As the tone and level of the sharemarket improves, the appeal of the Chinalco deal will wane even further.
The UK institutions were unhappy that their pre-emptive rights to participate in any capital raising were circumvented by Rio's deal with Chinalco. Rio shareholders generally weren't convinced Rio had extracted sufficient value from Chinalco in return for effectively extinguishing their control premium – the level of influence Chinalco would have over both the Rio register and at the asset level would make the group essentially takeover proof.
The extent of the sharemarket's bounce – Rio shares are now nearly 90 per cent higher than at their low-point last December and have risen more than a third in the past month – lessens the relative appeal of the Chinalco deal, particularly its equity component.
It also improves the capacity of the market to supply an alternate source of capital, as the HSBC raising demonstrated. Rio has also shown it can sell assets at reasonable prices, raising $US2.5 billion from the sale of non-core assets so far this year to add to the $US3 billion sold last year.
Rio's chief financial officer, Guy Elliott, raised eyebrows last month when he conceded Rio did have a "Plan B." He told an investor conference that Rio had a back-up plan in case the Chinalco deal was blocked by government or shareholders, involving bond issues, asset sales, equity raising and debt re-scheduling. There were reports in London over the weekend that Rio has a $US8 billion equity raising planned if the Chinalco deal falls over for any reason.
The environment for both equity and debt issues has improved markedly in recent weeks, while the prospect of the deal getting past the Australian Government without substantial revisions appears to have diminished.
While it remains improbable that the government will block the Chinalco deal, it looks increasingly likely that, as a minimum, the government will impose significant conditions on the groups.
The nature of the government's approval of the Hunan Valin alliance with Fortescue Metals would suggest, if the government is to be consistent, that Chinalco's proposed level of influence within Rio's board committees would be constrained, its representation on strategic alliance committees at the asset level could be a sticking point and the proposed marketing joint venture would be ruled out.
If its layers of proposed involvement were whittled down, would Chinalco still proceed on the same terms? Would it seek to renegotiate the value it has attributed to Rio convertible equity and the investments in Rio assets? Equally, if the market continues to firm, would Rio's commitment to the proposal and its terms start to wane?
Markets are inherently uncertain and, in the midst of a global financial crisis and economic recession, the current markets are more fragile than they have been for a very long time. If they continue to improve between now and the shareholder meetings that will vote on the deal, however, the opposition from Rio shareholders will only strengthen.
The strongest argument for the proposed deal has been that Rio had no viable alternative that would completely and comprehensively deal with the threat posed by the debt it took on for the ill-timed takeover of Alcan.
It has argued that it needs something close to $US20 billion to de-leverage its balance sheet and give it the capacity to repay the $US19 billion mountain of debt that matures this year and next.
In the circumstances that prevailed earlier this year, when markets were volatile and still trending down, Chinalco represented the only option for fixing the Rio balance sheet in an instant – although Rio's institutional shareholders weren't quite as convinced.
They still aren't. Rio has been constantly engaged with its London and Australian institutional shareholders since it announced the Chinalco deal in February and would be aware that they are still agitated. This month's annual meeting could produce some fireworks.
As the tone and level of the sharemarket improves, the appeal of the Chinalco deal will wane even further.
The UK institutions were unhappy that their pre-emptive rights to participate in any capital raising were circumvented by Rio's deal with Chinalco. Rio shareholders generally weren't convinced Rio had extracted sufficient value from Chinalco in return for effectively extinguishing their control premium – the level of influence Chinalco would have over both the Rio register and at the asset level would make the group essentially takeover proof.
The extent of the sharemarket's bounce – Rio shares are now nearly 90 per cent higher than at their low-point last December and have risen more than a third in the past month – lessens the relative appeal of the Chinalco deal, particularly its equity component.
It also improves the capacity of the market to supply an alternate source of capital, as the HSBC raising demonstrated. Rio has also shown it can sell assets at reasonable prices, raising $US2.5 billion from the sale of non-core assets so far this year to add to the $US3 billion sold last year.
Rio's chief financial officer, Guy Elliott, raised eyebrows last month when he conceded Rio did have a "Plan B." He told an investor conference that Rio had a back-up plan in case the Chinalco deal was blocked by government or shareholders, involving bond issues, asset sales, equity raising and debt re-scheduling. There were reports in London over the weekend that Rio has a $US8 billion equity raising planned if the Chinalco deal falls over for any reason.
The environment for both equity and debt issues has improved markedly in recent weeks, while the prospect of the deal getting past the Australian Government without substantial revisions appears to have diminished.
While it remains improbable that the government will block the Chinalco deal, it looks increasingly likely that, as a minimum, the government will impose significant conditions on the groups.
The nature of the government's approval of the Hunan Valin alliance with Fortescue Metals would suggest, if the government is to be consistent, that Chinalco's proposed level of influence within Rio's board committees would be constrained, its representation on strategic alliance committees at the asset level could be a sticking point and the proposed marketing joint venture would be ruled out.
If its layers of proposed involvement were whittled down, would Chinalco still proceed on the same terms? Would it seek to renegotiate the value it has attributed to Rio convertible equity and the investments in Rio assets? Equally, if the market continues to firm, would Rio's commitment to the proposal and its terms start to wane?
Markets are inherently uncertain and, in the midst of a global financial crisis and economic recession, the current markets are more fragile than they have been for a very long time. If they continue to improve between now and the shareholder meetings that will vote on the deal, however, the opposition from Rio shareholders will only strengthen.
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