Rio names its price

The most striking aspect of Rio Tinto proposed "strategic partnership" with Chinalco is not much the dollars involved – the $US19.5 billion in cash involved was leaked well in advance – but how complicated the deals are and how pervasive the Chinese influence in Rio's core assets will be.

At face value, the "partnership" breaks down into two core elements – the $12.3 billion of investments in Rio's iron ore, alumina and bauxite and copper projects and the $7.2 billion to be invested in Rio convertible securities that would give Chinalco 19 per cent of the London end of the dual-listed entity and 14.9 per cent of the Australian entity. They equate to an effective 18 per cent interest in the entire group.

Neither element is straightforward, with the equity convertible and different premia in different tranches in each entity at different prices over a period of up to 60 years. Only the Chinese would do a deal which contemplates a 60-year horizon.

The investment in the Rio businesses is a mixture of direct investment and a form of tracking security or synthetic that would give Chinalco a return based on the cash generated by the underlying businesses. Presumably that relates, at least partly, to the desire to avoid capital gains taxes, stamp duties and changes to state legislation.

It is going to take some time for the market to digest the detail of the proposal but it would appear reasonable to conclude that Chinalco is proposing to pay a big price, not to control Rio, but to ensure that it has significant influence at the corporate level and, at the project level, both influence and longterm security of resource supply.

Apart from two board seats Chinalco will have representation within the product group and strategic exploration alliances Rio plans to establish. Chinalco will also be able to place its nominees on the product groups' holding company boards and will be able to second executives into each of the strategic alliances. It will also be guaranteed longterm shares of output of iron ore and bauxite, securing a minimum level of supply for China.

Chinalco will bind Rio even closer by creating access for Rio to explore within China and even arrange future debt funding with Chinese institutions. Over time Rio is going to be tied very tightly, probably inescapably, to China.

Rio tried to present the alliance as if it was just a series of conventional joint ventures. It isn't. The shareholdings at the corporate level and the breadth and depth of engagement and enmeshment with Chinalco make it something quite different. If the deal is endorsed by shareholders, Rio will be forever changed, and forever locked in the embrace of China Inc.

A deal involving some sacrifice had to be made to cope with the destructive impact of Rio's decision to pay massively over the odds for Alcan at the top of the market – Rio wrote $8.4 billion off the value of those assets in its results – and then to debt fund the entire deal.

Without raising something approaching the $19.5 billion Chinalco is stumping up, Rio was at severe risk, with a $8.9 billion debt repayment due in October and another $10 billion next year.

The price of the Alcan mistake is, under the Chinalco proposal, that It has been forced to hand over slices of its best assets. 15 per cent of Hammersley and 30 per cent of Weipa are amongst the nine interests being sold. If and when the recovery comes, its exposure to it will be diminished.

At least Rio appears to be getting good values, in the current circumstances for those strategic slices of its best assets.

Rio claims that, in aggregate, it is getting a 124 per cent premium for the current market enterprise values of the assets involved and that the prices are consistent with the net present value of the assets. It also says that while Chinalco would pay the equivalent of 18 per cent of Rio's current market enterprise value it would get the equivalent of only 8 per cent of the group's earnings before interest, tax, depreciation and amortisation.

All things are, of course, relative. However attractive the Chinalco deal might be to a desperate Rio, it would get better prices for bits of its best assets in a better environment if it were itself in a stronger condition.

While Rio's Tom Albanese continues, remarkably, to pour scorn on BHP's attempted and ultimately aborted merger last year, Rio shareholders have been backed into an uncomfortable corner by a board and management whose track record – the Alcan deal and the arrogant refusal to engage with BHP – doesn't provide much confidence in their judgment.

Shareholders will get to vote on the proposals in May, with the shadow of the October deadline for repayment of the first slab of the Alcan funding hanging over their deliberations.

There is a strong institutional constituency for the alternative of a deeply-discounted rights issue, asset sales and capital preservation measures.

Whether it remains strong now that the detail of the deal with Chinalco is out, will have a significant bearing on Rio's future, not just in the next year or two but over the next several decades, perhaps the next 60 years or more.