Rio Tinto's near miss

An unanswerable question that flows from the high-profile failure of China's Chinalco to execute its controversial alliance with Rio Tinto is whether, had it sought less, or the timing and context been different, the outcome would still have been the same.

One suspects it might not have been. The timing, during the worst of the financial crisis, and the multi-layered nature of Chinalco's demands reeked of opportunism by Chinalco and desperation by Rio.

A less complex deal, one that involved a less pervasive and conflicted presence by Chinalco in Rio's affairs and that didn't appear quite so opportunistic, might well have been more saleable.

Indeed, in the not too distant future, when the rapidly recovering Rio has completed the deleveraging and streamlining of its portfolio and put its post-Alcan controversies completely behind it, a cleaner and simpler and more conventional alliance with a Chinese entity (perhaps even Chinalco, which remains Rio's biggest shareholder) might well be regarded as providing competitive advantage if Rio secured preferential access to the Chinese market and/or funding.

There is little doubt that the Chinese were bewildered and, at the time, quite angry about the reception the Chinalco proposal received from Rio shareholders, the media and the public at large, particularly in Australia.

Rio's decision – under extreme pressure from its own shareholders and against the backdrop of rapidly improving equity markets – to abandon the proposal, raise $US15 billion of equity and agree to joint venture its Pilbara iron ore operations with BHP Billiton, raised the tensions further (Full coverage: Rio-BHP joint venture).

It would appear, however, that after a period of introspection, the Chinese have come to a more balanced and quite sophisticated understanding of what happened to the Chinalco deal.

Fairfax's estimable China correspondent, John Garnaut, produced a fascinating report today on an investigation of the deal and its failure that was produced for China's State Council, the equivalent of our federal cabinet.

According to Garnaut, the failure of the proposal has been attributed to the rapid recovery in the world's resources and equity markets – a recovery beyond anyone's expectations. The failure had also exposed China's lack of experience, talent and political acuity.

There doesn't appear to be any continuing resentment towards Rio, which did inform Chinalco that it was discussing the joint venture with BHP, and an acknowledgement that Rio had more strategic interests in pursuing the Pilbara joint venture than a vertical merger with Chinalco, which raised potential conflicts of interests, given Chinalco's status as a potential major customer.

The Chinese do, however, blame BHP for running a skilful media strategy and for its lobbying and fomenting a bigger than expected public backlash against the deal in Australia.

The reality, of course, is that neither BHP, nor the Australian Government, nor the public reaction blew up the Chinalco deal.

As the Chinese appear to have finally appreciated, once the markets started recovering and Rio could be confident of raising sufficient capital to fully stabilise a debt-laden balance sheet, it was always going to be sensitive to the views of its own shareholders.

They wanted to refinance Rio themselves rather than allow Chinalco to gain key slices of Rio's most attractive assets, as well as pervasive influence, on terms negotiated while Rio was on its knees.

The acceptance that the combination of Chinalco's own misjudgments and external circumstances played the larger role in the failure of the deal is an important sign that China's understanding of the context in which sensitive strategic investments occur is rapidly maturing.

It appears to now have a better understanding of the way governance works within big listed companies and of the reality that boards ultimately answer to shareholders and are sensitive to their views.

It is also fascinating that, according to Garnaut's report, the post-mortem has quite dispassionately come to grips with the conflict of interest issue – it acknowledges that a "vertical merger" could harm the interests of other non-Rio shareholders – that under-pinned much external cynicism about the alliance.

Rio – because of its size, significance and the strategic nature of some of its key operations – was an unusually sensitive target for a Chinese state-owned enterprise's ambitions.

A host of other proposed investments have been approved by Australian companies and the government, albeit some with modifications and undertakings, and without anything like the same level or intensity of debate and controversy.

If the Chinese take on board the messages within their post-mortem of the aborted Rio proposal, they can still achieve their goals of achieving security of supply and a hedge against the price impacts of their own growing demand without the confrontations and controversies that the Rio experience generated. That would be, not just in their interest, but in our's too.