Taking Rio back to the future

Rio Tinto once prided itself on the quality of its transaction evaluation. After the disastrous decisions to buy Alcan and Riversdale, Sam Walsh appears determined the mining major is as diligent in the future as it once was.

How a company responds to a major mistake can provide telling insights into why it believed it made the mistake. The Rio Tinto annual report provides a glimpse into its perception of the cause of the breakdown in processes that claimed the scalp of former chief executive Tom Albanese.

Just over a year ago, Albanese and the much-respected executive who oversaw the ill-fated acquisition of the Mozambique coal miner, Riversdale Mining, fell on their swords after Rio was forced to write-off $US3 billion of the $US4bn purchase price.

It was that event which shocked a group that prided itself on its ability to assess and execute projects, far more than the latest write-down of Alcan assets, which led to the resignations of Albanese and Doug Ritchie and the appointment of veteran executive, Sam Walsh, as CEO.

Riversdale was Rio’s first significant acquisition after its Alcan-inspired brush with disaster during the financial crisis, and its admission it had under-estimated the extent and cost of the infrastructure required to develop Riversdale’s resources and had over-estimated the scale of the resources was an embarrassment to the organisation.

When Jan du Plessis became chairman of Rio in very difficult circumstances in 2009, one of the most telling changes he made to Rio’s governance structures was to remove himself from the group’s investment committee. His predecessor, Paul Skinner, had chaired that committee.

Having the chairman of the board chairing an investment committee creates the risk they both shape the committee's recommendations on spending to the board and, given the recommendations will be backed by both chairman and CEO, make it very difficult for the non-executives on the board to challenge the recommendations without creating a governance crisis.

Rio's latest annual report shows that Sam Walsh has also spent some time thinking about that investment committee and how it functions, presumably in response to his own post mortem of what went wrong in the committee’s assessment of Riversdale.

When Walsh became CEO a year ago he said he would strengthen the balance sheet and the group’s processes for allocating capital. In the annual report Rio says it set up ‘’cash generation offices’’ during the year to strengthen the focus on cash and improve visibility for senior managers, and had ‘’elevated’’ the role of subject matter experts in the economic and technical evaluation phases of projects. It had also strengthened the investment committee approvals process.

Rio said it planned to continue to apply its "enhanced" capital allocation systems and controls to maintain discipline in 2014.

There is a clear implication in those comments that Walsh wasn’t happy with the extent of emphasis on cash generation but, more relevant to the Riversdale fiasco, also wasn’t comfortable with the way major investments were being assessed.

If the role of subject matter experts had to be elevated, it implies those experts hadn’t made, or been able to make, the contribution he felt should have been made in the past. If the systems of capital allocation had to be enhanced, clearly he felt they were previously inadequate.

There have been suggestions within Rio that under Albanese -- and this may have developed during the period the committee was led by the chairman -- the investment committee had to a large extent been disconnected from the technical experts within the company, with investment proposals not being subjected to the same levels of scrutiny by the experts as they had been in the past.

Walsh, a Rio veteran, appears to have ventured back to the future, ensuring every significant proposal has to run the gauntlet of an intense evaluation process before it reaches the committee.

In the pre-crisis period and, indeed, in the post-crisis environment, where until relatively recently there was a scramble by resources companies to get new projects into the market during the commodity price boom, there was a sense of urgency that perhaps explains why short-cuts were taken.

In the current environment, where Rio and its peers are extremely capital conscious and are carving into their pipelines of new projects to reduce capital expenditures, strengthen their balance sheets and position themselves to respond to shareholder demands for bigger returns, there is no rush to spend the cash and that creates an opportunity to impose more stringent processes.

Rio once prided itself on the quality of its evaluation and execution of transaction. It was built to a large degree on a series of very strategic and successful acquisitions. Alcan and Riversdale are the blots on its copybook. Walsh appears determined to ensure that in future Rio remains as diligent as it once was.

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