What a beautiful, impossible, merger it would be
Rio Tinto is both a wondrous prize and a huge risk for BHP. That Marius Kloppers is going for it is almost a sign of desperation.
Rio would be a massive and very difficult acquisition for BHP. The cultures are completely different and deeply entrenched, and just getting to first base with the European competition regulators will be very tough.
And then there’s having to deal with the outrage and feverish opposition of the Chinese customers.
That BHP is going for Rio Tinto is, in some ways, a sign of desperation … but, oh my, what a beautiful merger it would be.
It’s all about steel -- and China. True, putting these two companies together would give them tremendously strong positions in copper, steaming coal, aluminium, gold and uranium.
But in coking coal a merged BHP and Rio would own two-thirds of the market and in iron ore at least half. The synergies from running the entire Pilbara as a single operation would be extraordinary.
And clearly when Marius Kloppers looked around the world for assets to buy and fulfil his promise of growth by acquisition, there was very little available that would not dilute the quality of BHP’s existing portfolio, or else be too small to worry about.
Despite all the difficulties, Rio is the obvious candidate. If he can pull it off at anything like a reasonable price, he would set up BHP for generations to come.
And perhaps the willingness of Mick Davis at Xstrata to pay a 35 per cent premium for Jubilee Mines focused Kloppers’ mind on what he needs to do -- so he wrote to Rio’s board and offered 3:1.
At the time, BHP’s price would have been around $A45, so that was a bid worth A$135 a share, a premium at the time of 20 per cent. He probably felt that was a reasonable starting point.
There was some toing and froing. Rio’s board thought about it and said no.
And then, in London, BHP raised the stakes by making it public and trying to put pressure on the Rio board. It was Negotiating Tactics 101.
There was some talk in London last night Melbourne time that the story got out inadvertently -- that one of the bankers talked and BHP was forced to make a statement to the market to pre-empt a more substantial leak.
That idea is given weight by the peculiar series of statements from the two companies: first one from BHP "acknowledging” that it had approached Rio Tinto, and then a quickie from Rio confirming BHP’s but adding that the approach was rejected.
BHP then put out another statement confirming the earlier one and saying that, in effect, it is not planning to go away. "BHP ... intends to continue to seek an opportunity to meet and discuss its proposal with Rio Tinto," that statement said.
Rio then put out its own formal statement confirming that "major discussions” had taken place after BHP made a proposal to take over Rio by offering three of its shares for every one Rio share, but that was rejected because it "significantly undervalued” the company and its prospects.
It’s ironic that Brian Gilbertson was bundled out of BHP after trying to get up a takeover of Rio Tinto, but this time, of course it’s very different.
Specifically, conditions in commodity markets have changed dramatically -- especially for iron ore and coking coal, as a result of the stupendous demand for steel in China and India, caused by mass migration of people from the rural parts of those countries to apartments in the cities.
That ensures that prices and volume demand for steel-making materials will continue to rise strongly and that very significant premiums can be justified for high-quality mining operations in those businesses. (Brian Gilbertson himself has been engaged in a brutal takeover battle for a producer of another steel raw material -- manganese).
And then there’s Rio Tinto’s fabulous Oyu Tolgoi copper deposit in Mongolia, one of the greatest the world has ever known.
The other thing that has changed is BHP’s cash flow, not that there is any talk at this stage of a cash bid for Rio. BHP is throwing off free cash, after all financing and investing, and after dividends, of nearly $10 billion a year.
There is simply nothing to do with that money except give it back to shareholders.
BHP has made it clear that it not going to just give up now after being rejected. Rio is in play now and BHP is the only buyer.
Although the approach seems to have been messily revealed yesterday, we can be sure it has been carefully thought through and the boxes ticked, including potential anti-trust issues.
It should a fascinating tussle, if the wrestling of elephants for supremacy can be called a tussle, and it should have a dramatic impact on the whole sharemarket -- at least in the short term.
The fact that not only did Rio’s price go up 25 per cent immediately, but that BHP’s rose a few per cent as well, tells you that this is merger the market wants to see.
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