Is Rio Tinto a takeover target?

Rio Tinto's iron ore division is the best mining business in the world. Over the past five years, Rio has generated US$47bn in earnings before interest and tax from shovelling and selling dirt. Return on assets over that period has average about 90%. The Pilbara operation is the envy of peers, the bane of steel makers and the backbone of Western Australia's economy. And it is now a target.

Commodity trader and miner, Glencore, offered to merge with Rio to form a US$160bn colossus that would overtake BHP to become the world's largest miner. Rio has spurred the offer but it does highlight that the dramatic fall in iron ore prices has created a perception of vulnerability.

The perception is false. Even after dramatic falls, Rio should still generate operating margins of 50% and return on assets of about 40% from iron ore. No other miner can match its resource base, low costs and logistical nous.  It's easy to see why Glencore would want the business, it's harder to understand why Rio would sell without an astronomical price tag.

Glencore is significantly smaller than its target and has a balance sheet that is already stretched so a deal is unlikely. Not only has it displayed outsized ambitions with limited resources, it's going against a sensible industry trend to get smaller.

BHP, Rio, Anglo American and most of the industry have accepted that size is a limited advantage in the mining game. Across the industry, miners are selling assets, spending less cash and prioritising profits.

Glencore typically goes against the grain, often with great success, but this proposal is a case of reach exceeding grasp. Rio is safe from the assault and investors haven't shown too much concern about falling iron ore prices. Glencore investors, however, face a new threat: ambition.