Waiting Game for Chinalco's Rio Tinto Deal

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Australia’s foreign investment authorities are giving no hints about the possible outcome of an inquiry into a proposed stake increase in Australian miner Rio Tinto by China’s state-owned China Aluminum Corp. (Chinalco).



But official scrutiny into the huge, US$ 19.5 billion deal, which Chinalco and the debt-ridden Rio Tinto announced February 9, will take plenty of time and stretch far beyond the inquiry soon to be launched by the Foreign Investment Review Board.



Chinalco’s plan to boost its holdings in the world’s third-largest mining company by up to 18 percent is also being closely examined by government regulators in the United States, Germany, Britain and China.

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And it will need backing from Rio Tinto shareholders, who plan to discuss the proposal in March.



The Australian investment board may take up to 130 days to study the plan before making a recommendation to Treasurer Wayne Swan, who has veto power. Patrick Colmer, treasury general manager for foreign investment, said input would be sought from state as well as national officials.



Chinalco wants to invest US$ 12.3 billion for minority stakes in Rio Tinto’s key mining assets, including some of its biggest Australian iron ore and aluminum operations. Chinalco also plans to buy US$ 7.2 billion in subordinated convertible bonds which could double its current equity interest in Rio Tinto to 18 percent.

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Chinalco’s Cheerleaders



Chinese industry insiders have applauded the latest proposal, saying it would help Chinalco move up the industry chain by providing access to Rio Tinto’s vast mineral resources. The deal is also expected to change the future structure of global resource supplies, and block mining giant BHP Billiton’s 2-year-old attempt to acquire Rio Tinto and monopolize the global iron ore market.



The deal would give Chinalco access rights to Rio Tinto management and operations, as well as a chance to nominate two, new non-executive board members to what is now a 15-member board of directors.



A company source said Chinalco has been seeking deeper involvement in Rio Tinto since joining hands with Alcoa in January 2008 – a move seen as an effort to thwart BHP’s takeover attempts.



Although Rio Tinto’s board rejected BHP’s takeover offer in February 2008, Chinalco has been worried about future offers. A source close to the situation said Chinalco started discussions with Rio Tinto over further cooperation last April, although at the time asset purchases were off the table.

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In early November, the European Union’s anti-trust regulator announced opposition to a BHP takeover of Rio Tinto, triggering a slump for Rio Tinto stock. A few weeks later, Rio Tinto’s share prices fell again after BHP said it had dropped its buyout plan.



Meanwhile, debt pressure has been mounting for Rio Tinto, which has been forced to cut jobs and still owes US$ 40 billion borrowed for the 2007 acquisition of Canada’s Alcan Inc. The company is due for a US$ 8.9 billion debt payment in October and US$ 10 billion next year.



Rio Tinto’s declining share value has reduced the value of Chinalco’s 2008 investment by two-thirds. And Chinalco’s latest offer values Rio Tinto’s assets at US$ 80 billion -- 85 percent above current market value. But none of that seems to bother Chinalco, which has called the stock slump an opportunity for the company to buy a larger stake in the Australian miner.

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Mining Assets



Chinalco’s next step calls for steering US$ 12.3 billion into Rio Tinto’s mining assets , including the world’s largest aluminum ore mine in Weipa,  the world’s largest copper mine Escondida in Chile, the Kennecott Utah Copper Corp., and the Hamersley iron ore mine.



Rio Tinto is the world’s third largest iron ore miner, producing 175 million tons in 2008, of which 56 percent was sold to China, according to company CEO Tom Albanese.



Chinalco plans to set up trading companies with Rio Tinto to sell aluminum and iron ore. An iron ore venture would sell at least 30 percent of the 110 million annual iron ore production of Hamersley mine to China, and secure supplies of aluminum ore from Weipa for Chinalco for the next 25 years.



Meanwhile, by investing US$ 7.2 billion in bonds, Chinalco’s stake in Rio Tinto could rise as high as 18 percent from the current 9.3 percent.

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Market Skeptics



Chinalco told Rio Tinto it would complete fund-raising for the deal by March 31. But that promise stirred market concerns over the company's financial situation.



After its first investment in Rio Tinto, Chinalco’s liability-to-equity ratio surged to 130 percent. It had been 20 percent as recently as 2006. And so far, Chinalco has not repaid the US$ 8 billion borrowed from China Development Bank.



Speaking with Caijing, Chinalco’s former general manager Xiao Yaqing expressed confidence in the company’s ability to complete the fund-raising according to the requirements of the Rio Tinto agreement. He also said the Chinese company has discussed financial packages with several banks, and that many have shown interest in supporting the deal.



On the Rio Tinto side, however, there have been lingering disagreements over dealing with Chinalco. The doubts have been raised despite the potential for Chinalco to help Rio Tinto repay debt.

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A dispute over the proposal prompted the company’s chairman-designate Jim Leng – who opposes the Chinalco deal -- to resign February 9. Leng’s departure cleared the way for Rio Tinto’s board to agree to the deal. But the market voiced concern over whether the transaction would win shareholder approval.



In recent interviews with the business media, several of Rio Tinto’s institutional investors said they’re not categorically opposed to a deal with Chinalco but would carefully consider details before casting votes.



The deal also churned up concerns over Chinalco’s expansion into the resources. “From the western view, miners are not willing to set up strategic partnerships with clients, since they believe it may change the market structure,” said a Chinese source at an Australian mining company.

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Regulatory Wall



Besides potential challenges among Rio Tinto’s shareholders, Chinalco will have to face government regulators who may pose an insurmountable hurdle. In addition to an anti-trust review in Australia, the transaction needs support from government regulators in China, Europe and the United States.



Australian officials have been careful to comment on the deal without suggesting support or opposition. But before the deal’s announcement, the nation’s treasurer Swan said the government would revise regulations on foreign acquisitions by requiring government approval for any investment, including deals involving convertible bonds and other instruments.



Swan’s announcement was seen as targeting a Chinalco-Rio Tinto deal. In an interview February 12, he avoided commenting on the Chinalco offer and would only say it would be reviewed according to the latest foreign investment guidelines.



Some analysts said the Australian government is unlikely to block the deal, since it would give Chinalco only a minority stake in Rio Tinto. Moreover, supporters say, a tie-up may attract more investment and create new job opportunities in Australia.

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One bit of good news for Chinalco’s regulatory effort came from Alcoa, which recently announced a plan to buy back US$ 1 billion in Rio Tinto convertible bonds bought in the 2008 deal. The decision signaled Alcoa’s withdrawal from Rio Tinto.



A Chinalco source said Alcoa’s move would provide “the biggest support” for the Chinese company’s argument in favor of a Rio Tinto investment, increasing the likelihood that the deal would pass a U.S. government review.



Alongside the latest investment plan, Chinalco announced a major management shuffle. Xiong Weiping, a general manager for China Travel Service (Holdings) Hong Kong Ltd. and a former Chinalco executive, was appointed the new general manager, replacing Xiao Yaqing. Xiao, who stepped for a government position, told Caijing his departure would not affect Chinalco’s decisions on the deal.

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