Rio Tinto and the Chinese Option

Yet another hubristic American executive looks like trying to save his own skin by following two bad deals with yet another. In the process he may be sparking a revival of resource nationalism and putting strains on Australia's relations with China.

China's Chalco has been smart to offer to come to the rescue of Tom Albanese, chief executive of the Anglo-Australian mining giant Rio Tinto. Chalco itself may be relatively small and poorly performing but it has the weight of mainland money behind it to be able to bail out Rio from its mega debts acquired in the process of Albanese's costly buying spree. Chalco is offering to put up US$19 billion in cash, US$7 billion in convertible bonds and US$12 billion for direct stakes in a clutch of assets ranging from bauxite, alumina and iron ore in Australia to the giant Escondida copper mine in Chile, Indonesia's Grasberg copper and gold deposit and Kennecott copper in the US. Chalco would get a board seat and on conversion of the bonds its stake in Rio would rise from the 9 percent to 18 percent.

But this time a combination of investor self-interest and a surge in Australian resource nationalism could ditch Albanese's plan to get himself off the hook by allowing one of its major customers to acquire major stakes both in Rio itself and some of its operating subsidiaries.

Albanese, it should be recalled, got Rio into US$37 billion of debt by paying a fancy price — US$39 billion — for Alcan, the Canadian aluminum producer in 2007, massively outbidding Alcoa of the US. He then compounded that error by resisting an even more top-of-the-market bid from bigger rival BHP Billiton. The market then collapsed just in time for BHP to walk away from its own costly offer, leaving Rio shareholders with a pile of debt and devastated share price which fell at one point from £7,000 sterling a share in mid 2008 to 1,000. So much for another Big Swinging Dick executive.

There are three obstacles for Albanese and Chalco – the British authorities, the Australian authorities and the other shareholders. The British, seldom nationalistic when it comes to takeovers, particularly when none of the assets are theirs, are unlikely to offer nationalist opposition though the lack of a rights issue could fall foul of London listing rules. Shareholders will object vigorously that they have been deprived of the right to come to Rio's rescue and partake of recovery via a rights issue. That is a strong argument but the UK institutional shareholders could perhaps be bought off with some deal sweeteners.

But what neither Albanese nor the Chinese may have bargained for is the opposition welling up in Australia to "selling the farm." This could of course be dismissed as the sort of nationalism which in the US ditched the Chinese bid for Unocal. Australia, with a huge external deficit and about to go into recession, may seem in a poor position to offend its major customer, China, by opposing the deal. Thus far Australia has not resisted China's purchases of Australian mineral assets. However, in this case, the nature of the deal as well as the importance of Rio Tinto to Australia are raising hackles including from such market-oriented columnists as Stephen Bartolomeusz of Business Spectator.

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"Anything that undermined the negotiating position of the Australian producers relative to their customers would of course be contrary to Australian national interests," he wrote.

Opposition to the Chalco deal will also be strengthened by the resignation of the recently appointed Rio chairman-designate Jim Leng who fought against what many see as an attempt by Albanese and the board to escape from the consequences of their earlier failures.

There is more than just narrow nationalism in the opposition in Australia, and indeed among other investors in Rio. There is a fundamental conflict of interest both between Chalco and Rio as well as between China and Australia (and other ore exporters). The former want low prices, the latter high ones. With this deal China's state-owned company would have direct say in mine development policies in its suppliers and direct links into major global mines. In particular China is believed to want to break the combined influence that Rio and BHP have on iron ore prices.

Albanese's board now argues that Rio cannot afford to wait. Thanks to his earlier actions, it faces debt repayments of US$9 billion by October. But in addition to its capacity for a rights issue it would have little problem selling one or two assets to raise cash. BHP in particular could be a buyer, having been, mainly by luck, the one giant mining group to emerge from the recent boom and bust with relatively low debt.

Whether Beijing throws it political weight behind Chalco is also questionable because it may not want to be seen around the world as a dangerous predator taking advantage of others' temporary misfortunes and by demanding rights for its companies overseas that it does not offer to foreign ones in China.

As for the Australian Prime Minister, the Chinese-speaking ex-diplomat Kevin Rudd, he has already been under fire in some quarters for having an overly cosy relationship with Beijing. So it is possible that this deal will spark a revival of the resources nationalism which characterized some earlier Labor governments.