Rio Tinto is preparing to sell some of its birthright to Chinese state-owned group, Chinalco in an effort to stave off hard decisions on debt and asset sales it needs to make.
The company will raise $US19.5 billion from the deal, enough to halve the size of the debt taken on in the ill-advised purchase of Alcan in 2007 as it tried to make itself too expensive for BHP Billiton.
It didn’t work then; BHP bid, then withdrew after the financial crunch made debt a ‘no-no’ especially the $US37 billion that Rio had on its books.
The Chinalco deal took attention away from Rio’s 2008 full year profit, which was a bit better than the market expected.
Rio reported a 38% rise in underlying profit of $US10.3 billion for the calendar year 2008, beating market expectations of around $US9.8 billion.
However, net profit tumbled 50% to $US3.7 billion, hit by asset impairment charges of $US8.4 billion, the majority of write-downs relating to the group’s aluminium business.
These were partly offset by asset sales worth $US1.5 billion. Further assets sales happened after balance date (last week)
Rio declared a final dividend of 68 US cents, taking total dividends for the year to $US1.36, unchanged from 2007.
Given the outlook for commodities this year, that level of payout is unsustainable.
Rio Tinto’s chairman Paul Skinner said in a statement; “Although the condition of the global economy and of demand for our products deteriorated very rapidly in the fourth quarter of 2008, the Group nevertheless registered record underlying earnings of $10.3 billion for the year, a rise of 38 per cent on the prior year.
Tom Albanese, Rio Tinto’s chief executive said in the same statement: “These record results demonstrate the outstanding value that Rio Tinto’s assets and long term investments generate when markets are buoyant, with cash flow from operations in excess of $20 billion in 2008.
"As a consequence, the Group has been able to reduce net debt by $6.5 billion during the year from free cash flow and divestment proceeds.
“Given the current uncertain economic conditions and the unprecedented rate of deterioration in our markets and prices, we are now focusing our efforts on maximising and conserving cash generation and paying down debt.
“In December, as part of our commitment to reduce net debt by $10 billion in 2009, we announced that capital expenditure for 2009 will be reduced from over $9 billion to $4 billion and that controllable operating costs will be reduced by at least $2.5 billion per annum in 2010, to include a global headcount reduction totalling 14,000 contractor and employee roles worldwide. “
That cut in debt was to replace attempts to sell around $US10 billion in assets, Rio couldn’t find buyers as the global financial crunch closed in, shutting off credit markets and driving down commodity prices, and share prices alike.
A huge, discounted rights issue was always a possibility, but never entertained: a move that forced chairman designate, Jim Leng, to walk three weeks after he had been named to replace Paul Skinner.
It seems that rather than take big losses and possible loss of their positions, members of the board and management always wanted to sell to Chinalco, which snapped up 9% of Rio’s share in a dawn raid in London just over 12 months ago. Chinalco is looking at huge losses on that stake, but because it’s owned by the Chinese Government. It has access to a lot of money.
There is strategic sense for China to buy shares in mines like Escondida, Hamersley and Weipa, but the latter two mines are the foundation stones of Rio’s strength through the Australian arm which is a modern version of the old CRA.
Australian Government approval will be needed, despite claims the deal will be structured to get around those requirements.
At nearly $20 billion, this will be one of the largest deals done by China in a Western company. A Chinese bank is about to pay $US20 billion for the life business of the stricken US insurer, AIG.
For that reason, it will have to be sensitive to local feelings (The Chinese Government knows all about chauvinism).
The Chinese Government will want the Australian Government to approve these deals (and Chile in the case of Escondida) because not to have them, or to be seen being "creative’ financially would damage the standing of Rio, Chinalco and the Chinese Government.
But the main problem is the absurdity of Rio inviting in a major consumer of some of its products (bauxite/alumina and aluminium) and a company owned by a Government which controls other major buyers of Rio (and Australian commodities) in the steel and copper industries.
In introduces an unwelcome intruder into the pricing process: Rio will never be able to shake off suspicion that it is doing price and other deals to suit their "owner" if those arrangements are seen to advantage China or discriminate against Australia or other companies (and companies from other countries, such as Vale, the big Brazilian iron ore exporter).
BHP and Rio will no longer be able to negotiate from a separate, but common front.Rio claimed there would be ‘good governance’, but in practice its a case of whoever is paying, calls the tune.
Why would BHP (or any other company) share information with Rio on pricing etc when Chinalco will have a board member and the Rio board would be discussing contract pricing and other matters every meeting?
The Financial Times’ Lex column wrote that Rio was making a big mistake because it was adopting a strategic solution to a financial problem. It said Rio should be raising money from shareholders.
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