How Rio dumped its China deal

Riotinto & BHP Billiton merge iron-ore mines;

June 7, 2009

Secret talks between old rivals Rio Tinto and BHP Billiton sparked a tie-up that shakes the mining world to its core

Dominic O’Connell

http://business.timesonline.co.uk/tol/business/article6446019.ece

A few hours after he was presented to Rio Tinto shareholders at their annual meeting in April, Jan du Plessis, the mining group’s new chairman, slipped away for a secret meeting with a rival.

He didn’t have far to go. The shareholder meeting was at Sydney’s Sofitel Wentworth, a five-star hotel in the business district. The clandestine summit – with Don Argus, veteran chairman of BHP Billiton – was in a private room at the Sheraton on the Park, a 10-minute walk away.

If shareholders had known about the rendezvous, they would have been surprised. Rio, which is quoted in London and Sydney, had fought off a hostile takeover bid from BHP, another dual-listed group, a few months earlier. The deal would have created the world’s biggest mining company, a colossus with big shares in the global production of iron ore, copper, aluminium and other vital natural resources. Despite the rebuff, Argus was keen to talk to the new man; he had sent Du Plessis a welcome note the day his appointment to Rio was announced.

The Sydney meeting had far-reaching consequences, and set in motion a chain of events that had their dramatic denouement last week when Rio announced a whopping $15 billion (£9.4 billion) rights issue and a shock $5.8 billion deal with BHP to merge Australian iron-ore interests. At the same time, it dumped a historic tie-up with Chinalco, the Chinese state-owned mining group.

The Chinalco deal had been put in place by Paul Skinner, Du Plessis’s predecessor, to fix Rio’s biggest problem – a $40 billion debt mountain built up in an ill-timed purchase of Alcan, the aluminium group. Skinner and Tom Albanese, Rio’s chief executive, hatched a controversial scheme in which Chinalco would inject a much needed $19 billion, and in return increase its stake in Rio and secure rights over some of its most valuable mines.

For the Chinese it was a watershed. Not only did it give Beijing a measure of ownership of the vital raw materials its economy needs, it was also the biggest investment by China in a foreign group, an important foothold into global business.

Unfortunately for Skinner, a vocal group of shareholders hated the deal. There was also a furious, nationalistic backlash in Australia, where Chinese influence over natural resources was unpopular. And Rio’s share price, depressed when the Chinalco deal was done, had started to climb, making the option of raising money in a rights issue more feasible.

Argus knew Du Plessis was under pressure to come up with an alternative. Why not, he suggested at the Sydney tête-à-tête, a deal with BHP? Not the full-blown takeover proposed earlier, but a merger of their Australian iron-ore operations?

Du Plessis liked the idea. The pair talked so much that they forgot to get a drink, and a parched Du Plessis had to grab some water while scrambling to catch his flight back to London after the meeting. He later directed Albanese to open talks with Marius Kloppers, BHP’s chief executive, to see if Argus’s plan would work. It must have been a difficult assignment for both men, who had traded harsh words during the abortive takeover battle. Kloppers had criticised Rio’s management, questioning their a c u m e n , w h i l e R i o h a d belittled BHP, saying they were trying to grab Rio on the cheap.

Last week’s announcement indicates they were probably able to bury their differences. BHP accepted that its Australian iron-ore business was worth less than Rio’s and agreed to pay $5.8 billion to make up the difference and allow the proposed joint-venture to proceed.

Du Plessis, a South African best known for his chairmanship of tobacco group BAT, said ditching Chinalco and deciding to go for the rights issue and BHP tie-up had presented “the most complicated set of challenges in my business career”.

For some, Rio’s about-turn was hard to swallow. Directors and managers had defended the Chinalco deal in the face of some strident opposition, arguing that it offered not only the best value for shareholders, but also a great strategic opportunity for the company to work in concert with one of its largest customers.

Du Plessis denied the board lacked credibility. “Hindsight is a wonderful thing. It’s easy to forget that in December and January the world was a pretty ugly place, and I think the board took the right decision at the time. We are also taking the right decision now. If we had been determined, we probably could have got the Chinalco deal through with more than 51% of the votes. But it’s my judgment that it would have been inappropriate to proceed with a 51% majority – that’s not the way to go.”

Du Plessis also defended Albanese, who some critics think should carry the can for the Alcan purchase, the rejection of BHP and the failed Chinalco tie-up: “I absolutely do not need a new chief executive,” he said. The Chinese side had been kept informed of the progress of the BHP talks, he added, and he and Albanese were still hopeful of a close working relationship.

Sources close to Chinalco say that is wishful thinking. The company said it was “disappointed” the deal had failed. The sources went farther, saying the group, still a significant shareholder with 9% of Rio, would press for management and board changes. “The Chinese never forget,” one source said.

Albanese and Kloppers’s negotiations could still prove to be in vain. The merger will give BHP and Rio a stranglehold on the Pilbara, the region in northwest Australia that is one of the world’s key iron-ore provinces and the main supplier to Asia’s steel mills.

Steel trade groups have already come out against the deal, and it faces tough regulatory scrutiny in Australia and Europe. The two companies have allowed a year for clearance to be obtained.