While gathering our thoughts for a preview of Monday’s start of the Rio 4 industrial espionage trial, we received word of Rio Tinto’s $1.35 billion iron ore joint venture with Chinalco in Guinea. Having slept on it for more than 24 hours, this Bystander still can’t make anything out of it that isn’t surreal. Perhaps it is just another example of China’s remarkable ability to operate in parallel universes.
We had assumed that the trial of Australian Stern Hu and his three Chinese colleagues at Rio would proceed to its predetermined conclusion, with a routine sentence to follow. The main point the court proceedings are meant to be making is that China follows the administration of its law–not the same thing as following the rule of law, of course–and that nobody is above the process. With a host of domestic corruption cases in train, no foreigner, especially an ethnic Chinese one like Hu, can expect much by way of favors. Foreigners routinely underestimate how signals they assume are directed at them are really more for domestic consumption.
The case has strained though not severed relations between Beijing and Canberra. Those were further frayed last June when Rio Tinto pulled the plug at the eleventh hour on a $19.5 billion cash injection from Chinaclo that would have increased the state-owned aluminum giant’s 9% stake in the Anglo-Australian miner. A revisionist view of the causes of Rio’s change of heart more favorable to the company has taken hold in Beijing. Last year Rio’s sales to China accounted for a quarter of the company’s revenue.
The new joint venture between the two in Guinea gives Chinalco a 47% stake in Rio’s Simandou project which involves infrastructure work Chinese firms are well practiced at in Africa, building a mine, a port and a railway to connect the two. Last October, China signed a $7 billion mining and energy deal with Guinea’s military rulers, so it makes a well-connected partner for Rio in a project that has run into local political problems. The joint venture also gives China a voice on the sellers’ side of the table at the iron ore price negotiations where it is already sits on the other side as the buyer. More parallel worlds.
Conspiracy theorists start here: Xinhua has a report on the growing dispute with Australia over the detention without charge of four Rio Tinto executives, one an Australian citizen, on allegations of stealing state secrets. It is titled, China Striving To Create Fair Trading Environment, so you get its drift. But it concludes with the following tantalizing final paragraph:
But the spying case has cost the mining giant 100 billion yuan ($16 billion), with its market share dwindling by as much as 30 percent, according to a report by the China Times.
That is only $3 billion shy of the $19 billion that Chinalco was going to invest in Rio, before the mining company pulled the plug on the deal at the last minute, much to the chagrin of Chinalco and Beijing.
Could it be there is a measure there for how much longer the Rio Four will be held without charge?
The consolidation of the global natural resources industry in response to the bursting of the the commodities bubble of the early years of the decade and the subsequent global recession means one of two things: more joint ventures such as the one between BHP Billiton and Rio Tinto in iron ore or more combinations within a limited group of companies who need global economies of scale.
The collapse of Chinalco’s proposed $19.5 billion investment in Rio earlier this month makes it a potential bidder for either Anglo American or Xstrata, who have embarked on a merger dance of their own. Anglo’s iron ore, platinum, coal and copper assets make it the better prize for Chinalco. Xstrata’s scrappy entrepreneurial management style would sit uncomfortably with the state-controlled giant, making the Swiss-based company a more natural partner for Brazil’s Vale. Chinalco would also be better placed to circumvent the labour and monopoly concerns the South African government has raised that any bidder for Anglo will have to deal with.
Chinalco, though, will have to come up with a deal that values Anglo at somewhere upwards of $45 billion. Anglo shareholders have already rejected Xstrata’s no premium bid, and a 30% premium is the benchmark for successful mining industry mergers. Anglo’s current market capitalisation is $35 billion. Nor would Chinalco be likely to be able to squeeze out the $700 million-1.5 billion of cost savings (taxed and capitalised worth $3 billion-6 billion) that Xstrata sees in Anglo that could justify a lower bid price.
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There was obviously some wounded pride following the collapse of Chinalco’s proposed $19.5 billion investment in Rio Tinto. But to add insult to injury, Rio is now proposing an iron-ore joint venture with BHP Billiton in Western Australia.
Such a combination would account for 80% of the exports from one of China’s main sources of supply, Australia. To Chen Yanhai, who heads the raw materials department at the Ministry of Industry and Information Technology, “The potential deal has an obvious color of monopoly. The joint venture is likely to have a big impact on the Chinese steel industry as China is the world’s biggest iron ore importer” (from CCTV via Reuters). “The deal should be subject to Chinese anti-monopoly law,” Chen adds.
That sting in the tail will raise some eyebrows among international M&A bankers. China’s anti-monopoly law says the ministry has to approve business combinations if the joint global revenue of the companies involved exceeds 10 billion yuan ($1.5 billion) or 2 billion yuan in China if two or more of the firms involved each cross a threshold of 400 million yuan of revenue in China during the previous accounting year. Both BHP and Rio have blazed past that. In the year ended June 30, the former’s revenue in China was $11.7 billion while the latter’s was $10.8 billion.
It is unclear what remedies would be imposed if the Rio-BHP deal was found to be monopolistic by Beijing (or even if it could apply such a ruling), but Chen indicated aid to domestic miners could be one. There have already been discussions around this between Canberra and Beijing at the diplomatic level, we hear. And BHP says it and Rio would be discussing the potential regulatory issues with Chinese officials, according to Reuters.
Meanwhile, Chinalco has to decide what to do with the stake in Rio it does hold, and whether to take up its allotment of Rio’s rights issue that is replacing its investment. It could dump its stock with a grumpy flourish and take the loss, not do that but not take up its rights issue allotment, thus diluting its stake, or take up its rights and hang in to see what develops. Patience rather than petulance might well be the right virtue in this instance.
Rio Tinto has confirmed that the $19.5 billion Chinalco investment is off and that it will instead raise $15.2 billion through a rights issue (see “Chinalco’s Rio Deal On Verge Of Collapse“). Chinalco’s president Xiong Weiping said in a brief statement that the company is “very disappointed”. It is not clear what Chinalco’s next steps will be to secure raw material supplies around the world, or whether the rebuff to what would have been the largest Chinese foreign investment will deter other Chinese enterprise from investing overseas. “Chinalco will continue to explore opportunities to advance its strategic objectives and in the meantime will monitor developments at Rio Tinto as the company’s current largest single shareholder,” Xiong said in his statement. Which isn’t saying much at all.
Some Rio Tinto shareholders have long questioned the economic logic of the company taking a $19.5 billion investment from Chinalco, saying existing investors could raise the money through a rights issue. Now it appears they have the upper hand. Reports from London say that the Rio board is expected shortly to announce that it has withdrawn its support for the deal.
That might spare the generally pro-Beijing Australian government a potentially awkward decision on whether to veto the deal on national interest grounds (the Foreign Investment Review Board was due to rule on June 15th), and strike at least one item from the list of hot button issues with Beijing right now that spans maritime rights to Gitmo Uighurs.
A rising share price and easing debt markets have made a rights issue more feasible for Rio, which now plans to raise $15 billion that way to pay off debt, rather than take Chinalco’s convertible bond. But the state-owned aluminum giant is going to want a break-up fee for being jilted; $195 million is the number being bandied about.
The collapse of what would have been the largest Chinese foreign investment also reopens the door for Rio to some sort of tie up with BHP Billiton. Chinalco’s options look more limited.
As the dust settles on Beijing’s decision to block Coca-Cola’s $2.3 billion bid for Huiyuan Juice on antitrust grounds, how does Chinalco’s proposed $19.5 billion investment in Rio Tinto look?
Chinese officials have been quick to stress that the Huiyan decision, which stopped what would have been the largest foreign investment in China, was not protectionist, but it is not being seen that way by at least one Australian lawmaker. Sen. Barnaby Joyce, who has been pushing for a review of Australia’s foreign investment laws in the wake of the proposed Rio deal, says the Coke decision “shows that China is being protectionist but wants Australia to offer up its important assets for a quick sale.”
Australia’s Foreign Investment Review Board has already extended by up to 90 days its review of the deal, which would be China’s biggest overseas acquisition. A proposed $443 million investment by Hunan Valin Iron and Steel in Fortescue Metals has also had its review extended.
However open China remains to foreign direct investment in to basket-case companies and to greenfield FDI (and it does seem to be that), the perception that established brands and putative national champions are off-limits will only reinforce the forces of retaliation.
Chinalco’s president, Xiao Yaqing, is moving on at what would seem to be a critical time for the company with its $19.5 billion capital injection into Anglo-Australian miner Rio Tinto now starting to do the rounds of regulatory approvals. But having announced the proposed deal in London earlier this month, Xiao is now not just moving on, but up, to a position with the State Council, Caijing magazine reports. Xiong Weiping, who was president of Chinalco’s Hong Kong subsidiary before moving in 2006 to be general manager of China Travel Service in the territory, is tipped to replace Xiao at Chinalco.
Rio Tinto’s chief strategy officer, Doug Ritchie, says he is confident Chinalco’s proposed $19.5 billion capital injection will pass muster with the Australian regulators. The country’s Foreign Investment Review Board is seen as a key hurdle for the deal to clear, given the misgivings it has previously expressed about the state-owned aluminum company’s potential sway over Australia’s natural resources.
Speaking on TV, Ritchie said the deal had been structured to meet Canberra’s concerns. The Chinalco investment is split $12.3 billion in joint venture stakes in nine Rio businesses and $7.2 billion of convertible debt.
The later part may just have squeaked under the wire as the FIRB is seeking to amend its rules so convertible debt counts as equity when considering a foreign ownership stake.
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