Capital Markets

The Big Owe

Rio Tinto's hefty debts have pushed it to seek investment from China.
Economist StaffFebruary 3, 2009

Big mining companies have suffered an astounding reversal of fortunes in the past few months. As boom has turned to gloom, commodity prices have slumped, leaving mining firms with painful decisions to make. Rio Tinto is the latest to suffer. On Monday February 2nd the Anglo-Australian mining giant was forced to confirm press speculation, acknowledging that it is in talks with Chinalco, a state-owned Chinese aluminum maker. The Chinese firm may agree to a deal to help to alleviate Rio’s debts which were taken on before the credit crunch led to a foundering world economy.

Rio’s debt pile of some $40 billion was mostly run-up through its purchase of Alcan, a Canadian aluminum firm, in 2007. Around $9 billion is due later this year, and refinancing will be a tricky proposition given the parlous state of debt markets. Another $10 billion must be repaid in 2010. Rio has started a firesale of assets: it raised $1.6 billion last week by selling iron ore and potash businesses in Brazil and Argentina to Vale, a Brazilian rival. But prices are depressed and making a sale is not always possible-Rio has still not managed to offload Alcan’s packaging business, although it is reportedly in talks with a potential buyer.

Firms are also trying to cut costs. Rio will lay off 14,000 workers and will slash capital expenditure by $5 billion this year. In addition, the Chinese deal may provide much-needed ready cash. Chinalco is already Rio’s biggest investor with a 9 percent stake acquired expensively last year when shares were bubbling. Although Chinalco’s exact motivation was unclear, it probably invested in the hope of derailing a bid for Rio from BHP Billiton, another vast mining firm. China’s government had feared the pricing power of the pair together, which with Vale would dominate the market for seaborne iron ore. BHP’s bid was subsequently abandoned as business conditions deteriorated.

The talks may bring about a complex deal that would allow Chinalco to raise its stake in Rio over 11 percent through the purchase of a convertible bond. The Chinese firm is also likely to buy minority stakes in a variety of Rio’s prime assets. For its part Rio would receive some $15 billion. Although Rio has not revealed what assets might be included, there is speculation that it might even let go of its prized 30 percent stake in Chile’s Escondida, the world’s biggest copper mine.

As a result, Rio’s purchase of Alcan may prove to have been more costly than the bumper price tag first suggested. If it goes ahead with the deal Rio may, in turn, come to regret selling interests in valuable assets to a firm controlled by China, its most important customer. The prospects for Rio’s growth, already hurt by a sharp fall in investment, will be worsened by any sale of its better assets.

Yet, however unpalatable Rio may find going cap in hand to China, the alternative is no more enticing. Last week Rio said that it was considering a rights issue, but that would doubtless need to be deeply discounted. Xstrata, another highly indebted miner, announced a heavily discounted rights issue last Thursday. Minority shareholders were deeply concerned that Glencore, a commodity trader that owns a 35 percent stake, sold Xstrata a coalmine for $2 billion to meet its part of the cash call. The value of the mine is unclear and Glencore has an option to repurchase the mine for slightly more over the next year. But the uproar highlights the problems associated with having a leading shareholder (as Chinalco might become with Rio) with potentially differing interests to other investors.

A rights issue would also have the unfortunate effect of reminding shareholders of how much better off they might have been had Rio not rebuffed the advances of BHP. Tom Albanese, Rio’s boss, spent a busy year in 2008 explaining in detail why the takeover should not happen, before BHP pulled out anyway. Explaining how he is going to get Rio out of its current mess will put Mr. Albanese’s oratorical powers to a similarly stiff test.