Will China Buy into BHP Billiton?

A rumor has erupted in the Australian media that China is planning to buy up a 9% or greater stake in miner BHP Billiton, Ltd., Australia’s and the world's largest diversified resources company. The possible bid is being interpreted as an attempt to interfere in BHP’s proposed acquisition of rival Australian mega-miner Rio Tinto, the world’s second largest iron ore producer.

A rumor it still is, and BHP has denied the story.  And the idea of buying BHP shares to block its bid for Rio Tinto doesn’t make much sense.  The mere rumor of such a purchase pushed BHP’s stock price up by 4%.  One doesn’t interfere with a company’s acquisition attempts by jacking up its buying power.  

Still, a case can be made for China buying into BHP, though the challenges to any successful deal would be steep.

First, buying into foreign mining companies is a way to ensure access to vital overseas resources and possibly to affect prices. China’s steel industry is now the world's largest consumer of iron ore and has been hurt by a threefold gain in the commodity price since 2002. The price of iron ore has risen to record levels for a sixth straight year.

In February, Brazilian mining firm Vale, the world’s largest iron ore exporter, won a 71 percent increase for iron  ore from its Carajas mine from Nippon Steel Corp., JFE Holdings Inc., and Posco, Asia's three largest steelmakers. Rio Tinto and BHP Billiton, the second and third-ranked iron-ore exporters, are still in talks with Asian steelmakers for 2008 contracts. Moreover, BHP is backing a $156 billion hostile bid it made for Rio Tinto in February to create a combination that would vie with Brazil's Vale. All of this is going to have an effect on China’s steelmakers.

The decision to make such investment may also partly be linked to concern over the reduced purchasing power of China’s Treasury holdings due to the declining value of the dollar.

In China, The State Administration of Foreign Exchange (SAFE), which is under the central bank, has long conservatively managed China's rapidly swelling foreign reserves, which stood at about $1.68 trillion at the end of February. For a long time, SAFE invested largely in US Treasuries. Even now, about 70 per cent of its assets are in dollar bonds.

But in recent months, SAFE has used its cash to jump into more strategic areas. For example, SAFE has built up a 1.6 per cent stake in the French oil firm Total, worth about $2.8bn. It would not be surprising if China did want to buy a piece of BHP Billiton at this time, to get some work out of its foreign reserves.

But it will be hard for China to get a desired effect through buying stake in BHP Billiton at this point.

For one thing, the Australian government might not be so sanguine over a second Chinese attempt to grab a piece of one of its national treasures as it was a short while ago when Chinalco, a Chinese metals company, in partnership with America’s ALCOA, took a 9% stake in Rio Tinto.  BHP chiefs flew to Canberra at that time for a confidential meeting with the Australian prime minister to persuade the Australian government to deter any further bidding for mining companies by deep-pocketed China.

They may have been successful. The Australian government later released a statement of "principles," stating that foreign investment had to be in keeping with the national interest. The announcement mentioned sovereign wealth funds, warning that such investors would be subject to greater levels of scrutiny to assess whether their "operations are independent from the relevant foreign government".

As most Chinese overseas investment is from state or state-owned enterprises, in the eyes of foreign regulators such a connection might now taint these investors with the epithet "sovereign." Chinalco’s $14.1bn buy into Rio Tinto, China's largest ever offshore investment, was discussed as such in the foreign media and seen as a political statement that China intends to compete with global resources groups for a seat at the table in the current wave of industry consolidation.  But Chinalco cleverly hedged its bet by partnering with ALCOA.

Also, buying BHP shares, even to the tune of 9%, may not give a buyer any leverage in the company’s operations. According to BHP company regulation, directors are selected to the board according to their industry experience, not the amount shares they hold. BHP CEO Marius Kloppers has said that even the biggest shareholder might not get a seat on the company board.

Anyway, China’s overseas investors are taking heat for throwing around too much money. Buying BHP Billiton’s shares at this point would be enormously costly with the iron ore industry at a peak of its cycle now. Two months ago, Chinalco bought into Rio Tinto at a high price, higher than Rio Tinto’s current share price. Also, China Investment Corp (CIC), China's sovereign wealth fund, has, since its formation last September, been beset by criticism and recriminations from officials and the public at home, over its investment decisions.

So, if China wants to buy BHP Billiton stock, it had better find a foreign partner to relax any foreign country’s tension over Chinese sovereign wealth funds. And it should make a clear base line for the price it wants to pay for BHP Billiton.