Commodity Price Rebound Puts Chinalco-Rio Deal in Doubt

With the rebound on the mining market, Rio Tinto’s share price is once again rising, and Chinalco’s bid to buy into Rio Tinto for $19.5 billion is beginning to look a bit deficient. Chinalco Deputy General Manager Lu Youqing claimed again recently that the two sides were not about to revise the terms of the deal and that despite some new wrinkles in the market, Chinalco would stick to the original plan.

It has been reported by foreign media that Chinalco might revise terms about convertible bonds in the contract with Rio Tinto to make it more likely of approval by shareholders and Australian regulators. "This is merely guessing by outsiders. The two sides are working to finish the original plan," Lu Youqing explained.

Rumors about the change in the deal come also from a report by Swiss bank UBS. UBS says that BHP Billiton may help Rio to raise money as an alternative to the proposed $19.5 billion scheme with Chinalco. According to UBS, BHP may buy up much of Rio’s  additional offering, in return for which it may offer to set up a iron ore joint venture in Pilbara. BHP may move after Australia’s regulators make their judgment on Rio’s deal with Chinalco.

On May 5, Rio Tinto’s share prices in both Australia and the UK topped $45, the exercise price of the first batch of convertible bonds bought by Chinalco, and more and more market analysts now expect the agreement between Chinalco and Rio Tinto to be revised. This is the first time Rio’s share price has exceeded the exercise price. 

According to original plan, $7.2 billion of Chinalco’s investment is go into Rio Tinto’s convertible bonds. These convertible bonds are divided into parts A and B. Part A is to be converted into common shares in Rio Tinto’s listed sectors in Australia and the UK at $45 per share, and part B is to be converted into common shares in Rio Tinto’s listed sectors in Australia and the UK at $60 per share. Part A totals $3.1 billion, and part B $4.1 billion. 

Exercise prices for parts A and B are 107% and 176% higher, respectively, than Rio’s closing UK price on January 30, 2009, and 68% and 124% higher than its closing price in Australia on the same day.

Some Rio Tinto shareholders said they would urge Rio’s Doug Ritchie, head of global strategy, to choose other solutions, such as additional offerings on the open market. As the market is rebounding, a certain amount of financing is opening up. Citigroup said recently that due to the wave of additional offerings in recent weeks, the market’s interest in additional offerings, and the fact that Rio’s current share price had exceeded the exercise price, calls for additional offerings from Rio would grow stronger.

Rio Tinto has said that it did not know any detailed reasons for the fluctuation in its share price. "The company is still working to reach strategic cooperation, and is continuing to consult shareholders, and the deal will be conducted according to the original plan."

Wang Wenfu, president of Chinalco Overseas Holdings, added, "We’re against any revision of the agreement or additional conditions." According to the plan, Chinalco will pay $12.3 billion to buy a minor equity stake in other Rio Tinto assets. "Many shareholders are not considering this $12.3 billion investment."

Currently, Chinalco’s bid continues to gain support from Rio Tinto’s management. Doug Ritchie said on May 7 that Australia should reinforce ties with China to gain "cheap capital" which will boost Australia’s share in the global resource market. He said Chinalco’s capital injection in Rio would not give Chinalco the ability to affect commodity prices. Ritchie also denied the rumor that the two sides were revising the $19.5 billion plan. "The current plan is reasonable."

However, if Rio’s share price continues to climb, it will dilute the premium advantage of Chinalco’s convertible bonds. If the premium is diluted much further, more Rio Tinto shareholders may turn against the plan. On May 15, the company’s share price in Australia rose by 4.28% to 61.88 AUD per share (about $46.73). At this price, the premium of part A of convertible bonds has been almost completely diluted, and the premium for part B has been cut by 94.5%.

Wang Wenfu said the short-term fluctuation on the market was understandable, and that Chinalco has brought to Rio Tinto certainty and a series of resolutions to solve its debt problem, its future financing demands, and its plan to march into China’s resource industry.

Chinalco’s capital injection plan should be approved by Australia’s Foreign Investment Review Board, and the result is expected to be released before June 15. Rio Tinto may hold a special shareholder meeting in July to vote on the deal.