4 March 2009

Asia's miners line up for Outback

SYDNEY - Asian mining firms are closely watching developments related to the US$19.5 billion bid by Chinese aluminum giant Chinalco for a stake in multinational Rio Tinto, amid a developing buying blitz on Australia's cheap resources stocks.

Corporate lawyers say that Japanese, Chinese and South Korean companies are locked in negotiations for equity in a host of mid-sized miners, but the fate of the deals may hinge on whether the Chinalco-Rio deal gets regulatory approval.

"You have a weak Australian dollar, very low price/earning ratios of resource stocks and a lot of cashed-up Asian firms that are underwritten - in some cases at least - by official reserves," said one lawyer involved in acquisition talks. "[But] it counts for nought if the [Australian] regulators start talking tough."

State-owned Chinalco have met with Australia's Foreign Investment Review Board (IRB) to push its case for the purchase of sizeable stakes in some of Rio's key ore, aluminum and power assets, including the vast Hamersley Iron operation in Western Australia.

Chinalco has offered US$7.2 billion in the form of convertible bonds which, once converted to shares, would increase its stake in Rio from 9.3% to 18%. The bonds, which have a 60-year term, would attract annual interest of 9-9.5% and would be redeemable after seven years.

Rio badly needs the cash injection to clear US$38 billion of debt incurred when the multinational bought Canadian aluminum producer Alcan Inc in 2007, and board members are expected to approve the bid when they meet in May. The company is committed to repay US$8.9 billion in October and a further US$10 billion next year.

But investors argue that Rio, Australia's second-biggest resources company, could mortgage its future by hiving off key assets. The Australian government also fears that a takeover could allow the Chinese effectively to dictate terms in their tortuous annual price negotiations with the resources sector.

Big exporters like Rio and BHP-Billiton benefited from annual increases of 80-90% in shipment value during the boom years of Chinese economic expansion. But they were told last week by Baosteel's Shanghai steelworks that they could expect cuts of 30-50% this year due to waning demand.

There is plenty at stake for the slowing Australian economy: the country earned A$31 billion from iron ore exports last year and A$46 billion from coal, and government leaders are anxious that the miners keep the upper ground in negotiations.

The new president of Chinalco, Xiong Weiping, said in Sydney the Rio would set up a separate committee of independent - that is, non-Chinalco - directors to handle price talks and avoid a conflict of interest. That might be enough to mollify the IRB, especially if the review board also imposes a limit on Chinalco's future stake and withholds a board seat.

But that may not satisfy the government. The Australian treasurer (finance minister), Wayne Swan, has said he will seek parliamentary approval to amend the Foreign Acquisitions and Takeovers Act so that access to resources firms is tightened.

The biggest change is likely to be that any investment - particularly those involving instruments such as convertible notes - would be treated as equity. Swan said that Australia welcomed investment but treated resources as a special category. Intending buyers would have to prove that investments in the mining sector were in the "national interest".

Shareholders, especially institutional investors, will also have a strong say in the outcome, as many have been angered that the offering was made to Chinalco at a premium - and that they were left out. There are reports that Chinalco might substitute a rights issue of US$10 billion, but Xiong said in Sydney the firm was unwilling to alter the terms.

"We do not want to see any changes to the packaged agreement. I think the Rio Tinto board and its management team will listen very carefully to the requirements and requests from the shareholders."

Yet while opening the deal to outside investors would water down Chinalco's stake, that might be the price the firm has to pay to force the deal through. And it might be vital if Rio is to keep faith with shareholders and rescue its floundering share price.

Market analysts say a substantial number of institutional investors were caught out when they shorted Rio shares in anticipation of a rights issue to cover the debts and they have lots to lose from the deal. So do Rio's board members, who are struggling to convince analysts the deal is the best option.

There has already been one casualty: the designated chairman, Jim Leng, quit two weeks ago when his case for a rights issue found no support with other board members.

Nationalist sentiment is unlikely to have much bearing with remaining board members, as only two are Australian. One of these, former Cathay Pacific and British Airways boss Rod Eddington, has said he will not vote on the deal due to a perceived conflict of interest: he chairs the Australian operations of investment bank JP Morgan, one of Chinalco's advisers.

Rio chief executive Tom Albanese, a US national, said he stood by the deal, saying it would allow Rio to reactivate iron ore, alumina and coal projects that had been put on hold due to the company's difficult financial situation.

There is still a possibility of a rival bid from another suitor, as the Chinalco deal has not yet been voted on by investors. BHP, which considered launching a formal bid last year, is one possible investor, though it would mean Rio would have to pay a US$195 million "break fee" to Chinalco.

Other Asian miners also cannot be ruled out. China Minmetals wrapped up a A$2.6 billion (US$1.7 billion) takeover of OZ Minerals earlier his month, and Chinese steel producer Anshan Iron & Steel Group will pay A$162 million for a bigger stake in Gindalbie Metals.

Legal firm Corrs Chambers Westgarth, which specializes in mergers and acquisitions, confirmed it had had inquiries from Korean, Japanese and Chinese investors looking to acquire gold, coal, uranium and iron ore projects in Australia.

The investors include Japan's Sumitomo, Mitsui and Mitsubishi UFJ. They are believed to be looking at medium-sized producers such as Aquila Resources, Felix Resources and Gloucester Coal.

Alan Boyd, now based in Sydney, has reported on Asia for more than two decades.

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