BHP Billiton Ends Rio Tinto Takeover Battle

Posted by: Mark Scott on November 25

And so that’s it. After negotiating for over a year and spending $450 million on costs, Anglo-Australian mining giant BHP Billiton on Nov. 25 pulled its all-share takeover for rival Rio Tinto that had once been worth more than $150 billion. The fact that BHP’s offer is now worth a mere $62 billion shows just how much the economics of the mining industry have changed. With demand for commodities from emerging markets faltering, the global economic outlook appearing weak, and regulators asking questions about the proposed merger, BHP had little choice to mothball its plans.

The company’s chairman, Don Argus, summarized the mood. “We have concerns about the continued deterioration of near term global economic conditions, the lack of any certainty as to the time it will take for conditions to improve, and the risks that these issues imply for shareholder value,” he said in a statement. Argus did add, however, that BHP hadn’t changed its “view of the basic industrial logic of the combination, or of the longer term prospects for natural resource demand growth driven by emerging economies.”

In response, Rio Tinto, which had vehemently opposed the deal, merely said it had noted “the announcement today by BHP Billiton that it will not pursue its pre-conditional offers for the acquisition of Rio Tinto.”

So how did one of the largest M&A deals of recent years go so wrong? Basically, the economics no longer made sense. Commodity prices, for the time being, have tanked, unwanted assets are now harder to sell off, and the cost of debt has continued to spiral. Yet despite the Nov. 25 announcement, we may not have seen the last of BHP’s attempts to acquire its Anglo-Australian rival.

In the short-term, the mining sector is bracing itself for 12 to 18 months of weak demand as emerging markets, particularly China and India, face similar financial problems to their Western counterparts. A decline in developing world manufacturing means less need for raw materials, which has led to large drops in commodity prices. Without these high levels (although prices remain above historical averages), the top-dollar figure for BHP's all-share offer for Rio wasn't sustainable. The share prices for BHP and Rio, for example, have fallen 49% and 55% respectively since the beginning of the year. After the Nov. 25 announcement, BHP's stock rose 7.24%, while Rio's share price tumbled 36.73% by the close of trading in London.

Along with falling commodity prices, BHP also faced problems meeting the estimated $3.7 billion in costs savings that the company had outlined with the takeover. Almost the entire mining sector has put a freeze on expansion over the next 12 months, so the Anglo-Australian company would have found it difficult to sell unwanted assets. BHP Chief Executive Officer Marius Kloppers confirmed this problem on Nov. 25. "Other key elements that have substantially increased the risks to shareholder value… [include] concerns regarding the ability to divest other non-core assets," he said.

The final hurdle that eventually ended BHP's hopes for the acquisition was regulatory approval. The merged BHP-Rio company would have had an almost monopolistic position in several commodities. And although Australian officials green-lighted the takeover in October, the European Commission sent BHP a 'statement of objections' on Nov. 4 -- an EC spokesperson declined to provide specifics on the objections. Analysts reckon the company would have had to divest sizeable iron ore and/or coal assets to gain European regulatory approval -- something BHP was at pains not to do. According to a company statement, any forced asset sale during the economic downturn "would contribute to the cost and risk of the [Rio] transaction."

So where does BHP's announcement leave the mining industry? Only 6 months ago, companies were negotiating record prices hikes from their customers. Now they're postponing expansion plans and fretting about slowing commodity demand. Yet before we go writing off the sector, it's worth looking at companies' financial position.

Most of the major mining companies have large capital reserves (born out of the previous peaks in commodity prices), so they should weather the current credit issues without too much trouble. Smaller players could face a financial squeeze, which could lead to round of M&A activity as deep-pocketed large companies pick off credit-hit smaller firms.

Other larger deals also are still a possibility, although unlikely until the demand for commodities returns (estimates say this could happen by 2010). That means BHP may take another crack at Rio if/when conditions start to improve. When that could happen is open to debate. For now, the mining industry -- and BHP Billiton in particular -- is more focused on riding out the current economic storm.