What Lies Behind the Rio Tinto-Chinalco Deal

Posted by: Mark Scott on May 13

The future plans for London-based miner Rio Tinto seem to have move twists and turns than a South American soap opera. First, rival BHP Billiton tried — and failed — to buy Rio in a deal once worth $150 billion. Next, the state-owned Aluminum Corporation of China, or Chinalco, announced a $19.5 billion investment that would give it an 18% stake in the mining giant. That would represent China’s largest ever foreign direct investment. And now, the Sino-Anglo deal could be off as institutional investors consider throwing their weight behind a rights issue that could help repay roughly $20 billion of debt by October, 2010. By late afternoon trading in London on May 13, Rio’s share price had fallen 10.5%

The latest episode in the saga just shows how much the debt markets have changed even since the beginning of the year.

When the Chinalco deal was announced in February, the $7.2 billion of convertible bonds included in the agreement represented a significant premium to Rio’s share price. Since then -- ironically somewhat due to the Chinese interest -- the miner’s stock has jumped over 40%, eliminating the above-market value Chinalco initially had agreed to pay. Growing investor interest in corporate debt also has made raising funds in the market a more tantalizing prospect – particularly compared to giving up a sizeable chunk of Rio’s assets to Chinalco.

This all may sound like corporate shenanigans (and, to an extent, that’s what it is), but the future of Rio Tinto could have a major impact when the global economy eventually picks up. The miner, alongside BHP Billiton and Brazil’s Vale, provides much of the iron ore -- the main ingredient for steel -- that will feed the future economic development of countries like India and China. Whoever runs these companies, so the theory goes, will have significant sway on how these economies will develop.

By attempting to buy a large piece of Rio, state-backed Chinalco is positioning itself to be a big player in the commodities market. Western investors, as well as regulators, are wary about this move for both economic and political reasons.

Back in February, Rio had few options other than to turn to the Chinese for a bailout. Three months on, the financial conditions have changed, opening up other sources of capital that appear more politically appealing to regulators than Chinalco scooping 18% of the London-listed miner. The test now will be whether Western investors stump up the cash.