Why Chinalco's Buying Into Rio Tinto

The Chinese giant's new stake in the mining outfit is seen as Beijing's attempt to head off a BHP Billiton takeover, to protect the mainland's supply of ores

by Dexter Roberts and Chi-Chu Tschang

Chinalco chief Xiao Yaqing said Feb. 4 the Chinese company has no plans to increase its stake in Rio Tinto after last week acquiring 9% of the Anglo-Australian iron-ore producer. Anoek De Groot/AFP/Getty Images

Aluminum Corp. of China (Chinalco) (ACH) is a behemoth. Founded in 2001 in Beijing, it now has more than 200,000 employees, with 25 subsidiary companies. In 2007 it expanded its overseas investment into Australia, Peru, and Vietnam. And its Hong Kong-listed company has a market cap of $20.2 billion. Its revenues grew 24.1% to $18 billion last year, while profits reached $2.78 billion. Now Chinalco has set a new record for cash-flush China: The company, majority-controlled by the Chinese government, teamed up with Pittsburgh-based Alcoa (AA) on Feb. 1 to spend $14 billion for a 9% stake in Anglo-Australian iron ore producer Rio Tinto (RTP), making the largest overseas purchase by a Chinese company ever. Beijing-based Chinalco put up the lion's share, with Alcoa just pitching in $1.2 billion. The two paid $117.97 a share, a 21% premium over Rio's closing price the previous day.

Within China, there is plenty of speculation that Beijing had a hand in the Chinalco-Rio deal, which has cast uncertainty over Anglo-Australian resources giant BHP Billiton's plan to complete a hostile takeover of Rio Tinto for $100 billion. BHP must make a formal offer by Feb. 6 or withdraw its bid for at least six months (BusinessWeek.com, 2/1/08). The assumption among some observers is that China is raising a warning flag to alert BHP that any move to take over Rio will not go unchallenged. "From what we understand, [Chinalco] is representing the Chinese government in this deal," says Ren Baifeng, an analyst with Antaike, a market research firm focused on the metals industry. "Two Fridays ago, there was word that Rio Tinto's management was secretly in Beijing for talks about this deal," he adds.

Protecting China's Steel Industry

Chinalco insists that it is not acting on behalf of the Chinese government. The company has strongly denied unconfirmed reports over the past few days that China's sovereign wealth fund, China Investment Corp., has assembled a $120 billion war chest for Chinalco to use in blocking any possible BHP bid for Rio Tinto. Speaking to reporters in Australia, Chinalco chief Xiao Yaqing said Feb. 4 that the investment in Rio was "entirely Chinalco's own" decision. Xiao met Feb. 5 with Australian government officials to reassure them about the deal.

Regardless of Xiao's denials, there is little doubt that Beijing has a strong interest in preventing a BHP-Rio Tinto deal, which was first proposed last November. If a merger were to go through it would create the largest single producer of iron ore, as well as of aluminum and other resources. The new company would have immense pricing power, potentially raising costs for Chinese steel producers such as Shanghai-based Baoshan Iron & Steel. This in turn could push up costs for a wide range of Chinese companies, from automakers to construction outfits, and have a significant impact on the overall Chinese economy, which already is struggling with an inflation rate that hit 6.5% in December.