Only a few months ago, London-based mining giant Rio Tinto (RTP) was riding so high on record demand for natural resources that it could dictate terms for customers. Just last June, for instance, it signed a long-term contract with China's Baosteel that nearly doubled the price of iron ore supplied to the Shanghai company.
How times have changed. On Feb. 2, Rio Tinto—slammed by a global collapse in commodities demand and saddled with $39 billion in debt—confirmed it was in talks that could result in the sale of up to $15 billion worth of assets or convertible debt to another state-owned Chinese firm, Aluminum Corp. of China (ACH), or Chinalco. Chinalco already owns 12% of Rio Tinto and could see its stake rise to 18% if the deal goes through.
Mining Boom Goes Bust
Such is the state of the mining sector, which has seen business fall off a cliff due to the global economic slowdown and manufacturing retrenchment. Analysts foresaw last autumn that a commodities downturn was coming, but even the most grizzled industry-watchers are shocked by the speed of the decline. Prices for raw materials such as iron and aluminum have plunged by more than half in the past year, while mining firms have seen their market capitalizations shrivel. The SPDR S&P Metals & Mining ETF (XME) is now down more than 70% from its peak last June.
To counteract the crisis, companies are scrambling to cut costs. BHP Billiton (BHP), the largest London-listed miner by value, is slashing 6% of its workforce, or 6,000 jobs, and closing once-lucrative operations across western Australia. "What we are seeing today is a sober reminder of the unwinding of the mining boom," the company's Chief Financial Officer Alex Vanselow told reporters on Jan. 21. Just a year ago, the Anglo-Australian company was offering an eye-watering $150 billion to buy Rio Tinto but finally abandoned the deal in November due to tumbling commodity prices. (Note: On Feb. 4, BHP Billiton reported that half-year profits in the six months ending Dec. 31 fell 57%—more than analysts had expected—to $2.6 billion. The company blamed the drop on extra costs to shut down operations after commodity prices slumped in the second half of 2008.)
A similar state of affairs faces the No. 2 London-listed miner, Anglo American (AAUK), which says it will slash capital expenditures by more than half this year, to $4.5 billion. The company is being conservative with spending even though its debt repayments will amount to only $3.3 billion by the end of 2010. Blame falling earnings: Citigroup (C) analyst Heath Jansen figures Anglo American booked around $11 billion in pretax profits last year, up 23% from 2007, but will likely see this year's figure decline by nearly 40%, to $6.6 billion.
Drastic Cuts for the Debt-Laden
The situation is even tougher for companies with big debt loads. Consider the travails of the No. 4 London-listed miner, Xstrata (XTA.L). The Anglo-Swiss company has $16.3 billion in debt obligations due in 2011, but its ability to make the payment will be hurt by a plunge in profits this year that could be as high as 66%, according to estimates from Citigroup's Jansen. Facing a potential cash crisis, the company was recently forced to announce a $5.9 billion rights issue that priced its shares at a two-thirds discount to their Jan. 28 close. Even so, that might not be enough to bridge the gap. "Xstrata may still need to renegotiate its debt covenants at the end of this year," Jansen says.
Worst off is Rio Tinto, which splashed out $38.1 billion to buy aluminum producer Alcan two years ago and now carries a net debt-to-equity ratio of 126%, compared with just 22% at rival BHP Billiton, according to data from Bloomberg. The company faces an $8.9 billion repayment by October 2009 and another $10 billion tranche due a year later. To improve its financial position, Rio already has announced plans to lay off 14% of its workforce, or 14,000 employees, and to slash 2009 capital spending from a planned $9 billion to just $4 billion. It even revealed a deal on Jan. 30 to sell some of its South American assets to Brazilian rival Companhia Vale do Rio Doce (RIO) for $1.6 billion.
Yet despite these measures, analysts figure Rio Tinto may need yet more capital—hence the potential deal with Chinalco. With credit markets still all but frozen, turning to cash-rich Chinese companies for help appears to be the only game in town. "This could present a fantastic opportunity for the Chinese," says an industry analyst who asked not to be named. Chinalco may buy minority shares of certain Rio Tinto assets or assume debt that could later be converted into equity in the parent company.
Needless to say, the potential deal symbolizes a massive power shift away from raw material suppliers to big customers such as Baosteel, India's Tata Steel (TISC.BO), and ArcelorMittal (MT). To be sure, they're feeling the effects of the downturn, too. But when it comes to setting commodity prices—or bailing out miners—they're in the driver's seat now.
Scott is a reporter in BusinessWeek's London bureau .