Hollow Ring Rises Above A Siren's Call

Sydney Morning Herald

Thursday November 27, 2008

Ian Verrender

Paul Skinner cut quite a dash at a breakfast briefing yesterday morning at the Westin Hotel in Sydney.

Relaxed, conservatively dressed and sounding every bit the urbane Englishman, the Rio Tinto chairman in ordinary circumstances should have been basking in the glow of victory, having vanquished a much stronger predator against almost insurmountable odds.

But these are not ordinary circumstances. And the victory has come at such a price that this is no victory at all. Skinner now chairs a company with its flanks, and almost every other part of its anatomy, exposed.

The priority now, he told the gathering, is to get on with life and continue the pursuit of shareholder value.

A nice line, with full marks for bravado, but one that did little to stop investors racing for the exit.

More than 40,000 small investors have jumped aboard Rio in the past four months alone, hoping to capitalise on the yawning gap between the company's share price and the implied offer from BHP.

That gap evaporated yesterday. Rio's share price plunged 33 per cent and, now that it no longer is propped up by BHP's balance sheet, rating agencies began the arduous task of downgrading the group. Not surprisingly, given Rio's much higher risk profile, debt markets immediately went to work blowing out its credit default swap rates.

Hindsight is a blessed thing.

No one a year ago could have foreseen the events that have unfolded in the past six months, let alone the six months before these. Unfortunately, with the world economy facing a monumental crisis and a global financial system teetering on the brink, many a strategy that seemed like a good idea at the time has turned sour.

And so it is that Rio's decision to fend off its suitor by loading itself up with debt and expanding into aluminium last year looks, in hindsight, to be pure folly.

On two occasions last year, before it splurged $US38 billion on Alcan, Rio Tinto rejected overtures from BHP for a merger. Once the bid was made public just over a year ago, Rio ceased all communications with BHP.

So where to now for Rio?

It is loaded up with debt - $US39 billion ($60 billion) of it - at a time when the rest of the world is desperate to discard it. The Alcan purchase has given it heavy exposure to North America, a region facing what may well turn out to be unprecedented economic difficulties. And it is stuck with $10 billion worth of Alcan packaging businesses it doesn't want and which will eat into management time and resources.

Should it desire to expand its mines, it will need to access capital. Capital is in very short supply these days. The Chinese Government-owned firm Chinalco yesterday indicated that it may increase its investment in the company - up to the maximum 14.99 per cent - and Skinner indicated the Federal Government should consider relaxing its rules on foreign investment.

BHP hasn't emerged unscathed either. London investors are calling for Marius Kloppers's head on a plate after the firm indicated that it would need to write off $450 million in transaction costs. A terrible waste, they tut. But better to write off 10 per cent of the expected transaction costs than bet the entire company as commodity prices head relentlessly south.

Unlike Rio, BHP has just $US6 billion in debt, even though it earns far more than its rival. It is undergeared and cashed up, just as asset prices are plummetting.

The next 12 months may present a once-in-a-generation opportunity to pick up cheap assets from distressed companies, an opportunity BHP would be denied if it had pursued its ambitions with Rio Tinto.

Kloppers is not the first BHP chief to have found himself singed by the siren lure of Rio Tinto.

Brian Gilbertson, the South African who engineered the merger of BHP and Billiton, and was once a mentor to Kloppers, was ejected from the top job at Melbourne's 180 Lonsdale Street after he pursued a merger without board approval early this decade.

Kloppers and the chairman, Don Argus, invested a huge amount of time and emotion into the Rio takeover. To abandon it - with the bidder's statement completed and ready to be sent to the printers - would have been no easy decision. But there is no doubt it was the right one.

They must now hope the European Union throws up the expected obstacles so it can legally abandon the offer.

© 2008 Sydney Morning Herald

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