RIO TINTO’S proposed $19.5 billion deal with Chinalco was unpopular in the first place, but by the time it entered its fifth month this week, its supporters were few and far between.
Both sides abandoned the deal yesterday, as long-running negotiations over changes to the transaction broke down.
In its place, Rio is expected to launch a rights issue of up to $15 billion as well as a possible joint venture with BHP Billiton, another blue-chip Australian iron ore miner.
On Rio’s side the volume of shareholder criticism of Chinalco had steadily risen since the deal was first proposed in February, increasing pressure on the negotiators to reach a compromise that would guarantee most Rio shareholders voted for the transaction in mid-summer.
Against Chinalco’s proposed cash injection of $19.5 billion, which Paul Skinner, the steel giant’s former chairman, claimed was necessary to reduce Rio’s $40 billion debt.
These included the sale of stakes in Rio assets around the world, giving Chinalco minority ownership of mines that still have up to 100 years of cash-generative life in them.
Of more immediate concern to Rio shareholders were the terms of a $7.2 billion convertible bond offered by Chinalco.
The bond, once converted to equity, would ensure the dilution of existing shareholders even while raising Chinalco’s stake to 18 per cent.
Shareholders also considered the unknown ramifications of embedding a state-owned Chinese miner in the fabric of a global mining company listed in the UK and Australia.
As the deal collapsed yesterday sources did not cite any single factor as the straw that broke the camel’s back.
Many shareholders and analysts were caught by surprise; they believed the Chinese group was prepared to amend terms rather than walk away.
But a final point of contention, a source said, was inability to agree changed terms to the convertible bond.
Rio was widely expected to demand a scaleback of the $7.2 billion convertible bond. This would lower Chinalco’s ownership stake and offer irate Rio shareholders a chance to participate in the fundraising, thereby decreasing their risk of dilution and increasing their chances of voting for the deal.
Chinalco was understood to be amenable to a revised bond, because its priority was gaining access to the top-quality mines that Rio offered it.
But Chinalco was understood to only accept a convertible bond that offered it a 15 per cent stake or higher, compared to the 18 per cent stake offered in the original proposal.
As rising commodity prices carried Rio’s share price higher,the conversion premium for Rio’s bond evaporated, making it likely that Chinalco would quickly convert the bonds to Rio shares.
This was salt in the wounds of some Rio shareholders, who viewed the rising share price as one more suggestion that Rio was not in the financial emergency that Mr Skinner and Tom Albanese, chief executive, conveyed in February, and indeed had less geopolitically complex options such as a United Kingdom rights issue.
But some investors speculated that the evaporated premium became a dealbreaker for Chinalco too, because the Chinese group might have been dependent on the convertible’s 9 per cent coupon to fund the costs of its investment in Rio.
In April Jan du Plessis came in as Rio’s new chairman. Rio investors projected his role as the “peacemaking” successor to Mr Skinner, who was seen by some observers as intransigent in his view of the Chinalco deal being the best and only option available to Rio.
Mr du Plessis quickly made two clear points. First, he and the board remained committed to Chinalco.
Also he would put no deal to Rio shareholders that had any chance of being voted down.
While the details of the failed deal remain unclear, it looks probable that these two points became incompatible by the time Mr du Plessis finished his meetings with Australian investors last week.
Shareholders have said that Rio was not prepared to see the deal pass even with a minority bloc voting “no”, because of the damage it would do to a board’s reputation.
Many people close to the deal expected Australia’s Foreign Investment Review Board on June 15 to resolve for the two companies the vexing issues facing their deal. On that date Firb was due to make its recommendation on the deal, based on national interest grounds, to Australia’s treasurer.
The Chinese state’s reaction to the collapsed deal is now keenly anticipated.
Rio, one person close to the deal said, “has damaged itself in China forever”.