Heard the one about BHP and CVRD?

THIS bloke in a New York bar rang me early yesterday. He is a funds manager and he was having a beer with a few worried clients. He wanted to know whether I had heard the news out of London: BHP Billiton was working with Brazil's CVRD to buy Rio Tinto. The amazing thing is, he was serious! After all, the London market had embraced the idea early, adding 3.7 per cent to Rio Tinto's price and 2.2 per cent to BHP Billiton's. And the hedge funds in New York were not alone in following the London lead. Rio surged 3.5 per cent on local markets yesterday, cracking $99 again on the back of the excitement. And BHP did pretty well, too, adding just over 1 per cent. So, once again, the speculators of London have set the hedge-fund hounds running on BHP's takeover aspirations. We have been hearing this sort of stuff now for the best part of a year and it has been resolutely unfounded. It still is. Because, rest assured, neither BHP nor CVRD is working, together or separately, on buying and breaking up Rio Tinto. For all of yesterday's "no comments" from both the alleged partners, it is not going to happen. Just as it didn't happen after speculation in May, which again spread like a virus from London to New York, that BHP would make a solo $US100 billion ($121 billion) play for Rio. A few months later, BHP and CVRD were going to make separate $US40 billion runs at Alcoa, after Rio revealed a $US38.1 billion bid for Alcan, a deal that had been two years in the making. The Alcoa pitch has not happened. So the pundits have looked again at their tea leaves and revived the Rio idea and added CVRD to the BHP mix. It shows just how skittish the international resources marketplace is, that speculation as seemingly unfounded as this has added instant value to Rio and BHP. According to sources at Rio, the speculation started swirling around the UK markets early on Tuesday and ended up in the Financial Times on Wednesday. That story was then picked up by the New York hedge-fund managers. Now, if Chip Goodyear was really planning to punctuate the end of his BHP career with a huge takeover, would he really have headed to Sydney for two days of APEC, which includes hosting an in-house chat show on global warming? And would BHP's boss-to-be Marius Kloppers be smiling his way through APEC meet-and-greet sessions rather than bunkering down in a war room at BHP headquarters in Melbourne? Remember, too, that a merger of BHP with Rio, or its Australian forebear, CRA Ltd, has been contemplated three times in the past, costing at least two chief executives their careers. Kloppers has made it clear he intends to respond more quickly to opportunity than his predecessor and that BHP is keen to flex its relatively unlimited financial muscle. But chasing Rio would be an extremely ambitious way for Kloppers to make his mark. And look at the logic of a joint bid. Rio, once it completes the Alcan acquisition, will be essentially a three-tiered cake, with copper, iron ore and aluminium generating about 90 per cent of earnings. So, exactly who would get what in a break-up of the Anglo-Australian's colonies? Well, just for the sake of the argument, let's say that CVRD gets the spanking new post-Alcan aluminium business and BHP walks with the Anglo-Australian miner's copper. But who would get the iron ore business? Because the winner of that end of the empire would end up controlling maybe half the global seaborne iron ore business. The synergies that the Hamersley and North iron ore operations would deliver to BHP would be staggering. But CVRD has long coveted a position in the Pilbara, so it would not walk easily from those assets. Of course, this is all nonsense. Because the regulators of Europe, Australia and probably the US simply would not let that deal go through. How do we know that? Well, just recall, if you will, what happened back in 2001 when the Europeans almost stopped the Mitsui-CVRD takeover of fellow Brazilian iron ore player, Caemi. The European Commission took a dim view of the Caemi transaction, eventually forcing CVRD-Mitsui to sell a core Canadian asset and to create a completely separate ownership structure to hold and operate Caemi. Crucially, the commission found that the seaborne iron ore trade should be treated by competition regulators as a discrete and contiguous market, rejecting any idea that it could be divided into western European and Asian blocs. Given the dependence of the Europeans on the seaborne trade, the regulator expressed serious concern over the idea that the four big iron ore producers would become three. Now, the result of a joint bid by BHP and CVRD would be quite different. Not only would three become two, with one becoming ultra-powerful in the increasingly tight seaborne marketplace, but it would also deliver market-influencing power in the copper and aluminium markets, too. And if you think the European competition regulator is not important in this debate, forget it. Europe remains the biggest, or second-biggest, market by volume for each of the companies we are talking about here. Maintaining unencumbered access to those markets is, obviously, essential to the continued prosperity of each. The other indicative aspect of the commission's review of the fate of Caemi in 2001 was that it had been BHP which originally planned to take out the Brazilian. As the commission noted at the time: "The first phase investigation of the proposed merger between BHP and Caemi had already identified serious competition concerns arising from that transaction and the commission had decided to open an in-depth inquiry." There is no reason, either, to imagine the competition regulator would be any less disturbed by the market concentration implied in a take-out of Rio by BHP, either alone or in partnership. As we noted back in May, when this sort of silly stuff emerged last, the complexity of political and regulatory hurdles implicit in a BHP bid for Rio are nothing short of mind-boggling. Would ACCC chairman Graeme Samuel, for example, really want BHP, in cahoots with CVRD or not, owning 100 per cent of the current (and say 90 per cent of future) Pilbara iron ore exports? And surely neither Samuel, nor his old colleagues at the National Competition Council, would be thrilled by the idea that all three integrated iron ore rail and port systems would be owned by BHP. One answer to that little problem could well be to have an initial public offering, or sell the combined infrastructure business. That is a deal which was investigated during the late 90s, and it is still reckoned by some to be a good way forward for BHP and Rio. But it is an idea that has been rejected often by both BHP and Rio, because it flies in the face of everything that they believe to be important about their need for a dedicated, closed transport system in the Pilbara. And it is not like either BHP or Rio need the cash that would be generated from a deal like that.