In the Chinalco Deal, a Road Not Taken Is Beckoning Rio Tinto

If the Rio Tinto board faced the same choice on fixing its balance sheet today as it did in the dark days of February, it is a fair bet it would take a different course. It would likely opt for a rights issue rather than its complex $19.5 billion deal with Chinalco, a Chinese state-controlled company. Since its original decision, commodity prices have soared, boosting mining valuations and undermining much of the rationale for the deal. Even so, that is unlikely to be enough on its own to persuade Rio to walk away. Rio's liquidity position has improved considerably. Assume a one-off cut to iron-ore prices of 30% from April this year; that aluminum and copper prices stay around today's levels; and Rio completes the $10 billion rights issue it previously considered. It would meet its $18.9 billion of loan repayments through 2010 with some room to spare, according to broker Canaccord Adams. With the bond markets open, as demonstrated by Rio's recent $3.5 billion issue, Rio should have some flexibility. But Rio's lingering problem isn't just liquidity but excessive leverage. The attraction of the Chinalco deal is that it includes asset sales, enabling Rio to refinance debts and reduce leverage upfront, without being exposed to the vagaries of metal prices. That is still an important consideration, particularly given the uncertainty over the global economic outlook. Rio can't afford to walk away from Chinalco only to find metal prices slump again and it needs to sell assets at fire-sale prices. That means Rio would likely want the comfort of firm bids for some assets before it would consider abandoning Chinalco. Bankers say there is no shortage of interest. But it isn't clear whether there are real offers at high enough prices to justify Rio paying Chinalco a $195 million breakup fee and risk offending its biggest customer: China. Chinalco has set the bar high, particularly with the price it is paying for a stake in Rio's Escondida copper mine in Chile. Attractive bids may yet materialize. After all, rival mining companies, among them Rio's erstwhile suitor BHP Billiton, have a strategic interest in preventing Rio getting too cozy with China. Such moves would put Rio's board in a bind. Walking away from Chinalco would almost certainly cost Rio boss Tom Albanese his job and would be an embarrassing U-turn for the board as a whole. Still, at least it would avoid the possible humiliation of having a deal turned down by either its own shareholders or the Australian government.