Chinalco deal no longer a must as BHP goes to Rio

RIO Tinto has been queried by the Australian Stock Exchange on this week's share price slide, but its reply may be short and not to the point. Its shares are falling because investors have woken up to the fact its $US19.5 billion ($A26 billion) Chinalco deal has gone from being a necessity to an option. A new deal with BHP Billiton is another. There has been cautious engagement, and BHP boss Marius Kloppers and Rio chief Tom Albanese touched base when at the Bank of America/Merrill Lynch mining conference in Barcelona this week. Rio cannot solicit offers under the terms of its deal with Chinalco, but the duo presumably discussed matters of common interest. A new share issue is also in the mix, as a stand alone or as a supplement to a revised Chinalco deal, or one with BHP. The share price action certainly deserved the query: Rio shares hit $71.60 last Friday, and have fallen by $14, or 19.6 per cent, since, including a $7.65, 11.7 per cent plunge yesterday on reports that it will launch a $10 billion share issue after scrapping, or heavily modifying, the Chinalco deal — a deal it has consistently championed. But an informative response is only likely if Albanese and his team of executives and advisers have sifted through the options. The winnowing process is believed to be incomplete, although there are subterranean signs of heightened activity. There is no doubt the original $US19.5 million deal, which would have seen Chinalco double its stake in Rio and take minority joint-venture interests in key assets including Rio's main Pilbara operations, no longer stacks up. At the very least, it should be renegotiated to reflect the fact Rio's share price has leapt from a low of $32 in December, ahead of February's Chinalco announcement, to last Friday's $71.60 high. Even after this week's descent, Rio's shares are still 8 per cent above the strike price of convertible bonds that Chinalco would receive under the original terms of its deal. Easier credit markets and heightened asset sale interest are other factors that demand a rewrite in Rio's favour, and the extent of Chinalco's head company and joint venture buy-in must also be modified if the deal is to pass muster on foreign investment grounds in Canberra. A general share issue or convertible bond issue of about $10 billion would lower the foreign investment hurdle, by diluting Chinalco's eventual stake from 18 per cent to below Australia's primary 15 per cent foreign investment hurdle, and would respond to institutional anger about the original decision to bypass them in favour of Chinalco. The issue would be priced at a discount to Rio's market price, something this week's share price slide reflects (somewhat perversely making an issue less attractive to Rio in the process). And it could be introduced as an adjunct to either the Chinalco deal or a BHP variant — most likely centred on a merger of BHP's and Rio's Pilbara iron-ore assets: Rio's Pilbara operation is bigger, and a marriage would involve a transfer of value to Rio, as would BHP's acquisition of Rio's 30 per cent minority stake in the Escondida copper mine, something BHP unsuccessfully proposed late last year. None of the options is straightforward, however. The $US195 million break fee that Rio would need to pay Chinalco if it walked is not a deal-killer, and the insertion of BHP in Chinalco's place would defuse foreign investment concerns that dog the original transaction. But before BHP dropped its full bid for Rio last year it became clear that the European Commission has serious competition concerns about a Pilbara combination. That obstacle would have to be faced again if Rio and BHP revived the Pilbara part of the full merger that BHP failed to interest Rio in last year, and abandoned as the global recession intensified. AFTER yesterday's 3.4 per cent retreat, the S&P/ASX 200 index is still up 19 per cent from its March 6 nadir. The Dow Jones Industrial Average also sold off on Wednesday night but was 26.5 per cent above its March 9 low, and the Morgan Stanley Capital International global sharemarket index was up 33.6 per cent. One of the features of the global rally so far is that it has been sentimental: shares' prices haven't been expanding in response to earnings rising, but in the belief that they will, as the economic slump eases. That's normal. Investors anticipate an earnings bounce rather than waiting for it to be confirmed, and price-earnings multiples expand as they do, in this case from 10.6 times for the MSCI global index at the end of last year to 10.5 times as the rally began in March, and to 13.8 times now, and from 9.8 times at the end of last year to 13.6 times now in the case of the ASX 200. That uniform advance in valuations masks much more variable performance, sector by sector, however. Evans & Partners chief investment officer Mike Hawkins has compared the five and 10-year average price-earnings multiples for the MSCI global index with the MSCI's Australian basket of shares, which is comparable to the ASX 200. Consumer discretionary shares in the Australian index — media companies, general retailers and casinos, basically — had the same price-earnings multiples on average as their MSCI global index equivalents over five and 10 years. They are now priced at just 45 per cent of their global counterparts, and appear to offer good value. Australian energy stocks, on the other hand, have gone from a 6 per cent premium over 10 years to a 44 per cent premium over five years, and are now at a 73 per cent price-earnings premium — overexcitement about coal seam gas may be a factor there. source：business.theage.com.au