Rio caught between a knot and a hard place on iron ore

WE ARE in for a few fast rounds of shadow-boxing as real deadlines finally loom for the $US19.5 billion ($A25.2 billion) Rio-Chinalco deal. It is a chicken-and-egg situation. Under the deal as advertised, the state-owned Chinese group would pay $US7.2 billion for Rio convertible bonds to double its stake to 18 per cent, and pay $US12.3 billion for direct stakes in key Rio assets, but it needs to be modified financially and structurally — to reflect a rally in which Rio's share price has more than doubled since talks with Chinalco revved in December, to deal Rio's other shareholders in, and to win a foreign investment nod from the Australian Government. But in a world where process has triumphed over product, change does not come easy. The shape of a revised Rio-Chinalco deal depends on feedback that Rio's new chairman, Jan Du Plessis, gets in coming days from Rio's biggest shareholders, and then on what the Federal Government says when it announces its foreign investment decision, probably in mid-June. The flawed but elaborately documented original deal will stay alive in the meantime, protected by a $US195 million break fee and an undertaking by Rio not to solicit alternatives. The non-solicit side deal in particular limits the ability of Rio and BHP Billiton to talk about a deal-breaker. The freeze in communication between the groups that developed during last year's BHP bid for Rio and which continued for a while after BHP abandoned the attempt last November has thawed, with Du Plessis and Rio chairman Don Argus meeting briefly last month, and BHP chief executive Marius Kloppers and Rio chief executive Tom Albanese meeting at an investment conference in Spain last week. And BHP has an alternative plan that centres on a combination of the two groups' iron assets in the Pilbara. Rio's no-solicit side agreement with Chinalco prevents it from pursuing a BHP alternative, however, and BHP is also partly captured by the process. BHP is not prevented from approaching Rio unilaterally, but after being ignored by Rio last year, Kloppers and his team will move carefully. There is a short-term concern that moving early would merely arm Rio for negotiating improved terms with Chinalco. And the shape of what BHP might propose depends on how much of the existing double-barrelled proposal survives after Du Plessis has collated the collected thoughts of Rio's big shareholders (there is no doubt that at the very least they want part of the bond issue to Chinalco, or any issue that replaces it), and after Treasurer Wayne Swan has delivered his verdict. BHP has attacked the deal in Canberra corridors as one that hands too much control to the Chinese company, but in the public domain it has been silent. Rio and Chinalco are publicly staying on script, but the number of Rio institutional shareholders calling for a new deal is rising, and as John Garnaut reported here yesterday, the Chinalco camp is sending signals that it would consider amending the deal, to cut its stake in Rio from 18 per cent to 15 per cent, scale back the plan for it to nominate two directors to Rio's board, and eliminate an iron ore supply arrangement. All that is pretty much as expected, and it would even carve out some bonds for the $US19.5 billion transaction, making room for a parallel issue to Rio's stroppy institutional shareholders. However, Chinalco is also said to regard its purchase of a direct 15 per cent interest in Rio's main Pilbara iron assets as a must-have. That puts Rio's Pilbara iron ore operation at the centre of a Gordian knot: as a non-negotiable element of Chinalco's deal with Rio, the key focus of the Federal Government's inquiries (the Government said last year that it would look particularly closely at acquisitions by state-owned enterprises, acquisitions by customers and acquisitions of developed resource assets, a trifecta that Rio-Chinalco serves up) and in the background, the object of BHP's hopeful affection. The knot is unlikely to be sliced before Rio's shareholders and Wayne Swan have spoken. source：business.theage.com.au