Tough questions for BHP, Rio after bid collapses

News was prepared under the information support of Online Daily Newspaper on Hellenic and international Shipping "Hellenic Shipping News".

30 Nov 2008

QUESTION will emerge as to why it took BHP so long to pull the pin on a deal that became excruciatingly unpopular with investors, its major customers and the regulators. AS the dust settles after the collapse of BHP Billiton's hostile takeover bid for Rio Tinto, BHP has blamed everything for its decision to pull the deal -- the European regulators, falling commodity prices, China, the global financial crisis and Rio's big debt pile. This is all true, but hubris and arrogance on both sides cannot be
ignored.
All up BHP will write off $450 million in costs related to the bid, but the real cost is far higher when you consider the hours spent by management, the plunging share price and the opportunity cost of not doing other deals or share buybacks.
There is also the incalculable damage BHP has done to its relationships with customers in the region. They were very concerned that the deal would create a monopoly in the iron ore trade.
As soon as the bid was pulled, a share rally occurred among Chinese steel makers Angang Steel, Maanshan Iron&Steel and Baoshan Iron&Steel.
In South Korea, shares of Posco, the world's fourth-largest steelmaker, lifted its share price, while Aluminum Corp of China (Chalco) rallied after its parent, Chinalco, said it planned to raise its 12 per cent stake in Rio to at least 14.99 per cent.
Shareholders on both sides of the transaction suffered, as shown by the share prices of the companies today versus a year ago. While some of this can be blamed on the financial crisis and resultant fall in commodity prices, a chunk of it can also be attributed to concerns by BHP shareholders that the miner had bid too much, and fears by Rio shareholders that the deal would not go ahead for a variety of reasons.
When the deal was pulled, BHP shares rebounded and analysts began putting out reports with buy ratings, and in the case of Merrill Lynch a price objective of $40 a share, which is around the levels it was trading at a year ago. BHP is currently trading at $31 a share but got to $21 a share just before the bid was scrapped.
Rio shareholders have fared much worse. After falling almost 40 per cent on the news that BHP had withdrawn its offer, analysts immediately put out reports with "hold" recommendations.
In the case of Merrill Lynch, it has put the stock on a price objective of $50 a share, which is a far cry from the $145 a share it was trading at a year ago.
Investors will no doubt be looking for blood at Rio Tinto after they fully absorb the sheer folly of the board's decision not to engage with BHP in what will go down in the history books as an excessively generous offer. Chairman Paul Skinner has signalled he will step down in December next year, but there are some mutterings that he might go earlier, particularly as the company struggles to find buyers for some of the non-core assets it acquired as part of its $US38 billion purchase of Canadian aluminium giant Alcan last year.
The brutal reality is that the board should have either sold off or spun off these non-core assets, including the multi-billion-dollar Alcan Packaging business, as soon as the Alcan transaction was completed.
Instead senior management and the board dragged their feet. A year on, the markets have deteriorated and Rio will struggle to find buyers at a decent price. If they refuse to sell they will have to continue to operate businesses that are non-core.
Worst still, credit-ratings agency Moody's has warned of a possible downgrade to Rio's high investment grade A3 rating, noting that asset sales would be a key focus of its rating review.
The for-sale list could include; Alcan Engineered Products, Alcan Packaging, Coal&Allied, Northparkes copper mine, Rio Tinto Energy America (RTEA) and Rio Tinto minerals -- talc and borates.
As Charlie Aitken, the head of institutional investing at Southern Cross Equities, said in a note: "Our view remained that Alcan was a defensive, top-of-the-cycle, debt-financed reaction to BHP's two initial soft approaches about a merger of equals.
"At the end of the day Rio's decision, which I still believe was a reactionary and defensive manoeuvre, to take on $US40 billion of debt to buy Alcan, scuttled this deal and has cost Rio shareholders very dearly. Alcan would arguably be only worth today a third of the price Rio paid for it." Rio has emerged from the takeover uncertainty of the past year, but now investors will turn their attention to the significant refinancing requirement -- approximately $US12 billion over the next 12 months, according to Deutsche Bank analyst Peter O'Connor.
In a note to clients, O'Connor states that Rio's options may be dictated by lenders and equity issuance may comprise part of the process.
Using a series of assumptions, O'Connor estimates that Rio could seek an equity "top-up" of about $US3 billion.
The upshot is Rio's chairman Paul Skinner will be watching his back.
Ironically, by BHP abandoning the bid, it has left Rio as a sitting duck to another predator who will try and exploit the company's weakened share price and disillusionment with the board. Interested parties could range from Anglo, a Chinese sovereign fund or Xstrata and Glencore teaming up.
BHP also has its issues. Firstly, in less than a week shareholders have been told the company will write off $450 million in costs related to the deal and another $US2.1 billion pre-tax impairment charge on its recently constructed Ravensthorpe greenfield and Yabulu brownfield projects.
It also needs better disclosure as to why the deal was pulled. Yes Rio is carrying a large amount of debt but BHP knew that when it made the bid.
Furthermore, commodity prices have fallen but as Marius Kloppers said in an interview just before the bid was pulled: "Some people have been a little irritated (at me) saying that this is a deal for all seasons. I mean when times are not that great, the synergies, the cost savings are really important."
The regulators were always going to have issues with the merger and if BHP was doing its job, it would have prepared a myriad of scenarios to ensure the deal could work.
BHP has failed to disclose what some of the EU requirements were, resulting in speculation that it either totally misjudged the EU, or is using it as an excuse to pull a deal that was becoming increasingly unpopular with a few board members, shareholders and customers.
Nobody wanted the deal more than Argus and Kloppers. Argus will no doubt lament what could have been if Kloppers' predecessor Chip Goodyear had more of a stomach to do a deal in early 2006 at a far cheaper price -- $90 a share -- and without the added complications of Alcan, debt, and a new chief executive starting at Rio.
He might also lament a wasted opportunity to do a deal with Woodside Petroleum back in 2002.
It is understood that discussions went well down the track. The problem back then is believed to be that chief executive Brian Gilbertson was not a strong believer in petroleum and the head of energy, Phil Aiken, didn't support it.
It was ultimately knocked back by the board on the basis it would dilute earnings per share for two years.
There is a saying that it is no good crying over spilt milk. Rio has a lot to cry about, as does BHP.
But before they pick themselves up they need to question the role of the key players in the collapsed bid, and whether both sides have been fair to their shareholders in terms of adequate disclosure.

Source: The Australian