Deal Imploding?

18 05 2010

It has been rumoured that in the wake of rising iron ore prices, delays in getting regulatory approvals and uncertainties related to the Australian super-tax, the Pilbara joint venture between Rio Tinto and BHP Billiton may be called off. The two companies have however publicly reiterated their commitment to the transaction yesterday although BHP Billiton said it would likely re-evaluate the deal if no agreement is reached by year-end.

The deal may no longer represent good value.

There is growing scepticism in analyst-circles on whether this deal will materialize. In an article published on April 14th, The Age reported that Rio Tinto shareholders were tipped to ditch the deal with BHP due to rising iron ore prices. In this context, the need to share the costs is less important, even though the estimated US $10 billion of savings arising from the transaction still appears significant despite savings.

Moreover, the compensation payment of US $5.8 billion granted to Rio Tinto in consideration of the more important quantity of iron ore contributed to the venture (about 5%) was established before iron ore prices increased, which is short-changing Rio Tinto according to analysts. This compensation payment could also be reduced as delays have allowed BHP Billiton to expand its production thus reducing the amount (to US $3.6 billion some predict) that it has to pay to make the joint venture a 50-50 undertaking. However, unless the payment is increased to at least US $6.4 billion, shareholders would likely vote down the deal, it has been reported by Australian Mining.

As you remember, initial discussions of a merger took place at a time when Rio Tinto was actively seeking to reduce the debt it incurred to make its cash acquisition of Alcan and shortly after the collapse of the Chinalco deal in the spring of 2009. Subsequently to the successful rights issue, improving economic environment and the establishment of a new pricing system more favourable to iron ore miners, the merger may not longer be a necessity for Rio Tinto.

Prospects for near-term progress (or lack thereof)

The deal still awaits approval of competition authorities in Australia, Europe, Japan and Korea. If no agreement is made by year-end Rio Tinto may be allowed to walk away without penalty, whereas if either party does so now, it will incur a US $275 million fee. Negotiations will drag…

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