BHP Billiton Enhanced Bid for Rio Tinto
Companies / Metals & Mining Feb 08, 2008 - 03:41 AM GMTBy: Fat_Prophets
BHP Billiton has enhanced its previous 3-for-1 scrip offer for Rio Tinto, by announcing on the final day before the 'put up of shut up' deadline, a fresh 3.4-for-1 scrip offer. What role the late entry of the Chinese-Alcoa alliance into proceedings had on BHP increasing its offer remains to be seen, but it would seem to have forced BHP's hand to some degree. BHP has also announced a US$6.0 billion interim result for the six months to 31 December 2007, which was broadly in line with market expectations.
"The motive for BHP remains clear - acquisition of Rio Tinto would create a mining company with unparalleled market and pricing influence."
Fat Prophets initially recommended buying BHP at $25.84 in January 2006 (Fat Mining 10). Our last review of this stock was during November (Fat Mining 102).
From a charting perspective, the longer-term outlook for BHP remains buoyant. As evident on the weekly chart, despite an increase in volatility over the past six months, the longer-term upward trend remains intact.
In the shorter-term, price movements are related closely to events surrounding the takeover bid for Rio Tinto. Although prices have eased back from the rebound high of $40.30, we believe that underlying investor support remains firm with support in the region of $35.65 to $34.55 to limit downside risks. Below here, the $31 low of January underpins the broader upward trend.
Once the current volatility subsides, we anticipate a period of consolidation in order to build a base to support future gains. In time, we believe that potential remains for a continuation of the long-term underlying upward trend.
BHP Billiton has tabled a fresh offer for Rio Tinto as it attempts to boost market support for its ambition to create the world's biggest mining group. Its bid is conditional upon gaining more than 50% of acceptances.
Hot on the heels of the entry of the Chinese-Alcoa alliance on the scene with their raid on the Rio Tinto share register last Friday in London, BHP has announced an enhanced 3.4-for-1 scrip offer for RIO just a day before the 'put up or shut up' deadline.
This effectively values RIO shares at A$156.74 per share, which is a premium to their closing price of $127.35 a share on Tuesday, prior to the announcement of the revised bid. This of course will change with the pullback in BHP's share price on the market on Wednesday.
Do we think at this initial stage that the new offer will be successful? Well, it's not going to be easy in our view, although it obviously stands a greater chance than the previous offer that was described as 'dead in the water', by the RIO board. We still believe a bid of around 4-for-1 will be needed to sway RIO holders. A lot will depend on the actions of the Chinese.
A consortium comprising Aluminium Corp of China (Chinalco) (backed by the Chinese government) and Alcoa of the US stunned the market late last week with a £7.2 billion swoop on Rio Tinto, that gave the consortium a 9% stake in the company, and a major say in what happens next.
The consortium says they do not plan to bid for the rest of RIO and interestingly also say that the price paid 'reflects fair value for RIO.' This was a view that Chinalco president, Xioa Yaqing, reiterated at a press conference in Sydney, to explain the deal on Monday afternoon.
Their purchase price represents around a 4-for-1 valuation with respect to BHP-RIO, so on the surface it would initially seem as though they would be hesitant to let their investment go on a 3.4-for-1 basis, if they were to sell into BHP's scrip offer.
It is clear to us that the Chinese are not interested in gaining control of RIO. This would be met with stringent opposition by the Australian federal government on national interest grounds, as the Chinese would be aware. The Australian government would seek to preserve resources of substantial national economic interest, principally the Pilbara iron ore assets in Western Australia.
The deal so far is a small price for the Chinese and Alcoa to pay to gain at the table in any future discussions with BHP and potentially get a share of the spoils resulting from the sell-off of chunks of the merged group's aluminium/alumina assets. Remember, one of the jewels in RIO's crown is the Alcan aluminium business, which it successfully acquired late last year, beating Alcoa in a takeover battle. Both Chinalco and Alcoa would be keen to share the spoils in any asset sell-off. The decision to strengthen its links with Chinalco was the simplest option for Alcoa after the failure of the Alcan bid. Bear in mind also that Chinalco and Alcoa have reserved their right to increase their stake, but only if BHP makes a formal bid or cuts a deal with Rio, which it has dome.
So the Chinese could look to raise the stakes from here. BHP's revised 3.4-for-1 share offer represents a 45% premium to Rio's pre-bid price in November last year and that the portions that each company would hold in a merged group would be BHP 56% and RIO 44%. As we have previously indicated, there are numerous compelling reasons as to why a getting together of the two groups makes sense. If a deal can be agreed, it would be close to the biggest takeover in history and would be worth between US$350 and US$400 billion.
The merged company would have estimated annual revenues of more than $US55 billion and estimated earnings of close to $US30 billion a year. The purchase of Rio would create a company that controls more than a third of the iron-ore market, supplies the most energy coal and copper, 25% of the world's uranium, and which owns mines and oilfields in six continents. In preparing its proposal, BHP Billiton says it has examined in detail the regulatory issues and other practicalities of a merger. But the deal has to run significant hurdles: firstly the Rio board will have to be convinced, secondly its shareholders will have to be convinced, and thirdly a range of regulatory approvals will be needed.
One of the major benefits of a merger in our view (although BHP denies this is a motivation) is greater market and price control. BHP in a very politically correct way says the bid is all about economies of scale, infrastructure sharing and removing duplication. This is what it has to say to avoid putting regulators and customers offside!
The reality however is that in our minds BHP would love to have a situation where it can be the dominant player, a one-stop shop if you like, in commodity markets across the globe.
Iron ore is a perfect example of a commodity where industry consolidation and market dominance by a handful of key players can generate a surge in earnings. Iron ore prices, which were previously in the doldrums, have rebounded to the point where prices will have risen for six consecutive years, to record levels.
The emergence of China is only a partial explanation. The control of supply is the major factor here. The concentration of 80% of the iron ore market into the hands of three key players (CVRD, RIO and BHP) means iron ore producers now have solidarity at price negotiations and unprecedented bargaining power.
BHP would love to try and duplicate this level of influence across the commodity spectrum.
A successful bid for RIO was never going to be easy to pull off. A company with high quality assets like Rio does not come along every day and with the furious takeover activity in the resources sector over recent years, the cupboard is getting increasingly bare.
BHP plans to complete any deal through two schemes of arrangement: one in Australia and one in the UK. This is because BHP currently has the majority of its shares listed in Australia, whilst but Rio has more of its capital in the UK. The combined group would have a similar amount of shares listed in Australia and London.
BHP says it has will put $US30 billion toward a share buyback to placate investors hoping for a cash component to the bid.
BHP said it expected the takeover would lead to $US3.7 billion of pre-tax cost savings by 2013, which is a fair time to wait. Around $US1.7 billion would come from cost savings achieved by removing duplication, and the remaining $US2 billion would be driven by the acceleration of volumes to customers.
BHP cited potential savings achievable by combining the pair's iron ore operations in Western Australia and coalmines in the Hunter Valley and Queensland's Bowen Basin. These are obvious examples.
From a broader perspective the bid is also highly significant. In our view it reflects enormous confidence in the sustainability of the current mining boom and the fact that it has a long way to run yet. We have firmly maintained our view that this is a decades-long situation unfolding and that we are still only in the early stages.
We nevertheless remain cautious about mega-mergers in the resource sector and the economy generally. Very few in recent have at the end of the day created value for shareholders. Good examples can be seen at the big end of the gold and oil sectors, where mega-mergers have created companies that are struggling to maintain output, boost profits and replenish declining reserves. These companies have effectively become 'too big' in our view.
BHP will have to ensure that it firstly doesn't overpay for Rio Tinto and secondly that it does not end up in a similar dead-end to the big players in the gold and oil sectors, which have hit a brick wall in terms of growth options.
Finally, a quick comment on BHP's earnings, which have been overshadowed by events surrounding its RIO bid.
BHP says the outlook for commodity prices remains strong after delivering a minor dip in first-half profit. The miner has reported interim earnings of $US6.017 billion, 2.4% lower than the previous corresponding period, but in line with market estimates.
BHP delivered record or equal-record production for seven major commodities, resulting in record half-year earnings for the group's iron ore, petroleum and manganese divisions. Revenue for the half increased by 15.5% to $US22.539 billion, with underlying EBIT coming in at $US9.623 billion.
Increased prices and sales volumes pushed underlying earnings for the company's iron ore division up 19.2% higher to $US1.673 billion. High oil prices helped to drive earnings in the petroleum division 22.3% higher to $US1.972 billion, while the manganese group reported a 310.5% increase in earnings to $US431 million.
BHP has also announced its interim dividend will be increased by 45% to US29 cents per share.
BHP Billiton said in the medium term that the demand growth for its major commodities would remain robust, with bulk commodity contract prices and oil and thermal coal prices should remain strong. The company expects the industrialisation of China to drive strong demand growth in the longer-term.
However, BHP also said the pace of global economic growth had moderated as a result of a worldwide credit crisis, despite robust growth in many major economies. BHP Billiton expects the global economy to slow in the short-term as developed economies experience a moderation in their economic activity.
We will watch developments with great interest as they unfold with respect to RIO. In the meantime, BHP Billiton will remain firmly held within the Fat Prophets Mining & Resources portfolio.
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