It's been a while since we last checked in with Rio Tinto. But it's a bellwether that investors should come back to now and then, just to get a sense of where commodities equities are headed.
Like the rest of the market, Rio Tinto has been halved in the stock market's downward slide - down 58% from its closing high of $525.46 on May 22. Even Tuesday's 13% increase is cold comfort compared with the good ole days of spring. So what's the deal?
Shark Still Circling
Well, the deal is still not BHP.
BHP Billiton is still trying to acquire Rio Tinto in a 3.4-to-1 stock deal.
Back in November 2007, when the bid was new (and offered at 3-to-1) Rio Tinto said no on the basis it devalued the company. The International Herald Tribune said at the time:
Rio on Thursday rejected BHP's offer pitched at a premium of about 14 percent to Rio's Australian share price at the time, saying it was too cheap. Rio itself this year was forced to pay a 65 percent premium to acquire Canada's Alcan Inc at a cost of $38 billion, paid for it with debt.
As the implications of the takeover trickled through the market and investors weighed in, actual stock price ratios changed. Within a couple of weeks the actual ratio of the shares in the market was way over the proposed bid, at 3.3-to-1, forcing BHP to up the bid in February of 2008 to the current 3.4-to-1 offer.
Since then, there's been a steady erosion in the price of both companies, but BHP has managed to retain more value than Rio Tinto. Theoretically this means the deal is sweeter for Rio, but that situation may be shifting again, as in the very short term, Rio shares have been gaining on BHP. These latest market ups and downs have highlighted a real problem with this type of stock-only deal - the constant re-valuation of the deal with every change in stock price.
Last week, Rio Tinto was forced to deny rumors that it was entering actual talks with BHP about its bid, after big unexplained gains in its stock price. That denial (an actual official one) resulted in falling stock prices for both companies, once again changing the deal valuation.
On the regulatory side of the story, the Australian Competition and Consumer Commission (ACCC) released a statement in the beginning of October stating that it was not opposed to BHP's bid to take over Rio Tinto. ACCC Chairman Graeme Samuel said:
"While significant concerns were raised by interested parties in Australia and overseas, the ACCC found that the proposed acquisition would not be likely to substantially lessen competition in any relevant market."
South Africa has also approved the takeover bid, provided BHP sells the interest in the Coega Aluminum Smelter project it would acquire in the deal. These kinds of pre-negotiated approvals for hostile takeovers aren't unheard of, but in the realm of corporate warfare, they can often seem a little absurd.
On the other hand, the European Union is still investigating what its position will be on the merger. Japan will reportedly lobby for the EU to block BHP's bid because the two companies supply about 60% of Japan's iron ore, making Japan's steelmakers understandably nervous about increasing costs.
Working Together?
The irony of all the back-and-forth is that Rio Tinto and BHP are actually on the same side of a long-term legal battle to defend their rights to railways they built in Australia. Fortescue Metals Group has been fighting for access to the railways for years, and this past Monday, the Australian government upheld the recommendation by the ACCC that will allow third parties access to three key lines for the next 20 years.
Rio Tinto has said it will contest the decision on the grounds that it will reduce the amount of ore it will be able to transport on the railway. Rio Tinto told Bloomberg that "the ruling may cost Australia A$30 billion [$18 billion) and will risk further investment in iron ore production." BHP is also unhappy with the ruling, concerned about disruptions and delays of their own ore. For once, Rio Tinto and BHP can agree on at least something.
The Business Of Business
Rio Tinto released a third-quarter operations review on October 15. Global iron ore production was up 17% over the third quarter 2007. Australian coking and thermal coal as well as U.S. coal all were up over 3Q07. The weak point was (surprise) copper, which showed an overall 7% decrease in mined copper compared with 3Q07 due to "operational interruptions" (stuff broke) at its Escondida mine.
It is all well and good that production numbers are growing, but is there demand for Rio Tinto's products? When you talk about things like demand for iron ore, copper, coal and aluminum, you inevitably talk about China. And China's economy, while still growing, has slowed down. The third quarter review says it all:
There has been a deceleration in Chinese growth, which is expected to fall from nearly 12% in 2007 to less than 10 per cent this year. The slowdown is a product of tight credit policies in China that were introduced late last year to address inflationary concerns. These are only now being relaxed.
While apparent demand for steel making raw materials, copper and aluminum has slowed, lower prices mean that Chinese producers are facing margin pressure and should be expected to cut their production. For example, it is likely that the vast majority of Chinese aluminum producers are now making operating losses.
So it's good news/bad news. Bad news: slowing demand and declining prices for copper and aluminum (and almost everything else in commodity land). Good news: Rio Tinto is seeing the silver lining - lower prices mean that less-mature companies - the ones that rely on higher prices for commodities to make their margins - just can't do business is this climate and will be closing. Long term (very), that could be good news for the big boys.
Forward-Looking Statements
In the short term, Merrill Lynch is forecasting China's copper demand to grow at 9% next year, slightly up from this year, but lower than the previous year's growth rate of 13%. Looking long term, Rio Tinto's CEO Tom Albanese said that demand for products such as copper, aluminum and iron ore is expected to double by 2022. Rio Tinto is currently reviewing its capital investments in both the short and long term in order to put itself in the best position to take advantage of that expected recovery. And after all, while the rest of the world is talking about actual contraction, we're still talking about nearly double-digit growth in China - maybe not the tiger it was just a year or two ago, but still one of the fastest-growing commodity consumers in the world.