CHINALCO ACQUIRING RIO STAKE?

UNCLAS SECTION 01 OF 02 CANBERRA 000117 SENSITIVE SIPDIS STATE FOR USTR/BELL WHITE HOUSE FOR NSC TAGS: ECON EINV AS CH SUBJECT: CHINALCO ACQUIRING RIO STAKE? ¶1. (SBU) SUMMARY: Australian media is reporting that Chinese state-owned aluminum company Chinalco is negotiating with Rio Tinto to either increase its stake in Anglo-Australian resources giant Rio Tinto or buy specific resource assets. Reeling from falling commodities prices, Rio is scrambling to pay down its large debts, which now exceed the company's market value. Chinalco, which purchased 9% of Rio in February 2008, appears to be seeking to increase its foothold in Australia's resource sector by taking advantage of falling prices and Australian concern about minimizing job losses. The Australian Government has already approved Chinalco's earlier request to purchase up to 14.99% of Rio, but would need to give a new authorization for the Chinese firm to take a larger stake. Contacts believe that the Australian Government is leery of allowing Chinalco to take a 15% stake, as this would give it the right to a seat on the board. END SUMMARY. CHINESE FIRM UPPING STAKE IN RIO TINTO -------------- ¶2. (U) Chinese aluminum company Chinalco is currently in talks with Rio Tinto to increase its holdings in Rio or to acquire specific assets of the company. Chinalco is already Rio's largest shareholder (holding 9%) following its February 2008 US$14 billion investment. A year later, Rio has lost 80% of its market value due to a decline in world commodity prices and investor concern over Rio Tinto's US$39 billion debt (from the acquisition of Canadian aluminum producer Alcan) and refinancing burden. Chinalco is now seeking to increase its strategic foothold in Australia's iron ore and aluminum assets. ¶3. (SBU) Rio Tinto's market value recently fell to US$34 billion - less than the value of its debt - due to concern that it has to repay US$8.9 billion of debt by October 2009 and $US10 billion in October 2010, following BHP Billiton's abandonment of a takeover bid for Rio Tinto in November 2008. From April 2009, Rio will experience a major fall in coal and iron ore export revenue when long-term contracts are renegotiated - possibly with a 50% price cut; Rio has already been discounting to some customers. Asset sales have proved insufficient to reduce debt. In 2008, Rio failed in a plan to sell US$10 billion worth of assets to reduce its debt. Last week, Rio made its first big asset sale in more than five months, announcing the US$1.6 billion sale of its Brazilian iron ore and Argentine potash assets, which had a combined book value of less than US$240 million. Rio's revised corporate restructuring plan is to reduce US$10 billion worth of debt in 2009 through asset sales, cutting capital spending and reducing its global workforce by 14,000. For Rio, the deal would help avoid a costly major rights issue. Reportedly, a US$9 billion rights issue is planned if talks with the Chinalco fall through, possibly if it is vetoed by the Chinese or Australian governments. ¶4. (SBU) The proposed acquisition by Chinalco would be one of China's biggest strategic overseas investments outside the financial sector. Chinese companies have been expected to accelerate investments in Australia's natural resources since the global Qinvestments in Australia's natural resources since the global downturn sharply reduced mine values and the depreciation of the Australian Dollar (about 35% since July 2008) has made their shares much more affordable than during the previous mining boom. If Rio pursues asset sales, Chinalco is likely to be especially interested in Rio's vast Pilbara network of iron ore mines, railways and ports in Western Australia. Chinalco already owns a bauxite project in Queensland. ¶5. (SBU) Chinalco's proposed investment would require review by the Foreign Investment Review Board (FIRB) and approval by Treasurer Wayne Swan. It could be the precursor for a wave of new Chinese resources investments. Approval is more likely because of the sharp downturn in the mining sector and capital liquidity crisis affecting major debtors such as Rio Tinto and Fortescue Metals. Australian media reports that Chinalco and Rio Tinto are in the final stages of talks that could see the state-owned Chinese company invest about US$20 billion (A$31 billion) for asset stakes and equity in the miner. The proposal would need approval from Treasury's Foreign Investment Review Board given Chinalco's links to the Chinese government. On 2 February, Treasurer Wayne Swan said the government encouraged investment in the mining sector, but warned that all deals would be assessed against strict guidelines; "Any proposal to CANBERRA 00000117 002 OF 002 increase its level of ownership above 14.99 per cent (approved in August 2008) would require re-assessment at that time against Australia's national interests." The proposal could include a combination of asset sales, convertible notes and share issues. In February 2008, Chinalco's president, Xiao Yaqin, said the acquisition of a stake in Rio Tinto was a strategic investment and the Chinese company had no plans to interfere in Rio management. The Treasurer may require a similar undertaking in 2009. ¶6. (SBU) COMMENT: Increased Chinese resources investment in Australia seems a natural consequence of the long-term interest of both Chinalco and the Chinese government in securing greater security in the supply of resources and energy to China - especially after the very sharp increases in the price of coal and iron ore in recent years. The dire capital refinancing situation facing many Australian companies carrying large debts, combined with the Government's desire to limit job losses in the resource sector is likely to encourage approval of asset sales. However, Swan is likely to be more cautious about setting a precedent of allowing state-owned Chinese companies to get board seats in firms with major Australian assets. In the current economic climate, it would be a difficult decision to turn away foreign investment. This investment could lead to a wave of strategic mining investments from China which could lead to closer resources and energy trade and investment ties between China and Australia. END COMMENT. CLUNE