RIO SPURNS CHINALCO, EMBRACES BHP

C O N F I D E N T I A L SECTION 01 OF 02 CANBERRA 000537 NOFORN SIPDIS STATE FOR EAP/ANP AND EEB; STATE PLEASE PASS USTR - WEISEL, BISBEE E.O. 12958: DECL: 06/05/2019 TAGS: EINV EIND ECON AS CH SUBJECT: RIO SPURNS CHINALCO, EMBRACES BHP REF: A. CANBERRA 143 ¶B. CANBERRA 330 ¶C. PERTH 19 ¶D. MELBOURNE 42 CANBERRA 00000537 001.4 OF 002 Classified By: Economic Counselor Edgard Kagan, reasons 1.4 b, d ¶1. (C/NF) SUMMARY: Anglo-Australian mining giant Rio Tinto today rejected a $19.2 billion deal with state-owned Chinese company Chinalco. Instead, Rio immediately announced a $5.8 billion joint venture with fellow resource giant BHP Billiton to combine their existing iron ore operations in the Pilbara region of Western Australia. The Chinalco proposal was subject to increasingly strong opposition from Australian politicians and Rio shareholders; the collapse of the deal spares the Rudd Government from having to make a difficult decision on whether to approve the deal. Having worked hard to torpedo the Rio/Chinalco deal, BHP believes that it has scored a major victory by preventing a state-owned Chinese firm from influencing iron ore pricing negotiations from the producer side. Eager to mend fences with a major customer, BHP has reached agreement with four major Chinese steel producers on iron-ore pricing that will be "noticeably" lower than that reached with Japanese customers. Though disappointed that it was not possible to salvage part of the Chinalco deal, Rio believes that the agreement with BHP will assure its survival as an independent entity and will be lucrative for both firms. Australia must now deal with the Chinese backlash, as Chinalco has made clear that it considers the Rudd Government's reluctance to approve the deal one of the major reasons for its collapse. END SUMMARY. RIO/CHINALCO DEAL FOUNDERS -------------- ¶2. (C/NF) Anglo-Australian mining giant Rio Tinto, the world's second largest iron ore producer announced June 5 that it was pulling out of its proposed $19.2 billion deal with Chinese state-owned aluminum producer Chinalco. The controversial deal would have seen Chinalco double its existing 9% stake in Rio by purchasing a convertible bond issue as well a purchase minority stakes in a number of Rio assets, including a 15% stake in Rio's Pilbara iron ore operations valued at $5.1 billion. The deal was driven by Rio's need to pay down $38.7 billion in debt resulting from its 2007 acquisition of Canadian aluminum producer ALCAN, of which over $18 billion is due in 2009 and 2010. However, many Rio shareholders criticized Chinalco,s preferential ownership of proposed bonds, and proposed joint ownership of major assets. Newly appointed Rio Chairman Jan du Plessis, a South African, tried to renegotiate of the terms of the February 2009 agreement to address Australian Government and shareholder concerns. Rio Tinto's Australian Government Relations Manager Mark O'Neill told us June 5 that "Chinalco-lite" collapsed because the Chinese company insisted on board representation. Rio will pay Chinalco $195 million as a breakup fee. BHP BILLITON-RIO TINTO JOINT VENTURE AGREEMENT -------------- - ¶3. (U) Immediately after revealing the end of the Chinalco bid, BHP and Rio, the world's second and third largest iron ore miners, announced their agreement to combine their Pilbara iron ore operations in a 50-50 joint venture; Rio will receive almost US$5.8 billion from BHP. Rio said the Qwill receive almost US$5.8 billion from BHP. Rio said the joint venture with BHP (which itself attempted a takeover of Rio in 2007-08) would unlock significant value, with net present value of the savings to be more than US$10 billion by combining nearby mines into single operations, including greater efficiency in their rail operations. BHP WINS BIG -------------- ¶4. (C/NF) BHP has been lobbying extensively to block the deal (reftels),highlighting concerns about Chinese investment and the possibility that seats on the Rio board would give Chinese representatives important insights into the producer side of the annual iron ore price negotiations. The collapse of the Chinalco deal forced Rio to agree to merge its Pilbara iron ore operations with BHP's, a longstanding goal that CANBERRA 00000537 002.2 OF 002 should allow both companies to reduce operating costs. Despite the 50/50 participation in the joint venture that will produce the iron ore, BHP will appoint the CEO, giving it effective control. Treasurer Wayne Swan's Chief of Staff has told us on several occasions that BHP has played its cards with consummate skill, in part due to the increasing marginalization of BHP CEO Marius Kloppers as BHP Chairman Don Argus has taken the lead in lobbying the GOA with the able assistance of BHP's well-connected VP for Government relations, Bernie Delaney. ¶5. (C/NF) BHP has suffered some fallout in its relations with the Chinese government and some key steel producers, Delaney told us on June 5. Recognizing the need to "do some damage control," BHP has recently reached agreement with four PRC steelmakers on iron ore prices that are "noticeably" lower than the 37% reduction that Japanese and Korean customers agreed to in the May. Delaney said that the catch is that contract is quarterly and not yearly, which brings BHP closer to its longstanding goal of "index pricing." He noted that this agreement has yet to be announced because BHP is still negotiating with most of its Chinese customers. The other major challenge will be regulatory approval by Brussels, according the Delaney, who said "we would not have gone ahead without a clear signal that the EU is willing to sign off once we do a few things to address their major concerns." GOA Avoids Tough Decision While Rio Survives -------------- ¶6. (C/NF) The deal,s sudden collapse spares the GOA from making a difficult decision, caught between significant opposition to allowing a Chinese SOE a key stake in Rio, and worried about the loss of jobs Rio threatened would happen should the GOA have rejected the proposal. It leaves PM Rudd to deal with an unhappy China -- we noticed a very glum Chinese Ambassador Zhang Junsai waiting outside Rudd's office with Chinalco CEO Xiong Weiping on the afternoon of June 5. BHP's Bernie Delaney and Rio Tinto Government Relations Manager Mark O'Neill separately told us June 5 that the Government had made clear that it would not approve the Rio/Chinalco deal without some significant changes. This, combined with growing opposition from Rio shareholders, led to the deal's collapse, according to O'Neill. He expressed disappointment with the collapse of the Chinalco deal and BHP winning control of the JV that will operate the joint assets. However, Rio will still control the marketing of its 50% share of the production and will share more or less equally in the cost savings from rationalizing the two companies' operations. More importantly, BHP's $5.8 billion, combined with a successful rights issue, will allow Rio to address its debt repayment challenge in the coming two years, allowing its survival as an independent company and avoiding fire sales of assets that would have hurt longer term shareholder interests. COMMENT -------------- ¶7. (C/NF) Today,s events bring to a sudden end what would have been the largest ever Chinese overseas investment. Despite Prime Minister Rudd,s protestations after the deal,s collapse that Australia was open to Chinese investment, this move ) and the speed with which Rio jumped Qinvestment, this move ) and the speed with which Rio jumped from the Chinalco,s arms to BHP,s bed ) may well raise suspicions in Beijing about Australia,s openness to Chinese investment. The new BHP-Rio iron ore joint venture will greatly concern global steel producers who already believed those two companies had too much power to set iron ore prices. CLUNE