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