Stephen Bartholomeusz
BHP passes on Rio's debt
BHP Billiton has made what would have been an excruciatingly difficult, even painful, decision to effectively end its 12-month pursuit of Rio Tinto.
While BHP can only really withdraw the offer if the European Union imposes some conditions on it as the price of competition policy clearance, the reality is that from the moment it announced the bid BHP knew there was no prospect of the offer getting past the EU unscathed. Now the BHP board is counting on the EU to get it off a potentially dangerous hook by making some demand, however small.
As China slowed, commodity prices plummeted and the oil price dived. As BHP and Rio Tinto’s share prices were smashed the appeal of the merger started to wane, rapidly and significantly. Perversely, the closer BHP got to succeeding, the less appealing success was looking.
As discussed earlier this week (BHP's $42 billion question, November 24) the one issue that would have loomed increasingly large in the minds of BHP’s directors would have been the $US42 billion of debt Rio into took on to acquire Alcan at the top of the pre-crisis market.
The broad similarity of the two groups’ portfolios meant that it wasn’t the crash in commodity prices that undermined a deal that was always predicated on relative rather than absolute values. Unfortunately, while everything else fell the size of Rio Tinto’s debt didn’t.
Nor was Rio Tinto able to get away the $10 billion of asset sales it planned before the end of this year as part of a $15 billion debt-reduction program. A BHP-owned Rio Tinto would have faced major write-downs and would have carried about $50 billion of borrowings into a bleak and uncertain future.
The BHP board, having expended so much energy, emotion and more than a few dollars on stalking Rio Tinto, would have been very reluctant to give up the pursuit with a successful and a history-making merger in sight. BHP has had one brush with disaster during the tenures of some of the BHP directors, however, and they were never going to risk experiencing that kind of pain again.
The effective removal of the safety net under Rio Tinto’s price leaves the group exposed. It will now have to carry that debt into 2009 alone. It faces major write-downs on the Alcan assets it couldn’t sell – and perhaps on some that it never planned to sell.
It may have to raise capital, which would ignite shareholder discontent given Rio Tinto fought so hard against the BHP bid. Foregoing a premium to face dilution and a potential meltdown in the Rio Tinto share price would infuriate some on the Rio Tinto register.
It is, of course, conceivable that BHP could return in the second half of next year, once the dust settles, Rio Tinto’s shareholders have been sufficiently bruised and the outlook becomes clearer. The historic moment, however, may have passed, with the past year showing how long and difficult such a bid process can be.
There are also suggestions that Rio Tinto is already trying to line up another Chinese cornerstone investor. With Chinalco already on the register that could secure Rio Tinto’s backdoor.
From BHP’s perspective however, it is better to pass on that historic opportunity than leverage itself significantly when the rest of the world is furiously de-leveraging.
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