Prospects may dim for Rio Tinto's $19.5 billion proposed link-up with Chinalco if strong markets boost the attraction of a rights issue and investors believe a new chairman is more willing to consider alternatives.

A buoyant share price could embolden disgruntled shareholders to vote down the deal that would see China's top aluminium maker double its Rio stake and buy portions of key mines.

Although political opposition has grown in Australia to the prospect of Rio linking up with a Chinese state-owned firm, a more serious threat might be a recovery in metals markets, analysts and shareholders say.

A higher share price would make dilution from a rights issue less painful while an upturn could mean that Rio has more chance to sell non-core assets and raise cash to trim its heavy debt.

A lot depends on how positive the markets are feeling. The more positive it feels about an area, the less likely it is to want the company selling assets and the more prepared it will be to fund and keep a 100 percent ownership, said an official at a top-10 shareholder of UK Rio shares, who asked not to be named.

Rio shares have gained 37 percent so far this year, outperforming the UK mining index by a quarter and making dilution from any rights issue less onerous.

Shareholders' decision on the Chinalco transaction may be based on how the global economy acts in the coming few months, Tony Robson at BMO Capital Markets said.

A significant downturn may mean Chinalco is approved, while a modest recovery or signs of recovery may see it voted down.

RIGHTS ISSUE

A $10 billion rights issue combined with other alternatives would be more attractive in the long term than the Chinalco deal, said analyst Olivia Ker of Bank of America/Merrill Lynch.

A rights issue could be priced at a discount of 20 percent and the funds raised would be enough to plug what she estimates is a $8.4 billion shortfall over the next two years, she said in a note.

Major shareholders voiced sharp opposition to the plan under which Chinalco would pay $12.3 billion for stakes in Rio's key iron ore, copper and aluminium assets and $7.2 billion for convertible notes that would double its Rio stake to 18 percent.

Some institutions are unhappy because they regard the deal as favouring one shareholder and breaking the pre-emption rights principle under which all shareholders should be allowed an equal chance to invest when a firm is issuing new shares.

A lot of shareholders will vote against the deal as it stands at the moment. What percentage that will be I cannot say, said Robert Talbut, chief investment officer of Royal London Asset Management.

RLAM is ranked as the 26th largest shareholder in Rio Tinto London shares, according to Thomson Reuters data.

Rio, the world's third biggest mining group by market value, has said it rejected a broad-based rights issue partly because it would have to be at a discount while Chinalco agreed to pay a premium to convert bonds to shares.

Some private investors are happy with the deal, since a rights issue would probably involve cutting or scrapping the dividend, said Charles Stanley analyst Tom Gidley Kitchin.

Private investors don't necessarily want to put new money into the firm and they don't want to invest a lot more money in order to get maybe no more income in terms of dividends.

If metals markets suffer more blood-letting, shareholders may be wary of voting down a deal that pays off half of Rio's $39 billion in debt, but a more rosy economic scenario could provide more options.

Investors also have more time to mull alternatives since Australia's Foreign Investment Review Board has extended their review of the deal by three months.

One wild card investors may consider when deciding how to cast their votes is the potential impact of a new chairman.

Jan du Plessis, current chairman of British American Tobacco , takes over as Rio chair next month and some investors expect him to be more open to possible alternatives.

Options include revisiting a deal with arch-rival BHP Billiton, which last November dropped a hostile all-share takeover bid for Rio worth $66 billion.

Perhaps the Chalco deal does have less of a chance of progressing under the new chair -- but probably because the new hire will be more open to either an agreed deal with BHPB or a rights issue in July should commodity markets roar, analyst Michael Rawlinson at Liberum Capital in London said.

More likely than revisiting last year's full takeover deal would be a joint venture focused on the two firms' flagship iron ore operations in the Pilbara. The bulk of $3.7 billion in synergy benefits touted by BHP for its hostile takeover centred on Australian iron ore mines.

Rio's new chair is South African and might be more comfortable with BHP's South African Chief Executive Marius Kloppers than other Rio executives, analysts said.

Stronger markets could also help Rio's divestment programme. The firm had hoped last year to slash its debt by selling non-core operations, but the effort stalled amid the downturn.

Investors were reminded of the potential for asset sales when Rio said on March 9 that it had sold its U.S. Jacobs Ranch coal operation for $761 million and said it was pressing forward with other asset sales.

Rio has said it was open to feedback from shareholders and investors say that it would likely rejig the deal rather than risking a negative vote if it saw the tide turning against it.

By the time this goes to a vote, the company's going to have to ensure that it has enough votes to get everything through. The idea that they would go to a vote and lose, that would just be a catastrophe for them, Gidley-Kitchin said. (Additional reporting by Raji Menon; Editing by David Cowell)

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