In an analysis published Thursday, Standard & Poor's said they viewed Chinalco's proposed $19.5 billion cash injection into Rio Tinto as positive as a demonstration of management's willingness and ability to strengthen its debt burden during the current industry downturn.
However, we believe the transaction may also involve potentially negative consequences for Rio Tinto's business profile, Credit Analysts Alex Herbert and Trevor Pritchard wrote.
In our view, the sale of meaningful minority stakes in key assets is complex, and involves execution and integration challenges, they said.
By Rio Tinto selling meaningful minority stakes in some of its core iron ore, copper, and aluminum assets, and allowing [Chinalco] Board representation, Rio Tinto's business quality could weaken in our view, the analysts advised. We regard the transaction as complex, with execution and integration challenges. The high profile resignation of chairman-designate Jim Leng on Feb. 9, 2009, reinforces this point.
Nevertheless, S&P also regards the announced transaction to be overall positive for Rio Tinto's near-term credit quality and as a step forward in strengthening liquidity and lower the group's large debt burden. Accordingly, absent any adverse developments, upon completion of the key components of the transaction, we plan to affirm the long-term ‘BBB' rating, raise the short-term rating to ‘A-2' from ‘A-3', and to revise the outlook to stable from negative.
Supportive factors include a substantial portfolio of low-cost, high-quality reserves, healthy profit margins, and positive free operating cash flow generation, the analysts noted. Constraining factors include a rapidly weakening global economic outlook and sharply declining commodity prices.
However, S&P is giving Rio Tinto a negative outlook until the deal with Chinalco is completed, citing uncertainty about whether the necessary approvals needed to complete the transaction will be received.
In the absence of any adverse developments, we plans to revise the outlook to stable, once we believe that there is a high likelihood that the key components of the transaction will complete, the analysts said. Shareholder, government, and regulatory approvals will in our view be key milestones. In the event that key components of the transaction do not proceed, and if material debt maturities due in October 2009 and 2010 remain outstanding, then increased negative rating pressure would in our view likely develop.
In our view, the Chinalco transaction has a positive impact on Rio Tinto's capital structure, which in our opinion eliminates refinancing risks in 2009 and 2010, they added. We also consider this to help mitigate potential downside risks caused by continued uncertainty as to the depth and duration of the market downturn, including the level of future metals and minerals prices.