Major miner Rio Tinto says in its 2008 annual report released on Monday that if a potential cash injection into Rio Tinto of $19.5bn from smaller miner Chinalco does not materialise, Rio Tinto may have to consider other strategic and financing options. The proposed deal needs the blessing of a number of governments, and is resisted by an increasing number of Rio Tinto shareholders.In the 2008 annual report, Rio Tinto chairman Paul Skinner recalls that in November 2007 Rio Tinto received an unsolicited approach from BHP Billiton proposing a combination of the two companies, followed in February 2008 by a pre-conditional takeover offer which BHP Billiton finally withdrew in November 2008, citing deterioration of near-term global economic conditions.Skinner appears to have sidestepped the issue of Rio Tinto's debt levels, a factor specifically cited as adverse by BHP Billiton. Beyond savaged commodity prices for some of its operating divisions, Rio Tinto faced one of the mining world's biggest net debt figures by the end of 2008. Net debt decreased during the year by $6.5bn, to $38.7bn by 2008 year-end. During 2007, Rio Tinto had paid $38bn in cash for Alcan; today, Rio Tinto's entire market capitalisation, or value, sits at $42bn.During the term of the offer, Skinner says Rio Tinto's board monitored the situation closely and nothing changed our view that the BHP Billiton bid significantly undervalued our assets and future prospects. He adds that Rio Tinto remains a very strong standalone company with a world class portfolio of assets which, even in tough markets, are highly cash generative.Were BHP Billiton's all-paper offer still in the market today, it would value Rio Tinto at just over $64bn. Today, again, BHP Billiton sits with net debt of less than $5bn, and a market value of $111bn. Rio Tinto, meanwhile, hopes to sell convertibles of $7.2bn to Chinalco, and equity stakes in some of its most prized assets for $12.3bn, also to Chinalco.Rio Tinto was able to pay net debt down somewhat during 2008, according to its annual report, as a result of free cash flow, asset disposals and other derivative and exchange movements. Net debt to total capital remained unchanged at 63% at 31 December 2008 following impairment charges and the decline of the Australian and Canadian dollars; interest cover halved to ten times from 20 times in 2007.Rio Tinto made net capital expenditures of $8.5bn in 2008, but is now limiting capital expenditures for 2009 to around $4bn, to reflect falling demand, while sustaining its growth trajectory. The group's annual report states that Rio Tinto retains the goal of returning our balance sheet to a single A credit rating and will reduce net debt by $10bn in 2009. In the meantime our cash flows are able to repay the existing level of debt.This is no doubt the case, but Rio Tinto has in 2009 sold some fine assets, separately to the proposed Chinalco deal, as well: Jacobs Ranch for $761m; potash assets for $850m, and certain iron ore assets for $750m.Of Rio Tinto's total post tax impairment charge of $8.4bn for 2008, $7.9bn relates to the group's aluminium businesses. Under certain circumstances, Rio Tinto may have to pay a break fee of $195m to Chinalco. During 2008 Rio Tinto incurred advisory and other costs related to the rejection by the board of the pre-conditional takeover proposal from BHP Billiton. These costs totalled $270m (net of tax) in 2008.Seemingly determined to have the last word on the issue, investors are told that the Rio Tinto board has extensively considered a range of strategic options, and has concluded that the opportunity offered by the strategic partnership with Chinalco, together with the value on offer for the investments by Chinalco in certain of Rio Tinto's mineral assets and in the convertible bonds, is superior to other identified options and offers greater medium term certainty and long term value for Rio Tinto's shareholders.
Chinalco may have a relatively modest market value of $13bn, nearly $100bn short of the number for BHP Billiton, but Chinalco is backed by the Chinese government. BHP Billiton and Rio Tinto already have a number of historic links: the Resolution copper project in Arizona (55% Rio Tinto, 45% BHP Billiton); Chile's Escondida (58% BHP Billiton, 30% Rio Tinto), the world's biggest copper mine; Richards Bay Minerals (50:50), and MRN Porto Trombetas (14.8% BHP Billiton, 12% Rio Tinto Alcan).
SELECTED MINING NET DEBT: MARKET VALUE RATIOS
Note: most debt numbers are as at 31 December 2008
(1) 30 June 2008
(2) Unlisted; market value is an estimate
Source: market & company data; analysis by Barry Sergeant.