The second deal which is $19.5billion transferable bonds purchasing between Chinalco and Rio Tinto has started for more than 2 months, but it is still not clear whether it will succeed. Nowadays, the market doubt whether Rio Tinto will choose default.
The Wall Street Journal’s attitude towards this news is positive, it doesn’t think Rio will walk away from Chinalco, maybe because American Aluminium involved in the first acquisition, and America are supporting this case. It thinks although both board and shareholders are not satisfied with this deal, considering the cost and return, it’s still a good deal. It was reported that “Walking away from Chinalco would almost certainly cost Rio boss Tom Albanese his job and would be an embarrassing U-turn for the board as a whole.”
However, the Financial Times’ attitude is negative, and thinks the board will block the deal. It was reported that “Now that Rio's resurgent shares have nudged through the first of the two strike prices, effectively handing the Chinese company fresh equity at a discount, they are tetchier still.” It thinks the shareholders would be very angry about the deal so that the Rio will choose to break up with Chinalco.
The Bloomberg seems neutral towards the deal. It thinks Chinalco is not likely to accept the change of the deal and Rio should accept this as it should focus on the profit cooperating with Chinalco in the long run.
The Chinese financial media’s attitude is positive, it believes the bargaining chip of the Chinalco, and believe considering the financial problem, Rio will have to give in.
In my opinion, Chinalco will spare no effort to make this deal control. Here are some motivations I think.
Advantage of vertical acquisition
As we know, vertical acquisition has the advantage of reducing uncertainty over the availability or quality of supplies or the demand for output. To start with the reason why the acquisition took place, let’s look at the price of aluminium in the past few years.
The world’s growth rate of demand for aluminium is around 5% during 2004 to 2007, and the demand exceeds supply all the time. From 2006, the price of aluminum grew from $1.1/lb to 1.42/lb in the early 2008, which was roughly 29% increase in price. Although the world’s aluminum price has dropped recently, as a long-run investment, it’s definitely worthy.
Besides, with the world’s excess liquidity, the market had the expectation that the price would still go up. Although Chinalco is the world’s second largest alumina producer, it still needs to import more than 30% of the aluminium resources to be used in production, and Australia’s geographical position nears China, which can save the transportation fee. So if the vertical acquisition succeeds, it will not only lower its cost of production and distribution, but also reduce uncertainty over the availability or quality of supplies for output, and China will have more bargaining chip in negotiating of setting the price of aluminium.
Furthermore, the success of the acquisition can protect against monopolistic practices from the supply side. As we know, BHP is the world's largest mining company and has the market share of 33%, in order to expand its ability of market influence, the company wanted to control 47% of Rion Tinto’s market share. The success of Chinalco was a great attempt to block BHP's efforts to take control of Rio, so that other countries will not suffer price soaring of aluminum. Moreover, it also maintains the right of other consumers to against monopoly.
The benefit Rio Tinto gets
The attraction of the Chinalco deal is asset sales, which enabling Rio to refinance debts and reduce leverage upfront, without being exposed to the vagaries of metal prices. That is still an important consideration, particularly given the uncertainty over the global economic outlook.
The consequence of default
If Rio Tinto chooses to default, it will face huge default payment, which is $195million. And Chinalco has the support with Chinese government, we don’t know the consequence of offending Chinese.
Conclusion
Although there are lots of contradiction among the deal, I believe those two companies will go through. And if it really succeeds, China will get 19% of Rio’s market share, it’s a successful acquisition not only is it a hedge for the price of the resources needed for production, but also an investment for the resources such as iron ire. No need to store the resources, simply owning the stock share, sharing the benefit with Rio Tinto, and get more power to set the price. Further more, it will have more bargaining chip in negotiating.
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