UPDATE: Support For Rio Tinto-Chinalco Deal Hinges On Price

Support for Rio Tinto Ltd.'s (RTP) US$19.5 billion proposed landmark deal with Aluminium Corp. of China Ltd., or Chinalco, hinges on price, analysts and shareholders said Thursday.

Following detailed media reports of an imminent deal, Rio Thursday confirmed it had struck an agreement for a cash injection, including US$7.2 billion in convertible bonds and US$12.3 billion in asset sales, in a move to ease Rio's US$38.7 billion debt burden.

The transaction, if approved by the Australian government, shareholders and regulators, will be China's largest foreign investment and will likely give Rio Tinto benefits beyond helping it repay debt, but questions remain over whether it will gain Australian government approval.

"Shareholders should be reasonably happy with the deal," said Gavin Wendt, an analyst at Fat Prophets, prior to the announcement that matched early media reports.

"Rio shares have been going up as details of the talks with Chinalco leaked, and it means Rio won't be doing a discounted rights issue that could dramatically lower its share price."

Chinalco's deal with debt-laden Rio includes two tranches of convertible bonds that could ultimately deliver an 18% stake in the miner, as well as minority stakes in key Rio assets including Hamersley Iron, Escondida, Grasberg, La Granja, Weipa, Yarwun and Boyne operations.

Chinalco already holds a 9% Rio stake, in a joint venture with Alcoa Inc. (AA), and the aluminum giant will receive a seat on the board.

Analysts and shareholders said support for the deal would depend on asset prices, to offset concerns over the loss of long-term value by selling key operations.

Sales include stakes in some of Rio's most prized assets, foremost a 15% stake in Hamersley Iron valued at US$5.15 billion, a 15% stake in copper mine Escondida valued at US$3.39 billion and a 30% stake in its Weipa aluminum asset, valued at US$1.2 billion.

Rio Tinto Chief Executive Tom Albanese said Chinalco has paid a premium of more than 124% for its stakes.

"These were good valuations before the downturn, they are outstanding today," Albanese said.

"If the price is right, the deal is positive. It all depends on the asset price," a fund manager who holds Rio shares said, adding there still was the risk of a discounted rights issue should shareholders vote down the deal.

From Rio's perspective, the deal with Chinalco would create options beyond an immediate solution to the repayment of US$8.9 billion debt due in October, with another US$10 billion due next year.

These include better access to potential deals with the world's largest consumer of raw materials, as well as a door to funding through China's banks, an analyst said.

 
   BHP, Australian Government Potential Stumbling Blocks 
 

But potential stumbling blocks include Australian government approval and rival BHP Billiton Ltd. (BHP) gatecrashing Rio's bailout, if it feels Chinalco is getting assets cheaply.

In a sign Australia will be tough in assessing the deal, Treasurer Wayne Swan Thursday tightened the country's foreign investment rules so that investments through instruments such as convertible bonds will be treated as equity.

Previously, Swan had said the Australian government would give particularly close scrutiny to investments by state-owned entities and by companies that are consumers of the target's products and will want to see that investment decisions are being driven by commercial considerations.

Winning Australian government approval will be crucial to the deal and one person familiar with the situation said Rio Tinto executives had already sounded out lawmakers in meetings in Canberra last week.

On a positive note, Swan in September greenlighted China's Sinosteel Corp. to acquire up to 49.9% of iron ore developer Murchison Metals Ltd.

More recently, the government allowed China's Shenzhen Zhongjin Lingnan Nonfemet Co. (000060.SZ) to buy a 50.1% stake in zinc miner Perilya Ltd. (PEM.AU) for A$45.5 million.

While nowhere near the size of the potential Rio deal, largescale participation of foreign companies in Australia's resources sector is nothing new.

BMA, the BHP Billiton 50-50 joint venture with Japan's Mitsubishi, is the world's largest supplier of seaborne coking coal, established in 2001 and only one of many significant partnerships with Japanese and Chinese companies.

"Government approval is more likely than not," said a Melbourne-based analyst. "There's already a strong foreign presence in the Australian resources industry. These asset sales are minority stakes, not controlling stakes."

Still, Swan and the Foreign Investment Review Board are unlikely to approve any deal without bulletproof guarantees Rio remains in control of its assets, analysts said.

BHP is thought to be particularly interested in Rio's 30% stake in Escondida, the world's largest copper mine in Chile. BHP, Escondida's operator with a 57% stake, has preemptive rights to Rio's stake in the mine.

BHP Chief Executive Marius Kloppers has previously stated BHP has the balance sheet strength to acquire assets and would be interested in some of Rio's assets, especially its stake in Escondida.

Other competitors may join in the bidding to get a chance at acquiring parts of top-tier Rio Tinto assets, particularly Hamersley Iron, analysts said.

Those potential suitors include, aside from BHP, Comphania Vale do Rio Doce (RIO) and South Africa's Kumba Iron Ore Ltd. (KIO.JO), they said.

Rio's debt situation moved firmly into focus after BHP Billiton walked away from its bid for its smaller rival in late November last year. BHP cited concerns over Rio's US$39 billion debt load from the 2007 Alcan acquisition as well as falling commodity prices, sending Rio shares spiraling down over 30% in the aftermath of the announcement.

Rio has since been under pressure to make progress with US$10 billion of planned asset sales to pay off some of its debt, but has struggled in an environment of falling asset prices and cash-strapped buyers.

-By Elisabeth Behrmann, Dow Jones Newswires; 61-2-8272-4689 [e-mail]