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Rio dumps Chinalco for iron ore tie-up with BHP

GLOBAL miner Rio Tinto dumped plans for a US$19.5 billion tie-up with China's Chinalco and agreed to set up an iron ore joint venture with rival BHP Billiton and sell new shares to slash debt.

The new plan represents a victory for Rio shareholders who had opposed the deal with Chinalco, arguing it favoured the Chinese state firm and could give China greater influence over pricing of key commodities such as iron ore.

Shares in Rio jumped as much as 13 percent to a 7-month high of AUS$75.75, nearly triple the AUS$28.29 rights issue price, while BHP shares rose 10 percent to AUS$38.60.

Rio had lined up the deal with Chinalco in February as it was desperate to pay off half its US$38 billion in debt as it battled tight credit markets and a commodity price slump and had failed to sell assets to raise cash. But as equity and commodity markets rallied and credit markets eased, options opened up for Rio Tinto, and shareholders stepped up pressure on it to revise the Chinalco deal.

"We were not supporters of the Chinalco transaction. We're happy to see this alternative approach to solving Rio's issues with its debt," said Ross Barker, managing director of Australian Foundation Investment Co, Rio Tinto's sixth-largest shareholder in Australia and a BHP shareholder.

"A deal like this was really essential from Rio's point of view. And it's a good deal for BHP," he said.


Rio and BHP, the world's second- and third-largest iron ore miners, agreed to combine their operations into a 50-50 joint venture, generating savings of at least US$10 billion.

BHP, which dropped a bid to buy Rio last year, will pay Rio Tinto US$5.8 billion to take its equity interest in the venture to 50 percent, but it stressed the agreement was non-binding at this stage.

"This deal has been 10 years in the making and well worth the wait," BHP Chief Executive Marius Kloppers told reporters.

To cut debt, Rio said it was raising US$15.2 billion through a 21-for-40 rights offer, the fifth-largest rights issue on record, according to Thomson Reuters data.

Rio and BHP agreed to keep their iron ore marketing separate, a key factor designed to win approval from competition regulators, especially the European Commission, which last year raised concerns about BHP's proposed takeover of Rio due to the impact on iron ore markets.

Chinalco said it regretted Rio's decision after it had worked hard to try to revise the deal to reflect changed market conditions as well as shareholders' and regulators' concerns.

"As a result, we are very disappointed with this outcome," Chinalco President Xiong said in a statement.

"Rio has effectively been talking to BHP behind Chinalco's back and Chinalco is entitled to feel like a two-timed lover this morning," said Paul Bartholomew at Steel Business Briefing in Shanghai. "This is a big slap in the face for China, BHP and Rio's biggest iron ore consumer."


"My initial reaction is that it will be overwhelmingly positive for both companies because of the cost savings (and) the synergies," said Michael Bentley, resources portfolio manager at Northward Capital.

The cost of insuring Rio Tinto's debt fell by more than a third, with the spread on its credit default swaps (CDS) narrowing to around 190 basis points from 290 bp.

"We consider these initiatives are a superior outcome for Rio's credit quality as opposed to the Chinalco deal," Nomura International said, adding it was much better Rio was selling equity instead of convertible bonds, maintaining greater ownership of its assets, gaining joint venture savings and would not have a conflict with a major customer as a big shareholder.

The prospects for Chinalco were less clear.

Chinalco vice president Lu Youqing said the firm had not decided its next step and had not decided whether to participate in the rights offer.

"This is a big thing and is not determined by a single person," Lu told Reuters, adding the decision not to revise the deal with Rio Tinto was made by both sides.

BHP CEO Kloppers and his Rio Tinto counterpart said they did not expect their joint venture to hurt ties with the Chinese.

"We have an excellent relationship with Chinalco, and I remain very positive about the potential for future collaboration," Rio CEO Tom Albanese told reporters.

Under the deal agreed in February, Chinalco would have paid US$12.3 billion for stakes in Rio's key iron ore, copper and aluminium assets and US$7.2 billion for convertible notes that would have doubled its equity stake in Rio to 18 percent.

The prospects of winning approval from the Australian Competition and Consumer Commission (ACCC) for the joint venture are good, as the regulator last year did not seek to block BHP's proposed takeover of all of Rio.

"On the face of it, given that it was approved previously, there would have to be a compelling argument as to why this wouldn't be (approved) by the ACCC," said Trade Minister Simon Crean.

BHP launched a 3.4-for-1 share swap to take over Rio in February 2008, which Rio rejected saying it vastly undervalued the firm and its prospects. BHP dropped the deal last November after commodity markets collapsed.


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