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BHP Billiton, the world's largest mining company, is losing the support of investors and steelmakers for its proposed US$128 billion ($170 billion) takeover of Rio Tinto.
The hostile bid by chief executive officer Marius Kloppers has wiped out US$32 billion of market value at Melbourne-based BHP in two weeks, while angering customers Posco, Korea's biggest steelmaker, and JFE Steel, ranked third worldwide. The record commodities acquisition will raise iron ore prices and should be blocked by regulators, the steelmakers say.
The premium for Rio shares has fallen 35 per cent to A$9.68 ($11.22) since November 12.
Rio chief executive Tom Albanese said he had identified US$30 billion in asset sales and would boost dividends by 30 per cent (see sidebar).
"I would prefer strong competition with BHP and Rio fighting to deliver market share and the best growth," said Peter Chilton, who helps manage US$1.4 billion at Constellation Capital Management in Sydney. "I'm not sure size is always good for size's sake."
BlackRock's Graham Birch, who helps manage about $14 billion in natural resources assets, said he won't be "rushing" to accept BHP Billiton's proposal.
Rio Tinto dropped 83 pence, or 1.6 per cent, to 5232 pence at the close on the London Stock Exchange.
It gained 7.5 per cent on the Australian Stock Exchange earlier yesterday. BHP slid 27p, or 1.7 per cent, to 1541p in London.
The mining conglomerate would control about 38 per cent of iron-ore exports, the same as Brazil's Cia Vale do Rio Doce, according to ANZ.
BHP and London-based Rio Tinto would be the largest shipper of coal and supply about 6 per cent of all copper.
"I always get scared that when companies get too large that management talent may get too thin," said John Anton, a steel analyst at Boston-based Global Insight, the consulting company.
"You'd have to wonder if global antitrust regulators won't step in. There might be and should be some major questions raised."
Two of the world's biggest mergers punished shareholders.
When Germany's Daimler-Benz bought Chrysler for US$35 billion in 1998, Chrysler CEO Robert Eaton said the combined company would become the world's largest automobile maker.
The purchase lost shareholders about US$12.6 billion of market value in nine years.
Since the January 2001 announcement of America Online's acquisition of Time Warner for US$186 billion, the world's biggest merger, shareholders have lost US$126 billion.
"I don't think this deal will go ahead," said Andrew Pullar, fund manager at London-based Baker Steel Capital.
"There will be too many regulatory hurdles."
BHP says Rio has underperformed. A A$10,000 investment in BHP Billiton in June 2001, when the company was created through BHP's takeover of Billiton, rose to A$53,317, compared with A$37,612 for the same holding in Rio, according to BHP.
Return on assets at BHP has averaged 35 per cent during the past five years, compared with 32 per cent for Rio Tinto. BHP's five-year growth in earnings before interest, tax, depreciation and amortisation also outstrips Rio's, 29 per cent to 26 per cent.
The 50-year-old Albanese, who took over six months ago, yesterday said he rejected BHP's November 8 offer because his company had better growth potential alone. Rio's investments in iron ore generated 31 per cent of earnings last year, while aluminium will contribute 32 per cent after it bought Canada's Alcan to become the world's biggest maker of the metal.
"The sum of the parts is greatly in excess of the currently perceived whole," Albanese told reporters on a conference call.
"When we rejected BHP's recent proposal we did so because of exactly that reason, because it fundamentally undervalued Rio Tinto and its prospects."
An increase in aluminium prices to US$3500 a tonne in 2008, 31 per cent higher than this year's average, would make Rio Tinto shares worth as many as four of BHP's, according to Sanford C. Bernstein & Co analysts led by Andrew Keen in London. BHP has offered three shares for each of Rio's and said a combined company would generate US$3.7 billion in cost savings and additional revenue.
Rio Tinto also offers double the production growth in iron ore by 2010, compared with BHP, Bernstein said. After BHP's Kloppers, 45, spent last week in Asia lobbying for support of the takeover, several investors said it was unlikely to win approval.
"We don't really think where the current share prices are, with the current ratio, that it's the right price," said Donald Williams at Platypus Asset Management in Sydney. He wants Kloppers to offer A$150 for each Rio share.
"He's going to have to pay more if he wants it," said Rob Patterson at Argo Investments in Adelaide, Australia. Kloppers may need to offer a 60 per cent premium for Rio Tinto, Perennial Investment Partners said.
To be sure, the Australian Foundation Investment and Aberdeen Asset Management, which together own 16.9 million shares in Rio Tinto's stock in Australia and London, agree with Kloppers that the combined company would be better suited to meet rising commodities demand from China.
"Adding the two together will actually create more value," said Mark Daniels, at Aberdeen Asset in Sydney.
Steelmakers in China, the biggest national producer in the world, are already facing an increase of as much as 50 per cent in prices for iron ore in the year beginning April 1, according to an October report by Macquarie Group. Prices have tripled to US$72.11 a tonne for Brazilian iron ore the past five years.
About 1.6 tonnes of iron ore are needed to make a tonne of steel.
China Investment, a US$200 billion sovereign wealth fund, is planning an offer that may include the backing of state-owned steelmakers, including Baosteel Group, Shougang Corp.and Anshan Iron & Steel, the state-owned China Business Journal said.
The three biggest iron-ore companies account for about 75 per cent of the export iron-ore market. By comparison, the Organisation of Petroleum Exporting Countries supplies about 40 per cent of the world's oil.
After meeting Kloppers last week, Posco, JFE and Chinese steelmakers attacked the proposal, saying it would be harmful to the iron-ore market. The Brussels-based International Iron & Steel Institute, which represents ArcelorMittal and 18 others among the world's 20 largest steelmakers, urged regulators to block the bid.
Kloppers told Chinese steelmakers last week that BHP wouldn't use the takeover to control prices. Iron ore may be in short supply globally until 2015, Merrill Lynch said.
The backing from steelmakers marks a change for Rio Tinto, whose A$3 billion acquisition of North Ltd, then Australia's third-largest iron ore mining company, in 2000 was opposed by Japanese partners in the project, Mitsui, Nippon Steel and Sumitomo Metal Industries.
"Inevitably they have larger market share and will have more bargaining power with customers," said Shaun Giacomo, at SG Asset Management in Singapore.
- BLOOMBERG
