Downturn forces BHP to drop Rio Tinto bid

Falling commodity prices behind decision to halt process on offer of £38bn

One of the biggest deals in corporate history has become the latest victim of the global slowdown with BHP Billiton walking away from a $58bn (£38bn) offer for its rival Rio Tinto.

The world's largest mining company blamed falling commodity prices and the worsening economic climate for the decision to terminate a bidding process that has cost $450m (£294m) since it began 12 months ago.

Miners across the world have been hit by slowing demand, particularly in previously fast-growing emerging economies. The World Bank issued revised forecasts yesterday putting Chinese GDP growth at 7.5 per cent in 2009 – its slowest rate since 1990, and some 1.7 per cent lower than earlier predictions. Growth in 2008 will be 9.4 per cent, compared with 11.7 per cent last year, the bank said. And export growth will be particularly poor, at around 3.5 per cent in real terms, compared with 11 per cent this year.

Don Argus, the BHP chairman, said: "While we have not changed our view of the basic industrial logic of the combination, we have concerns about the continued deterioration of near-term global economic conditions."

Mining stocks have already taken a battering. When BHP first expressed an interest in Rio Tinto last year the all-share deal was worth some $140bn, more than double its current value. And with copper prices down by 43 per cent year-on-year in October, and another 23 per cent in the month since, it is not a good time to create a group with a combined debt of $46.5bn – $40bn of it from Rio Tinto – says BHP.

Divestments were also a problem. Although the proposed deal was cleared by US and Australian monopoly regulators, the EU Commission was trickier to satisfy. A "statement of objections" sent to BHP earlier this month is understood to point to the sale of iron ore and coking coal assets. Rio Tinto's own divestment programme, put together when it took over Alcan last year, is also looking difficult.

Marius Kloppers, the BHP chief executive, said: "BHP Billiton is very focussed on balance-sheet strength. Accordingly, the greater debt exposure of the combination plus the difficulty of divesting assets have increased the risks to shareholder value to an unacceptable level."

BHP Billiton's shares closed up 7.2 per cent at 1051p, signalling the City's support for the move. Conversely, Rio Tinto took a hammering, off by more than 40 per cent earlier in the day and closing down 36.7 per cent at 1550p.

Simon Toyne, an analyst at Numis, said: "The big price falls are from hedge funds caught the wrong way – long on Rio Tinto, short on BHP – and hastily unwinding their positions. But people are also revisiting Rio as a standalone business and that kind of debt is definitely sub-optimally high on the way into a deep downturn."

More worrying is what the deal's collapse says about BHP's confidence in the future, says Charles Cooper, at Evolution Securities. "What is apparent from reading between the lines is that there is a lot more doom and gloom in the commodities sector," he said.

As to any future revival of the plan, BHP says it will stick to today's decision. The City takes a less black-and-white view, but the make-up of the two players may change in the interim. Ian Henderson, a natural resources fund manager at JP Morgan, said: "There are synergies between the two companies that make it entirely possible to revisit the deal. But it is equally possible that the collapse of this bid opens the door for other business combinations, particularly [with] China."

Right on cue, yesterday's news from BHP was followed by reports that Chinalco, the Chinese state aluminium giant, is looking at raising its 9 per cent stake in Rio to 14.99 per cent, with some banks advising it to pursue as much as 49.99 per cent.

Marius Kloppers: The architect behind the deal

It is a new chief executive's cold sweat-inducing nightmare: having to explain to his board that the massive takeover deal he pioneered needs to be scrapped – at a cost of £294m.

Marius Kloppers, the BHP Billiton boss, faced such a daunting prospect before the announcement that the company was walking away from the £38bn bid for Rio Tinto it has been pursuing for 12 months. But Mr Kloppers – who took on the top job in October 2007, little more than a month before BHP approached its Anglo-Australian rival – is likely to survive.

Don Argus, BHP chairman, said yesterday that the company had not changed its view of "the basic industrial logic of the combination", but was concerned by the uncertain global economic situation and no longer felt the deal was in the best interests of shareholders. The City was also forgiving of a U-turn that, in less unpredictable circumstances, would have spelled the end for the deal's architect.

Ian Henderson, natural resources fund manager at JP Morgan, said: "His position is not in question at all. The board was behind him from the start in terms of the business combination and a year ago nobody was expecting that the world economy would be in its current state."

Charles Cooper at Evolution Securities said: "The cost to BHP is not going to sit comfortably, particularly given collapsing commodity prices and substantial writedowns in the nickel business, but people will probably be relatively understanding given the economic conditions."

Sarah Arnott