Rio Tinto admitted for the first time yesterday that it could be forced to resort to a rights issue if it is to pay down $10bn (£7bn) of debt this year as planned.
After a spate of rumours about the London and Sydney-listed mining giant's financial plans, the company was forced to issue a statement to the Australian Stock Exchange yesterday. Rio re-emphasised that it is looking at reducing both capital and operating expenditure, alongside possible job cuts and an expanded divestment programme, as ways of meeting the target to slice a quarter from its eye-watering $40bn debt.
It also acknowledged it is considering a rights issue. "In order to preserve maximum flexibility for the Group, the Boards do not rule out the potential to issue equity as one of the options it has available, if it is determined to be in the best interest of shareholders," the company said.
Rio's debt mountain – which was largely accrued with its £38bn purchase of Alcan, the US aluminium group, in 2007 – has left it particularly exposed to the recessionary winds buffeting the commodities sector.
Until November, the group's share price was somewhat buoyed by the hostile takeover moves of larger rival BHP Billiton. But when BHP walked away, citing both the economic climate and its target's massive debts, Rio's stock lost 37 per cent in a single day and, despite some small rises since then, is still trading more than 75 per cent below last May's high of 7078p.
With the withdrawal of the BHP bid, market speculation intensified about the need for a rights issue to fund the $9bn tranche of debt that needs refinancing in October.
The company stressed repeatedly yesterday that its situation has not changed since December, when it announced plans to cut 14,000 jobs, shave more than $5bn off capex plans for next year, and keep its dividend flat at $1.36 rather than raise it by 20 per cent as previously planned. But the City was not convinced and the shares dropped 1.46 per cent yesterday to close at 1615p. Simon Toyne, an analyst at Numis, said: "What has changed is that Rio has admitted that it may need a rights issue – which is not surprising but is a significant shift in emphasis."
But the strategy may prove to be a good one. With commodity prices as low as they are, and demand likely to remain depressed for the immediate future, the only other way for Rio to meet a debt-reduction commitment which is equivalent to almost a third of its $30.5bn market capitalisation is through major disposals. And fire sales are rarely in a company's best long-term interests.
"It is much better to raise money from the equity markets than to sell off core assets," Mr Toyne said.
"It is one thing to be selling non-core assets on a relatively modest scale, but it would be very disappointing to be selling core assets just for the purposes of reducing debt. Shareholders are better served by preserving a good set of assets for the upturn," he added.
Not only that, but the credit crunch is leaving divestment strategies tricky to pull off and putting significant pressure on prices. Rio already has first-hand experience of the difficulties. It put its engineered products and packaging units up for sale early last year, while trying to defend itself from BHP. Neither has yet been sold, and even the group's plans for its relatively small $1bn minerals business are suffering. Five suitors have finally been shortlisted to buy Rio's borates and talc division, including buyout firms Bain and Apollo. But the two logical frontrunners – France's Imerys and Canada's Teck Cominco – are both too stretched to lead bids, so the business is unlikely to fetch a high price.
Rio is already exploring new asset sales, with its 30 per cent stake in Escondida, the world's biggest copper mine, being touted by insiders as a likely option. But even an expanded programme may not be enough to bring in the money it needs. "It is a pretty poor time to be selling assets because there aren't many buyers out there, and prices are likely to be less than two years ago and quite possibly less than what you would get in two years' time," Mr Toyne said.
Rio has made some progress towards solving its gearing problems. It cut its debt by $3.2bn between June and October last year.