Rio risks a China crisis

Chinalco 'disappointed' as Rio abandons deal in favour of cash call and BHP alliance
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A backlash from China is the biggest risk facing Rio Tinto, analysts warned yesterday after the Anglo- Australian miner abandoned a $19.5bn financing deal with Chinalco, the state-owned aluminium giant.

Professor Shujie Yao, head of Chinese studies at the University of Nottingham, warned that the collapse of the deal, which would have been China's biggest overseas investment, would be received badly in Beijing.

"This will be a painful blow for Chinese esteem: Rio Tinto has been courting two lovers at the same time – one openly, and one under the table," he said. "It is the Chinese who stepped in to bail the business out four months ago when it was in desperate trouble, but the recovery since has given Rio Tinto chance to work up a covert deal."

Rio now intends to raise more than $20bn to pay down debts through a $15.5bn rights issue and a joint venture with BHP Billiton, its Australian mining rival. The miner's change of heart was announced in the early hours of yesterday morning.

Rio felt compelled to abandon its agreement with Chinalco, signed in February, after a sustained campaign of opposition from shareholders, as well as warnings from the Australian regulatory authorities.

While the price at which Chinalco planned to invest in Rio looked good when the deal was signed, the miner's value has since risen, narrowing the premium. In addition, capital markets have eased, making a rights issue a more viable fundraising option.

Rio's U-turn was greeted warmly by shareholders, with the miner's shares posting a 10 per cent gain yesterday, closing at 3,001p.

However, there is some concern among analysts about the extent to which Rio has damaged relationships with China, the miner's most important customer, particularly since it is in the final stages of delicate negotiations in the annual round of price- fixing for iron ore supplies.

While there had been some speculation in recent days that it was Chinalco which planned to walk away from the agreement, the fact that the miner is to pay a $195m break fee reveals that it called time on the deal.

In public, Chinalco was restrained yesterday, saying only that it was "very disappointed" and that it still believed its deal was "an outstanding value- creating opportunity".

Nevertheless, experts on China fear a backlash or, at the least, the loss of some of the strategic benefits Rio's tie-up with Chinalco would have delivered.

"The deal was expected to result in Rio being better positioned to obtain and keep exploration and mining rights in China, addressing what has been a problem for all foreigners for a number of years ... and we believed Rio might benefit from Chinese diplomatic power in its dealings with the governments of host countries," said Tom Gidley-Kitchin of Charles Stanley.

"This looks like the end of the road in terms of the Chinese increasing their share in Rio, obtaining board representation and/or buying Rio assets – there may be an opportunity to work together but the relationship will be much less close."

The first test of Chinese attitudes to the miner will come over the next few weeks. Rio has until 30 June to come to an agreement with Chinese steel producers over the prices it charges for iron ore. It has agreed a 33 per cent price cut for Japanese buyers, but the Chinese are believed to be holding out for a 40 per cent reduction.

Analysts warned that the Chinese steelmakers might now try to drive a hard bargain during the talks, amid fears that Rio's switch to a joint venture with BHP creates a dominant alliance. Any tension with key Chinese customers would put further pressure on Tom Albanese, Rio's chief executive, who already faces some speculation about his position. Not only was Mr Albanese a champion of the Chinalco arrangement, he oversaw Rio's $38.1bn acquisition of the Canadian aluminium giant Alcan in 2007, the deal that left the miner with so much debt to repay.

For the time being, however, Mr Albanese appears to have made his peace with shareholders, who have welcomed Rio's change of heart. Michael Rawlinson, an analyst with Liberum Capital, said: "We see Tom as a capable operator who can run a steady Rio well [though] it remains to be seen if the shareholder base will be as forgiving."