Rio Tinto plans $19.5bn Chinese deal to pay debt

Convertible bonds scheme will double Chinalco's stake to 18 per cent once exercised

Rio Tinto is set to reveal a $19.5bn (£13.6bn) deal with its biggest shareholder, a Chinese state-owned aluminium group, when it publishes its annual financial results this morning. The company refused to confirm or deny the plan yesterday, but trading of its shares was suspended in New York last night pending today's announcements.

The plan has two parts. Chinalco will buy $7.2bn (£5bn) worth of convertible bonds, to be exchanged for Rio shares in the future. It will also invest $12.3bn in some of the mining giant's iron ore, copper and aluminium assets, which is understood to be a substantial premium and does not involve Rio giving up control of the projects.

Once the bond option is exercised, Chinalco will see its stake double from 9 to 18 per cent. The deal, which needs the go-ahead from regulators and shareholders, will give Chinalco one Rio board seat immediately and another at a later date.

The good news for Rio is the help in paying down the $40bn debt incurred in its acquisition of Alcan, the US aluminium giant, in 2007. As recession sweeps the world's economies, commodity prices fall and demand dwindles, Rio has struggled with its massive debt – of which $8.9bn must be paid this year and $10bn next.

The company's troubles came to a head in November, when BHP Billiton, a larger rival, walked away from its hostile takeover bid. BHP cited the size of its target's debt alongside wider downturn-related caution.

BHP also pointed out that Rio's proposed post-Alcan divestments were proving hard to realise in the aftermath of the credit crunch. The decision sent Rio's share price plummeting 37 per cent in a day.

Since then the group has announced a package of cost-cutting measures, including 14,000 job losses, reduced capital expenditure and a flat dividend. At the end of January it agreed to sell two mines to Vale, a Brazilian rival, for $1.6bn, just days after admitting that it might have to resort to a rights issue to pay down its debts.

Although proponents of the Chinalco strategy claim that the deal raises many times the funds that an equity placing might do, not everyone is convinced. Jim Leng, a director of Corus, the steel group, joined the board of Rio in January, as a prelude to taking over as chairman when Paul Skinner steps down in March. But Mr Leng walked away from the job at the start of the week over a difference of opinion with regards to the Chinalco deal. It is understood that Mr Leng favoured a rights issue – believing it to be a financial solution to a financial problem – and had concerns that the company's long-term strategic freedom might be compromised by so close a deal with a company that is also one of its main customers.

Mr Skinner has problems of his own. Long tipped as the successor to Peter Sutherland at BP, some of the oil major's shareholders are now questioning the appointment of a man compromised by fending off BHP and buying Alcan. Mr Leng's resignation pushes Mr Skinner's departure date out to the summer, and so buys him some time.

The City is also divided on the question of Chinalco, with some analysts suggesting that the $19bn looks an unnecessarily large sum smacking slightly of panic rather than strategy. "We are concerned that management's primary aim may be to reach its stated target of $10bn net debt reduction by the end of 2009, rather than take their time and get the best possible deal for all shareholders," Paul Galloway, an analyst at UBS, said.