Rio finally succumbed to pressure from UK shareholders today who have been holding out against the sale to Chinalco of stakes in key assets and convertible bonds as the company threw in their lot with BHP. In a move that appears to have caught the Chinese by surprise as much as the rest of the market, Rio and BHP have agreed to merge their Pilbara mine assets into a 50/50 joint venture to eventually achieve an estimated $10bn of savings according to a Reuters report. As part of the deal, BHP will pay Rio $5.8bn to bring the equity split in Pilbara up to 50/50. In addition Rio is to make a 58% discounted 21 for 40 rights issue to raise a further $15.2bn. Combined, this will wipe over $20bn off Rio’s $38bn debt mountain and restore the company’s fortunes. The deal will allow Rio to get net debt down to $23.2 bn according to the Sydney Morning Herald. The move received the prompt approval of the market as Rio shares jumped 13% and BHP’s rose 10%. While at the same time, the cost of insuring Rio’s debt fell by a third with the spread of credit default swaps narrowing to around 190 from the previous 290 basis points.
The Chinese are not surprisingly horrified by the development fearing a duopoly of supply for imported iron ore. A Rio/BHP combination would supply around 270 million tons of ore a year, while Vale supplies around 240 million tons. To try to avoid objections by competition regulators, particularly in Europe, Rio and BHP have decided to continue to market iron ore separately from the JV. But we doubt anyone is fooled by that. It is in their interests to work together to maximize the returns, officially or unofficially they will find ways to work together.