Alcan introduces white knight (July 23, 2007)

Rio Tinto (RTP-N, RIO-L, RIO-A) has entered the lists as a friendly bidder for Alcan (AL-T, AL-N), in a deal that values the Montreal-based aluminum producer at $40 billion and knocks Alcoa (AA-N) out of contention as an acquirer.

Rio is offering $105.74 (US$101) per Alcan share, against Alcoa’s takeover offer of US$58.60 plus 0.4108 of a share, made on May 7. Three directors from Alcan, including chief executive Dick Evans, would be named to the Rio Tinto board; the other two would be outside directors. Rio’s aluminum operations, titled Rio Tinto Alcan, would be consolidated in Montreal, while the bauxite and alumina operations would continue to be managed from Brisbane, Australia. Rio, which is listed on the London, New York, and Australian stock exchanges, has said it would apply for a Toronto listing as well.

Alcoa withdrew its takeover offer the same day. Chief executive Alain Belda said in a statement that “at this price level, we have more attractive options,” which would include investments in other businesses. The company is also bringing back a share repurchase program it had suspended when it made the offer for Alcan.

Rio’s bid jumps Alcoa’s by about 33%, based on closing prices on July 11, which put the value of the Alcoa offer at US$76.03 per share. Rio’s bid is supported by Alcan’s board, which has been seeking a deal with one of the large base metal companies since negotiations for a friendly deal with Alcoa broke off earlier this year.

The new company would be the largest bauxite and smelted-aluminum producer in the world, and the fourth-largest alumina producer. The combined operations would be low-cost; at about US$1,500 per tonne, they land at the 40th percentile of the current aluminum cost curve. Over 80% of Alcan’s production is in the lower half of worldwide costs, and new production, mostly in China, is subject to very high energy costs, the largest input in aluminum production.

There is a future-watching choice in the takeover for Rio Tinto, in that Alcan’s power needs are mainly filled by hydroelectric power, either in owned plants or on long-term contracts from power utilities. If carbon taxes come in, hydroelectric power will be more competitive than steam-generation supplies.

Alcan would sell off its packaging division, making Rio Alcan purely a metal and alumina producer, although the company plans to keep Alcan’s Engineered Products division. Rio also plans to shear off some of its business units to create a more streamlined organization and to reduce the US$46 billion in debt the new organization will be taking on.

The bid, which is supposed to be mailed by July 23, is conditional on Rio seeing two-thirds of Alcan’s shares tendered, and will need the usual approvals from competition and securities regulators. Rio plans to pay for Alcan out of cash plus a loan facility underwritten by four major European banks. Rio Tinto shareholders will be presented with the takeover at a meeting in September or October, where it will need a simple majority.

There is a break fee of just over US$1 billion, payable by Alcan if it kills the deal, and a break fee if Rio backs out totalling 1% of Rio’s market capitalization, or US$1 billion, whichever is less. There is another reimbursement of US$200 million payable in other circumstances.

At news conferences in Montreal and London, management of the two companies forecast about US$600 million in cost savings, about half of which are expected by 2009, and the rest by 2010.

Rio brings a net debt of US$2.4 billion and Alcan US$5.8 billion, and given the US$38.1-billion purchase price, the combined company will have US$46.3 billion in debt. They expect to get full value out of the sale of Alcan’s packaging business, and expect to reduce debt from internal cash flows and from the possible sale of other Alcan or Rio assets.

“Obviously our gearing is going to rise,” says Guy Elliott, Rio’s chief financial officer, “but Rio Tinto’s balance sheet has more than enough capacity to accommodate this transaction, with its present gearing level being relatively low and cash flows high.”

The net debt of US$46.3 billion would bring the debt to around 64% of equity, or about 2.8 times earnings (before interest, taxes, and depreciation).

Speculation that Rio was a takeover target is certain to be dampened. The new debt essentially takes Rio Tinto out of the sights of any other acquisitors.

Pretax and pre-depreciation earnings for the combined companies would have been US$16.5 billion in 2006, out of revenues of US$49 billion. The pie-plate business would have generated about 7% of that. Rio’s commodity structure, about 40% copper and 30% iron ore, would now have about 25% of its earnings from primary aluminum production, with copper and iron shrinking to 53%.

Rio will cut short a US$8-billion share-buyback program, although there is only US$1.7 billion left to pay out.

There is a widely held opinion that BHP Billiton (BHP-N, BLT-L, BHP-A) is preparing a bid for Alcoa, probably with the intention of taking over upstream assets and selling off the aluminum goods business units. Some speculation had suggested that a private equity group might join BHP in a bid, taking the finished goods part of the deal, but that is now being discounted.

Other companies that might have the backing and taste for an Alcoa bid are Companhia Vale do Rio Doce (RIO-N) — which had been tipped as a possible bidder for Alcan — and Xstrata (XSRAF-O, XTA-L).

By the Numbers

US$101 Rio Tinto’s per share offer for Alcan

US$38.1 billion Total value of Alcan deal

US$46.3 billion Combined debt of both Rio and Alcan following the deal

US$600 million Proposed savings in synergies by 2010

About US$76 Alcoa’s earlier offer per share