Ironing out possible mega merger

Spurned by the board of Rio Tinto (RTP-N, RIO-L, RIO-A) in a friendly approach, BHP Billiton (BHP-N, BLT-L, BHP-A) has made its proposal for a US$138-billion all-share bid public in an attempt to bring Rio into merger discussions.

BHP Billiton said it would offer three shares for each Rio Tinto share, in two share-exchange deals that would preserve Rio’s dual-listed-company structure. Under the proposed share exchange, Rio shareholders would have about 41% of the new company, which would still be made up of separately incorporated listed companies in both the United Kingdom and Australia. BHP also said it would invite some of Rio’s outside directors onto the BHP board.

There would be a cash distribution to shareholders of the new company after the merger, via a US$30-billion share buyback. BHP also said it would maintain a “progressive dividend policy.” In fiscal 2007 it rolled out US47 per share annually, for a yield of 1.3% at current prices.

BHP is proposing that Australian Rio Tinto shares (in Rio Tinto Ltd.) be traded for BHP Billiton’s Australian shares (BHP Billiton Ltd.), and British Rio Tinto shares (Rio Tinto PLC) be traded for a combination of U.K.-domiciled BHP shares (BHP Billiton PLC) and Australian BHP shares, with the Australian shares making up 20% of the exchange. Under the proposed trade ratios, the new dual-listed company would be about equally distributed between holders of British and Australian shares.

The bid valued Australian Rio shares at A$127.41 and British Rio shares at 50.28, based on Nov. 9 closing prices of 16.28 for BHP Billiton in London and A$42.47 on the Australian Securities Exchange. Taking out Rio PLC’s 37% holding in Rio Limited, the proposal valued Rio at US$137.5 billion. The new company would have a market capitalization around US$400 billion, dwarfing rivals like Anglo American (AAUK-Q, AAL-L), at US$50 billion; Companhia Vale do Rio Doce (RIO-N), at US$172 billion; and Xstrata (XSRAF-O, XTA-L), at US$67 billion.

At presstime, Rio Tinto U.S. shares were US$447.25 and BHP shares were US$75.23. In Australia, BHP shares had closed at A$41.80, implying a bid of A$125.40 for Rio, and Rio shares closed at A$139. London-listed BHP shares were 15.91, implying a 47.73 bid for Rio, whose shares closed at 53.95. The imputed value of the whole bid, based on those prices, had fallen to US$130.5 billion, while Rio’s market capitalization had risen to US$146.8 billion.

BHP’s announcement did not actually make an offer for Rio, instead outlining the proposal and BHP’s interpretation of its advantages. The bid is at a premium of about 15% to Rio’s closing prices before the announcement, and would still allow Rio shareholders to participate in the new company.

The proposed bid would need approval from both BHP and Rio shareholders under plans of arrangement, with the domestic share trades in Australia and Britain allowing capital gains rollovers (which BHP said might not be allowed on the exchange of Australian BHP shares for British Rio shares). Any merger would need a sheaf of regulatory approvals, whose receipt would be a condition for the deal to go ahead.

BHP said that competition regulators were likely to focus on iron ore interests, in which the two companies have a combined market share around 27%. BHP’s view of the iron ore business is that it is competitive already, and “emerging and new low-cost producers” could be expected to move in and reduce the impact of the merger. It suggested it would need nine months to a year for clearance from competition authorities in Europe, Canada, Australia, the United States and South Africa.

The new company would get about 31% of its earnings out of base metals, 22% out of iron ore and coking coal, and 16% out of aluminum. That includes Rio Tinto’s recently completed takeover of Alcan for US$38 billion in cash. Rio received 98% of Alcan shares by the close of its bid on Nov. 8.

BHP earned US$13.4 billion on revenues of US$41.3 billion in its fiscal year 2007, which ended June 30. In 2006, it earned US$10.5 billion on revenues of US$34.1 billion.

Rio Tinto’s first half, the six months ended June 30, saw earnings of US$3.3 billion on revenues of US$13.9 billion. It earned US$7.9 billion on revenues of US$25.4 billion in 2006. Alcan earned US$1 billion on revenues of US$13 billion in the first half of 2007, and US$1.8 billion on revenues of US$23.6 billion in 2006.

The combined Rio Tinto and Alcan has net debt of about US$46.3 billion and expects to turn over US$49 billion in revenues in the coming year. BHP’s net debt at June 30 was US$8.7 billion, which would bring a combined company’s net debt to US$55 billion.

A simple fusion of balance sheets shows the combined company with US$125 billion in total assets, about US$38.4 billion in long-term liabilities, plus the US$38.1 billion in debt that Rio will take on in the Alcan payout.

On Nov. 8, BHP confirmed it had approached Rio’s management with a proposal for a friendly takeover. Rio went a couple of steps further in its own release, stating that BHP was offering three BHP Billiton shares for every Rio Tinto share, and that the board had unanimously rejected the offer, in the belief that it “significantly undervalues Rio Tinto and its prospects.”

That caused Rio stock to jump: New York-listed depository shares, representing four Rio U.K. shares, were up US$82.70 at US$440.20 on the close of trading Nov. 8.

Anglo American got swept along in the fun, with its U.S.-listed depository shares shooting up US$6.22, or 19%, to US$38.75 in Nov. 8 trading. Anglo had been rumoured as a takeover target for both BHP and Rio, and the knowledge that Rio might be in play was a spur to buyers. Anglo shares have since settled back to US$34.14.

The following Monday, BHP said that it wrote again to Rio Tinto’s board and that it continues to “seek an opportunity to meet and discuss its proposal.”

The essence of BHP’s pitch for the merger is in cost savings of around US$1.7 billion annually after a 3-year integration, with another US$2 billion a year in increased earnings in another four years. Naturally, no respectable mining merger is complete without putting a few geologists and metallurgists on the street: head office, sales, exploration and technology functions would be combined and trimmed.

In a presentation to investors, BHP noted several common areas of interest for the two companies, including Australian coal projects in Queensland and the Hunter Valley, the Northwest Territories diamond mines, mineral-sands projects in South Africa and Mozambique, and copper projects in Arizona. One part of the proposal is joint development of iron ore projects in the Pilbara block of Western Australia, where some resources, isolated by property lines, could be exploited in a consolidated property package.

T.N.M. Nugget

BHP/RIO TINTO

PROPOSED BHP BID FOR RIO TINTO3-for-1, valuing Rio Tinto at US$130.5B<

RIO TINTO’S STRUCTURERio Tinto PLC (U.K.), 997M shares, US$111B market value; Rio Tinto Ltd. (Austl.), 171M shares held by Rio PLC, 286M in public float; US$35B market value<

COMBINED COMPANY US$125B total assets, US$55B net debt

BID STRUCTURE Direct share exchange for Australian companies; exchange of 80% U.K. shares and 20% Australian shares for Rio’s London-listed shares

CONDITIONS Plan of Arrangement requiring approval of shareholders of both BHP and Rio Tinto; regulatory approval

TIMING At least 9 months for regulatory approval