Speculation that Rio Tinto could be on the cusp of announcing a deal with its Chinese shareholder Aluminum Corporation of China (Chinalco) to inject cash into the diversified miner sent shares 4% higher in early UK deals, having closed at their highest level in Australian trade since BHP Billiton withdrew its bid for the group.
The Australian-listed Rio shares closed at A$52.00 in on Wednesday amid market whispers the group has finalised a plan to help cut its debt bill, which currently stands at around US$39 billion, and will announce the deal when it unveils full-year results tomorrow morning.
The Anglo-Australian group has pledged to cut US$10 billion off its debt burden by the end of the year and last week confirmed it was holding discussions with 9% shareholder Chinalco over the possible sale of minority interests. At the time, investors cheered the news that Rio was looking at alternative ways to raise cash other than a value-dilutive rights issue. But not all are excited about the prospect of a Chinese solution to the debt problem.
Director and chairman-designate Jim Leng on Monday quit the board and said he no longer intends to take up the position of chairman after “a difference of opinion over which option the company should pursue”. The board room bust-up was reportedly down to Leng being unhappy with a possible Chinalco deal and his decision to leave the group was seen as an indication that this is indeed the solution the group is pushing for.
A number of industry analysts have also questioned the rationale of such a deal. “A deal with Chinalco could solve all its problems,” Evolution Securities analyst Charles Kernot said in a note to clients this morning, “but, while the asset sale part of the transaction may be at a premium to its current value, it would have to be at a discount to its future value otherwise we cannot see why Chinalco would be interested - even given country-strategic reasons.” Consequently, Rio would be in danger of selling its future growth potential at too low a price, Kernot concluded.
Evolution rates the Rio stock a Sell as it believes future growth attributable to Rio’s shareholders will be diminished whether the group opts for a rights issue or a mixture of asset sales and quasi-debt instruments.
Morningstar analysts concede that the debt is an issue for new investors. "We believe Rio is an extremely attractive long-term proposition," Australia-based analyst Mark Taylor said recently. "Rio is generally a well-managed resource exposure but given debt, may not be suitable for conservative investors in the current climate." Click here to read the full report.
Analysts at UBS are also concerned about Rio’s steps to reduce debt. “We are concerned that management’s primary aim may be to reach its stated target of US$10 billion net debt reduction by end 2009 rather than take their time and get the best possible deal for all shareholders,” the broker told investors on Wednesday.
UBS estimates Rio’s disposal proceeds could now reach US$23 billion without the miner resorting to selling stakes in its key iron ore operations. At the release of the group’s results tomorrow, the broker will be looking for details on joint ventures or a placing with Chinese interests but still thinks a rights issue is possible.
UBS has a Buy recommendation on the Rio shares, as does Canaccord Adams. The latter continues to believe that the market is over-pricing the financial risk of Rio’s leverage ratios and near-term debt repayment obligations.
Ahead of the group’s results, consensus estimates point to net income for the year of US$9.5 billion, up from US$7.1 billion in 2007, and earnings of US$7.75 per share. UB S is factoring in a US$1.7 billion dividend payout, although it believes it possible that Rio may cut this in an effort to meet its debt reduction target.
At 9.15am, Rio’s UK-listed shares were 4.5% higher at 1,988p, outperforming the broader FTSE 100 index, which slipped 0.04% lower to 4,211.23.
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