BHP Billiton (BLT) and Rio Tinto (RIO) terminated their proposed Pilbara iron ore production joint venture. Consummation of the deal was subject to a number of conditions, not the least being regulatory approval. This was always going to be a tough task, given the number of jurisdictions involved. After extensive talks, including more recently with the German Federal Cartel Office, it was apparent that approval was unlikely. Rio Tinto and BHP will no longer pursue the joint venture and mutually agreed that no $275.5 million breakup fee is payable by either.
This was to be a deal reflecting common sense. It covered the entirety of both Western Australia iron ore assets in a 50/50 joint venture. The net present value on a 100% basis of shorter rail hauls, combined mining operations, blending opportunities, and management and overhead savings were calculated to be in excess of $10 billion. Production could have been ramped up more rapidly than on a stand-alone basis. It has come to naught, though there might still be opportunities to do deals on some assets. The problem is the majors are extremely wary of carrying third-party product on their 100% owned lines--paranoid about the prospect of open access and the risk that others' rail stock might pose for their vital infrastructure and scheduling.
For now, life goes on as usual. Our BHP numbers assumed the joint venture would proceed. Unwinding that outcome means future iron ore production decreases a tad. Next year's leverage for BHP will be lower with the $5.8 billion equalisation payment to Rio Tinto no longer required. Despite all this, the impact on earnings and valuation is relatively minor. We did not include cost synergies in our numbers, and we were relatively conservative on the capital cost savings. The forgone savings from capital expenditure synergies does have some impact. Infrastructure spending will now necessarily be duplicated.
And what of these regulators in far-off lands? Couldn't BHP and Rio Tinto have just gone ahead and let them lump it? After all, where else were they going to get the iron ore from? The European Union was the key player, with others like the German Federal Cartel Office feeding into its decision. They were responding to the concerns of their constituent steel mills around the concentration in ownership of iron ore supply. BHP wasn't willing to speculate as to what remedies the EU and others could have sought. At the very least, it could have included requirements to sell certain assets; at the worst, restrictions on trade. Both BHP and Rio Tinto have assets in Europe and other jurisdictions and decided not to open that can of worms.
We remain positive on BHP.
Mark Taylor is Australasia Senior Resources Analyst for Morningstar.
