International Herald Tribune
Bowring: No free cash
Monday, February 16, 2009

HONG KONG: The offer by China to inject $19 billion into the cash-strapped Anglo-Australian mining giant Rio Tinto could prove more significant than China's 2005 bid for Unocal, which was thwarted by U.S. opposition.

The clash between the power of money and perceived national interests is growing more intense as cash-rich buyers try to take advantage of cash-strapped sellers.

In turn, this will test Australia's perception of itself, as well as a relationship with its largest trading partner that grew warm and cozy in the days when China's growth was unquestioned and the minerals boom in full swing.

On the face of things, the offer by Chinalco, China's listed but state-controlled aluminum company, is innocuous enough. It would acquire convertible bonds eventually giving it an 18 percent stake in Rio plus minority interests in major bauxite, copper and iron ore mines in Chile, Indonesia and the United States, as well as in Australia, and a seat on the Rio board.

Chinalco is offering to buy at well above the fire-sale prices that Rio might otherwise have faced. Its stakes will be far from control and could help secure long-term Chinese buyers for its ores.

The fact that Rio - which must repay a $9 billion loan this year - is desperate says much about mismanagement by hubristic Western executives, who instead of using the recent good times to hoard cash accumulated debt in efforts to outbid each other.

In the Rio case, the American chief executive, Tom Albanese, took on $39 billion in debt to outbid Alcoa for control of Alcan in 2007. Last year, he fought off a top-of-the market bid by rival BHP Billiton long enough for the mineral boom to collapse and BHP to withdraw.

Desperate to raise money without having to go to its own shareholders or lose face by selling assets to BHP, Rio has opted for China's ready cash.

The proposal may yet be defeated by market forces in the form of shareholder opposition or by London rules on the pre-emptive rights of existing shareholders. But more significant is the response of the Australian government, which will be watched closely by other countries where the mining interests to be acquired by China are of major importance to the national economy, such as the Escondida copper mine in Chile or the Grasberg copper and gold mine in Indonesia.

There are two major problems in the Chinalco bid. First, Chinalco is both much smaller than Rio and has had to shut down capacity in the face of collapsing demand and prices. The price of its Hong Kong listed subsidiary, Chalco, has fallen by 75 percent since a mid-2008 peak. Morgan Stanley forecast last month it will make a 3.5 billion yuan loss in 2009 and that its debt to equity ratio will rise to 54 percent.

Yet in addition to its own specialty, aluminum, it wants to acquire copper and iron ore. In other words, its access to cash and its interest in a wide range of minerals marks this out as a strategic step by the Chinese state, not an opportunistic move by a company.

Second, it is not hard for Australians to see Chinalco as the thin end of a wedge aimed at influencing the supply and pricing of Australian ores.

Chinalco is a major client for Australian bauxite. Other Chinese metals producers and users are clients of Rio's copper and iron ore mines. Chinalco itself has ambitions to diversify into other minerals. China has also been making it clear that it wants to break the combined influence of Rio and BHP on iron ore prices and was openly critical of the BHP bid for Rio. Australia and Brazil dominate world exports of iron ore and China is the main buyer.

Some prominent business commentators in Australia are claiming that this bid is clearly contrary to Australian national interests.

That places Labor Prime Minister Kevin Rudd in a delicate position. A Chinese-speaking former diplomat, he has always sought good relations with Beijing, but does not want to be seen as naïve about Chinese intentions.

With its external deficit, Australia needs capital, and several of its cash-short mining companies are looking to China for salvation. But for China, the more mine projects that can be kept alive now, the cheaper it will be able to buy ore when economies revive.

Australian approval cannot be taken for granted. In 2001 the Foreign Investment Review Board, under pressure from the government, rejected a takeover by Anglo-Dutch giant Shell of gas producer Woodside.

Resource nationalism waxes and wanes in Australia. Today, Australia, like Rio, is caught between a heightened sense of its own vulnerability to China, and its need for cash.

Even if this offer goes through, it will leave a mark on Australian perceptions and likely lead to tighter controls in future. And it will make other commodity exporters think twice about relationships with their major customers.