Aluminum Corp of China (Chinalco) spent US$14.5 billion (with US steelmaker Alcoa chipping in US$1 billion) on a stake in Rio Tinto in February. It was thought that owning 12% of Rio Tinto’s London-listed equity would be enough to ward off advances from BHP Billiton. A BHP-Rio merger was not something China wanted to see. It would have left 70% of the world’s seaborne iron ore in the hands of just two companies: the merged entity and Brazilian miner Vale.
As it turns out, the deteriorating global economic climate, not Chinalco, has put paid to BHP’s hopes of a US$68 billion takeover of Rio. BHP CEO Marius Kloppers said prices of the commodities the company deals in have fallen 50% in six weeks, creating an all-too-risky climate in which to be taking on the extra debt involved in acquiring Rio.
Although Chinalco didn’t have to take any direct action to thwart the deal, the fall in commodity prices and consequently in Rio’s share price has hit the Chinese firm with a US$10 billion paper loss on its investment. Is it worth that much money to keep BHP and Rio apart? Perhaps – given the pricing power that a combined entity would have wielded – but it’s something no company wants to see on its balance sheet.
Chinalco could of course capitalize on the situation and raise its own stake in Rio, although such a move would likely arouse strong opposition among Australian politicians. Another option is to acquire assets that a struggling Rio may seek to sell off.
What makes the situation all the more interesting is the indirect role Chinese steelmakers have played in the demise of the BHP takeover. China produces a third of the world’s steel and is therefore one of the iron ore miners’ biggest customers. Trouble in the Chinese property market, which has resulted in declining domestic steel demand – output was down 17% in October – is partly responsible for the recent sharp global downturn in prices of iron ore and other commodities.
Viewed in this context, it could be argued that Chinalco’s investment in Rio Tinto is yet another example of Chinese firms’ eyes being bigger than their stomachs – or at least their short-term concerns trumping their mid-term strategies.
From steelmakers to oil refiners to airlines, China rushed in when commodity prices were at their peak and signed up bulk supply contracts. Now they must face the financial reality that these assets are not worth what they once were.
* For more on Chinese investment in Australian mining assets, please see this report from the July issue of China Economic Review.