Reworking The Chinalco Deal

This story features RIO TINTO LIMITED, and other companies. For more info SHARE ANALYSIS: RIO

By Chris Shaw

The proposed Rio Tinto ((RIO)) deal with Chinalco has not been widely embaced by the market amid speculation alternatives may emerge, whether via renewed discussion with previous suitor BHP Billiton ((BHP)) or via an alternative proposal such as a capital raising of some form.

But few have considered the need for any adjustment to the terms of the Chinalco proposal until now, Deutsche Bank analysts making the point recent gains for Rio Tinto that have pushed the price through the US$45 per share level means one of the conversion milestones of the original proposal has now been breached.

As the broker points out, this share price appreciation has been unexpected to say the least as 10 weeks ago when the strike prices for the first tranche of the convertible bonds making up part of the deal were set, the prices represented premiums of 37% and 57% to the share price at the time. But now the first has been breached and the second (UK) is not too far away.

This increases pressure the deal, or at least the bond component of it, could be reworked in the broker’s view. Deutsche Bank points out the Rio Tinto chairman is this month visiting shareholders to count votes and see how the market feels about the proposal and or any alternatives, with a view to knowing the board has support when a deal is finally presented to shareholders for a vote.

The most likely outcome in the broker’s view is either the existing Chinalco proposal gets up, it is amended to reflect current conditions and values and thus a revised deal is approved, or the company goes in the direction of alternative funding such as a rights issue.

The one outcome that can’t occur in the broker’s view is for the company to not deliver on some deal to reduce its debt levels as a situation where the company simply limps through its refinancing requirements over the next two to three years is simply not good enough. This option  would mean no growth over that period, making it commercially unacceptable.

Given the increasing risk of a reworking of the proposal the broker retains its Buy rating on Rio Tinto, this despite the stock having outperformed both BHP and the broader Australian market by better than 20% since early March. The broker is not alone in its positive view as the FNArena database shows four Buy ratings and two Sells, with a number of brokers restricted from offering recommendations given their involvement in the corporate side of the deal.

Deutsche’s price target of $68.80 compares to an average target according to the database of $59.17. This average is being dragged down by the respective targets of RBS Australia and GSJB Were of $44.01 and $48.20 respectively, these brokers being the two stll rating the stock as a Sell.

In contrast, UBS has a $70 price target to go along with its Buy rating, which reflects its view there remain alternatives to the Chinalco proposal such as a rights or bond issue or a new proposal of some form from BHP.

Shares in Rio Tinto today are weaker and as at 11.35am the stock was down $1.04 or 1.6% at $63.39.

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