Ｃｈｉｎａｌｃｏ Ｆａｄｅｓ，Ｒｉｏ Ｔｉｎｔｏ Ｒｅｎｅｇｕｅｓ

Another deal broke down. The Chinese enterprises dream of taking more overseas resources has not come true. It is quite often that the state-owned enterprises of China are blocked on their way into foreign market.

Anglo-Australian mining giant Rio Tinto walked away from a proposed 19.5-billion-USD deal with Aluminum Corp. of China, dealing a blow to Chinas ambitions to buy access to raw materials crucial for its economic growth.

The proposed deal would have given state-owned Aluminum Corp., known as Chinalco, an 18% stake in Rio Tinto, the worlds third-largest miner and owner of rich iron-ore and copper mines in Australia and elsewhere. It also would have given the Chinese company direct stakes in some mining assets.

But Chinalcos plans fell victim to a potent mix of shareholder opposition, economics and politics, partly reflecting fears – especially in Australia – of the consequences of giving China direct access to a huge trove of natural resources. The deals collapse, previously reported by Dow Jones Newswires, came just days before Australian regulators were expected to set tough conditions for their approval of it.

The company also turned to a former suitor, mining titan BHP Billiton. The two companies agreed to combine their western Australian iron-ore assets in an equally owned joint venture, with BHP paying Rio Tinto 5.8 billion US dollars. Meanwhile, Rio Tinto compensated Chinalco with 195 million US dollars as contracted.

Mr. Xiong Weiping, General Manager of Chinalco, said to the media: “We are very disappointed!”

It seems that Rio Tinto is unable to keep their words, which is the main reason of the breakdown of the deal. However, the Chinese enterprises and government should see the deeper reasons and take a lesson from this failure.

Rio Tintos Breach of Promise

An Australian analyst pointed out that Rio Tinto chose to break away with Chinalco despite high compensation fees because the Australian economic situation began to take on a recovering trend.

“When Rio Tinto reached the agreement with Chinalco, it was in urgent need of capital from Chinalco to relieve it from the stress of liabilities. In 2008 the total amount of liabilities of Rio Tinto was 67.15 US dollars with current liabilities of 22.1 billion US dollars. Its total amount of paper cash and value in kind is only 1.181 billion US dollars,” said Qiu Hongguang, General Manager of Shanghai Sentao Investment & Consultancy.

According to his introduction, Rio Tinto then was in great debt trouble and imminently needed the aid from Chinalco. Meanwhile, China has been becoming more and more dependent on the overseas mining resources. Therefore, Chinalco hoped to take control of the rich non-ferrous metal resources of Rio Tinto to guarantee the supply.

Both parties can take what they need through this deal. In February 2009, they reached the agreement. According to the agreement, once this deal was approved, Chinalco would be the largest shareholder of Rio Tinto and would have two seats of board members of Rio Tinto.

However, two months after the agreement, the situation changed greatly.

“Rio Tintos stock price kept moving up and nearly doubled in 5 months. The financial situation of Rio Tinto also became better. It can be said that Rio Tinto has survived its most difficult period. The capital stress has been relieved,” said a market analyst.

Jan du Plessis, Board Chairman of Rio Tinto, said: “The financial market has been obviously bettered, which will bring two different kinds of influences: the first one is the apparent decrease in the value of the deal with Chinalco; the second one is that we, with stronger capital strength, have the qualification to look for the deals with more profits. Therefore, we had the opportunity to talk with BHP Billiton about setting a joint venture in Western Australia. The joint venture will bring us more substantial value.”

Deeper Reasons

The same market analyst said: “If the increase in Rio Tintos stock price was attributed to the Chinalcos acquisition, it would be quite stupid for Rio Tinto to reject the Chinese companys offer. On May 14, 2009, Rio Tintos stock price fell by 11%, which was the largest in this year. The basic reason is the pessimistic expectation of the market about the possibility of Chinalcos investment into Rio Tinto.”

From the beginning, some Rio Tintos shareholders and Australian government held the opposite opinions towards this deal. On February 9, Jim Leng, who was supposed to be the new director of Rio Tinto, left the board because he was dissatisfied with Rio Tintos adoption of the “Chinese Plan” to solve the problem of liabilities. Chinalcos second try of putting investment into Rio Tinto was confronted with an unprecedented uncertainty.

The Australian government held stronger opposite opinions.

Li Daokui, professor from Tsinghua University, said that the mining industry is the core industry of Australia. For the local government, Chinalco is the enterprise which is controlled by the Chinese government. Some conservative parties and councilors of the Australian government opposed this deal from the view of state safety.

“It is quite normal for a state-owned enterprise from China to be stopped on their way to the overseas market,” said many market analysts.

Besides the hurdles, the hostility towards the Chinese enterprises acquisitions pushed the price upward.

“There is a premium requirement in the market for the state-owned enterprises from China. In order to deal with this requirement, the Chinese enterprises have to give up some benefits they should have, like giving up position of the board members and becoming the pure financial investors. Despite this, the protesters still hold their opposition views.

An economist said in his analysis report that Rio Tintos shareholders were worried about many questions which may arise if Chinalco got enough vote rights. For example, Chinalco is a state-owned enterprise, so its interests are related the state interests. Therefore, the two companies interests may collide with each other in some occasions. The shareholders are worried about the possibility that Chinalco may not cooperate with them if Rio Tintos activities of purchasing the maximum proifts harm the state interests of China.

Zhang Tianbing, Vice President of Cole ATKearney Management Consultancy Co., Ltd., said that Rio Tinto wanted the money from China, not the possibility of being controlled by China.

The experts said that this is neither the first failure nor the last one of the Chinese enterprises in overseas acquisitions.

Resource Safety

It is widely known that China is extremely longing for the natural resources. Since 2007, the Chinese enterprises have been very active in purchasing the overseas resources. The large state-owned enterprises, as well as some private enterprises, went abroad to buy overseas resources one by one.

The Chinese government also encouraged the enterprises to “go out”. The state-owned enterprises quickly responded to this policy. For example, Sinosteel Corporation took over Australian Midwestern Corporation; China Minmetals Corporation acquired OZ Minerals; Valine Steel purchased the stake of FMG and Shenzhen Zhonggin Lingnan Nonfement Co., Ltd. acquired PEM Corporation, etc.

According to the public information, in recent years, Chinas demand for metal resources increased a lot. For example, its demand for iron ores took 49.8% of the global demand in 2008, while in 2004 the proportion was only 32.0%. It is forecasted that the proportion will continue to increase in the coming two years and in 2010 it will exceed half of the total demand of the world. Meanwhile, Chinas need for copper, aluminum and zinc are also increasing. Since the second half of 2006, the increase in Chinas demand for copper has been playing an important role of driving the global demand for copper.

Judged from those data, Chinas extensive economic growth pattern has not seen obvious changes in recent years. The corporate adjustment and transformation and industrial upgrading are also slow in the process.

“It will be quite painful in the way of transformation. The enterprises will face a lot of problems, like how to increase the investment into research and development and how to find the most effective development pattern.”

Now the Chinese enterprises advantages are still embodied in the low cost of environment and human resources, which is a hurdle in seeking the new development pattern.

Therefore, some experts forecasted that the Chinese enterprises will go on looking for the opportunities of overseas acquisition for the resource safety. But unfortunately, the results will not be changed in a short time.