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13. November 2007

BHP details bid proposals for Rio Tinto

There's no smoke without fire. The Australian newspapers in particular had been publishing rumours of a BHP Billiton bid for Rio Tinto for months - indeed almost ever since mining sector merger mania was the vogue with the big predations of CVRD for Inco, Xstrata for Falconbridge, Freeport for Phelps Dodge and Rio Tinto itself with its Alcan takeover, as well as many other minerals sector deals fuelled by high commodity prices and record earnings.

Now BHP Billiton has confirmed it has been in talks with Rio Tinto, and has detailed the price it has been offering in terms of an all-paper deal of three BHP shares for each Rio Tinto share, effectively valuing the latter at around $140 billion. Rio has confirmed that it has rejected the proposal as being not of sufficient value to make it attractive given the underlying value of its vast international holdings, not necessarily reflected in its share price.

Today, BHP has set out its proposals in rather more detail with an 18 page news release. Key is the statement that BHP "firmly believes that the rationale for combining BHP Billiton and Rio Tinto is compelling due to the strategic fit, the expected synergies and the opportunity to create an organisation without parallel. This combination w ill unlock unique value for both BHP Billiton and Rio Tinto shareholders."

BHP reckons on achieving over US$1 billion in synergy cost savings by year three should a merger take place. The company also promises a $30 billion share buy-back: "BHP Billiton estimates that the combined group would have the financial flexibility to return significant capital to its shareholders, and intends to make the first such return following completion through an initial share buy-back (or other appropriate mechanism) of approximately US$30 billion. This cash distribution would allow the combined group to have an efficient balance sheet while maintaining flexibility for future investment."

There are also a couple of interesting points to note about the statements from the two companies. BHP has not made a formal bid yet, but there is now little doubt that it will do so, although a hostile offer is likely to be exceedingly expensive. On the other hand, Rio does not seem to have rejected a BHP bid in principle, but argues so far that the bid is insufficient. This is not strong rejection language so there has to be the chance that a materially bigger BHP bid might be more to Rio's taste. Any hostile bid by BHP would almost certainly have to be substantially bigger than the initial proposal anyway, so there has to be the likelihood that BHP will still, perhaps, up its offer and see if it can woo the Rio board and shareholders on a friendly, rather than a contested, basis.

If Rio feels it is vulnerable to take-over, then it would probably prefer to deal with BHP, which does have a more similar culture and approach, than to other potential predators out there - and there have to be only a very few companies which could sensibly make a play for the world's third largest mining company.

A merged BHP/Rio outfit would be enormous in both mining terms and market capitalisation terms (US$350 billion plus) - indeed it would be one of the world's largest companies of any kind. With huge combined interests in iron ore, copper and aluminium - to name but a few, the kind of market dominance that would be involved is certain to raise competition eyebrows, although BHP says that it "has undertaken a thorough analysis of the anti-trust implications of this combination and is confident that anti-trust issues present no significant barriers to completing the proposed transaction, and that any possible regulatory concerns can be readily addressed. BHP Billiton considers that this process should not impact in a meaningful way either the future prospects of the combined group or the amount and achievability of synergies."

There is also a suggestion in the Australian press, which BHP has denied, that it has already been in talks with the Chinese over the ramifications of such a deal, in particular with respect to the iron ore on which China's huge and ever-growing steel industry is so dependent. Some suggestions out there are that BHP has already offered a long term deal over pricing with the Chinese, should a merger with Rio go ahead.

Further, Rio Tinto may have overstretched itself with the Alcan takeover, which has left it with a huge amount of debt, particularly should commodity markets turn down if there is a recession in the US and should Chinese consumption growth slow down.

But, the very fact that a company the size of Rio Tinto could be seen as a take-over target is likely to re-ignite merger fever in the natural resources sector. In base metals companies like Teck Cominco have to be viewed as a target - and even the enlarged Freeport McMoran following its Phelps Dodge acquisition. It's not only the mid-size outfits which have to be wary to retain their independence as merger fever drills down to their levels.

The precious metals sector too could be due for some consolidation. Newmont could be perceived as being weak following a recent spate of difficulties and poor results - as could Gold Fields and Harmony for the same reason should any company want to get embroiled in the South African mining scene. There has been speculation that Barrick might want to diversify into other precious metals, like platinum, but again this would almost certainly have to involve a leap of faith in South Africa, and there is a degree of nervousness around the country as contenders jockey for the country's Presidency when Thabo Mbeki reaches the end of his final term under the Constitution in 2009.

There has been speculation that the new BHP CEO, Marius Kloppers, a young-looking South African, is showing a more aggressive streak than his predecessor, Chip Goodyear, and is thus more likely to take the contested bid route than Goodyear would have done. But, very obviously from the recent statement, an agreed take-over - probably with some sweetening of the initial offer, would be the preferred route.

Given that the Rio Tinto share price rose immediately to reflect the BHP Billton proposal, and with speculation that the Chinese might make a move on Rio Tinto to protect their own strategic supplies of key metals and minerals, there has to be the prospect of another offer materialising, although sufficient finance may be difficult to raise for a cash deal in current circumstances - and apart from BHP there are likely to be few companies around where a paper offer might seem attractive to Rio shareholders.

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