Giants prepare for battle

GLENCORE versus Rio Tinto will be the major corporate fight of 2015.

Rio Tinto chief executive officer. Sam Walsh. Picture: Mark Cranitch.

THE biggest corporate battle of 2015 has already been heralded in skirmishes this year — Glencore’s audacious merger bid for Rio Tinto, the world’s second-largest miner.

Just as the outcome for the Australian economy next year will be determined substantially by choices made in China, so it will be for this battle of business giants, in which both are playing a long game.

Michael Komesaroff, an expert on China’s mining industry and a former Rio Tinto executive who then worked for a major Chinese resources corporation, says in new research for Gavekal Dragonomics, based in Hong Kong and Beijing, that “Beijing has a stake in the fate of Rio Tinto not only as the miner’s main customer but also as its biggest investor”.

Come April, when London stock exchange rules permit a further approach after the first was rebuffed, industry analysts expect Glencore’s chief executive, Ivan Glasenberg, to return with a fresh proposal.

The outcome, says Komesaroff, will shape the global mining industry in the post-commodity-boom world. It will be determined in large part by Beijing, “whose anti-monopoly regulators have shown themselves both willing and able to use their growing international clout to further China’s global resource strategies by forcing the sale of prize assets like copper mines to Chinese state-owned companies”.

A successful Glencore bid, he believes, will almost certainly end in the dismemberment of the Anglo-Australian giant that has dominated the global mining scene for over a century, with Chinese state-owned resources companies cherry-picking many of the company’s choicest businesses.

In 2008, Chinese state-owned resources company Chinalco bought 9.8 per cent of Rio to become its largest shareholder. The share value slid after that, poor investments eventually triggering a shift in management, with veteran iron ore boss Sam Walsh taking the top job last year.

He has cut costs, but has found it more difficult to unload underperforming assets in Canada, Zimbabwe, Australia and elsewhere.

Iron ore has consequently become more crucial than ever, ­supplying 70 per cent of the company’s value, as Rio produces about 20 per cent of the ore shipped annually — exposing it, however, to the collapse in price this year — triggering a 23 per cent fall in Rio’s share value this year, to beneath half what Chinalco paid in 2008.

This, says Komesaroff, “has exacerbated tensions with the company’s Chinese shareholders, possibly leaving Beijing more receptive to a proposed breakup of the mining giant”.

Two particular issues grate with the Chinese, he says.

First, despite being Rio’s largest shareholder, they have never been invited to join the board — perceived by some in ­Beijing as an anti-Chinese slight.

Second, in 2009 Rio abrogated a $US19.5 billion deal that would have seen Chinalco double its stake in Rio and gain two board seats as well as joint venture status in ­several key mines, including flagship iron ore mines in Western Australia.

Komesaroff says: “At the time Rio Tinto was struggling under a mountain of debt acquired as a result of its disastrous 2007 tilt at Alcan, and the Chinese saw themselves as the company’s ­saviours.”

Chinese officials, he claims, also have misgivings about Walsh.

“They regard him as aloof, more at home in London than ­Beijing and less sympathetic to Chinese concerns than his predecessor, Tom Albanese,” he says.

“Walsh also suffers in the eyes of Beijing because he was head of Rio Tinto’s iron ore division at a time the Chinese naively believe they were exploited by a cartel of Western producers which colluded to drive up the price of iron ore to the disadvantage of Chinese steel mills.

“That Rio Tinto’s Chinese iron ore negotiator, Stern Hu, was sentenced to 10 years in jail for bribery and theft of state secrets under Walsh’s leadership of the ore business does nothing extra for the new CEO’s reputation in Beijing.”

Chinese officials also harbour reservations about Glencore, though. These date back to 1997, when one of China’s largest zinc producers lost $US130 million selling zinc short in a rising market. At the time, Komesaroff says, officials blamed Glencore for encouraging naive managers to speculate beyond their means and capability, and warned other Chinese non-ferrous metal producers about the risks of dealing with the trading company.

“While the official attitude has softened over time, many senior executives in China’s metals industry recall the incident and remain wary of doing business with Glencore,” he says.

“It is likely their doubts have been compounded by Glencore’s trading culture, which seeks to maximise revenue. As the world’s largest buyer of most minerals and metals, China naturally prefers Rio Tinto’s production approach, which tends to maximise volume, leading to lower prices than the Glencore model.”

But Chinalco and its political masters could look favourably on a renewed Glencore bid for Rio, Komesaroff says.

It was widely reported that Glasenberg spoke to Xiong Wei­ping, then Chinalco’s president, ­before approaching Rio in October. It is not known what they discussed, but around the time of the reported meeting Chinalco established a committee of senior executives to examine the company’s strategic options, which suggests that discussions may have included Chinalco’s possible involvement in a takeover of Rio.

Glencore has built an immense range of commodity businesses through acquisition, and now bills itself as the only genuinely diversified natural resources company in terms of business activities, commodities and geography. Its big portfolio gap is iron ore.

Any tie-up between the companies will face close scrutiny from regulators, especially those in China, where the authorities have shown they are willing to use their anti-monopoly powers to benefit their national champions.

Glencore was forced early in 2014 to sell the Las Bambas mine in Peru, one of the world’s largest copper projects, to MMG — which is Melbourne-managed but Chinese-controlled and Hong Kong-listed — for $US7bn ($8.6bn) in order to gain approval from China’s Commerce Ministry for Glencore’s acquisition of Xstrata.

Apart from the size of the combined group’s copper production — about 18 per cent of global output — the regulators would also wish to address the potential of several huge projects to expand output further.

And copper is near the top of China’s list of commodities nominated as a strategic priority.

Glencore is already the world’s largest international trader in thermal coal. The addition of Rio’s 28 million tonnes of Australian production would see it produce more than 10 per cent of the product that is internationally shipped.

Divestments would also be likely in aluminium, Komesaroff believes, where the addition of Glencore’s trading volumes — it owns 8.75 per cent of Russian Rusal, the world’s largest producer — with Rio’s production of 3.6 million tonnes per year would exceed regulators’ tolerance ­levels.

Such a complex deal would take a year or so to tie down as a consequence of such regulatory complexities, with the pre-emptive rights of joint venturers adding a further layer of difficulty.

For Glasenberg, whose core goal remains the acquisition of Rio’s vast and high-quality Australian iron ore assets, divestment would be a price he might well be prepared to pay.

In such a case, says Komesaroff, “Glencore is likely to find willing buyers among China’s state-owned companies. Chinalco, for example, may value a stake in Rio’s low-cost aluminium smelters, which benefit from ­supplies of cheap non-polluting hydropower. And the proceeds would help fund the cash that Glencore would have to pay Rio Tinto’s shareholders.”

It is more difficult to predict, however, how eager China’s ultimate political decision-makers would be to pick up Rio’s assets. “China’s state resources companies are plagued by inefficiency and tainted by corruption scandals,” says Komesaroff.

Chinalco’s new chief, Ge Honglin, was appointed last month with a brief to improve the company’s disastrous bottom line — its listed subsidiary lost 4.12 billion yuan ($820m) in the first half of 2014 — and will probably have to embark on a round of ­redundancies.

As has become common in China, some senior managers are being detained by the communist party’s Central Commission for Discipline Inspection for “serious violations of discipline and law”.

Further, some recent high-­profile resources investments, such as Citic Pacific’s stake in Australia’s Sino Iron project, have proved to be financial disasters — if not diminishing the appetite for foreign purchases, at least prompting calls for considerably deeper due diligence.

But Komesaroff says that MMG’s purchase of Las Bambas and Baosteel’s acquisition with Aurizon of Aquila Resources ­suggest that “the Chinese are pragmatic buyers who will make selective investments in ­commodities like copper and iron ore, which they see as strategic ­resources.”

The National Development Reform Council would need to ­approve the involvement of a state entity, or the purchase of any ­assets divested by the miner’s new owner.

Xiao Yaqing, who when president of Chinalco first proposed taking a stake in Rio, has since then become an influential deputy director at the State Council, which ultimately controls the NDRC, says Komesaroff.

“He would be keen for Chinalco to participate in any takeover of Rio Tinto as a vindication of his original strategy,” he says.

And Chinalco’s recently replaced president, Xiong Weiping, is now chairman of the board of supervisors at the state-owned ­Assets Supervision and Administration Commission, whose ­approval would also be required for a takeover of Rio.

Komesaroff believes that, furthermore, “Beijing may be prepared to support the transaction financially via China’s state-owned banks. This is an environment in which Beijing and its state-owned enterprises are increasingly ­calling the shots.”