Wednesday, December 3, 2008
Q: The Billiton takeover of Rio just fell though. Any comments on the effect of this on the future of the two? – H.S.
A: As I told my S&A Oil Report subscribers yesterday, the party is over. The biggest merger in commodity history, between BHP Billiton and Rio Tinto, died with a whimper last week.
These two companies are among the world's largest commodity producers. They mine everything from coal to iron ore to diamonds.
Last November, BHP Billiton offered to buy Rio Tinto for $127 billion. In February, it upped its bid to $147 billion, a 26% premium to the share price. It's no wonder BHP was willing to pay up. The combined company would have been a commodity juggernaut. Take a look at what it would have controlled:
Then the entire commodity sector tanked, and banks got scared. While they couldn't back out directly, a delay gave them an escape hatch...
The European Commission, which regulates mergers in Europe, held up the deal and ultimately suspended its review, claiming the companies weren't supplying requested documents. Of course, by then, all the commodity prices were in the toilet, and markets were heading that way as well.
On November 25, BHP withdrew its bid. BHP's shares, which were down 75% from its high this year, rallied 15% on the news. Rio Tinto is another story. Its share price fell 27% after BHP backed out. The company recently hit its 52-week low and is down 85% from its high.
It's possible BHP is merely biding its time, hoping to buy Rio for a much lower price. But I'm not so sure Rio will fall much farther. Let me explain...
Rio Tinto is the largest aluminum producer in the world and the second-largest iron-ore producer. Iron ore and aluminum account for half of Rio Tinto's earnings. Aluminum prices fell 48% from the high, and iron ore prices are down 63%. It sounds bad, but that's not nearly as far as zinc (-74%) or nickel (-82%).
As a geologist, I love Rio Tinto. It's a global mining company with an interesting suite of mines and products. However, as an investor, I can't get past one big problem on the balance sheet: $42 billion of debt.
Rio should earn $19.8 billion in 2009. With that kind of cash coming in, it can more than cover its interest expense ($1.26 billion) and possibly pay down the $15 billion coming due in October. But it's going to be a close call. If earnings come in low, the stock will be crushed.
So I'm not in a hurry to buy Rio Tinto. I want to wait for two things to happen. First, I want to see what the fourth-quarter earnings look like... We could be in for a big bad surprise. Second, I want to see the price trend turn positive.
That's not going to happen until every last investor holding on in hopes of a merger throws in the towel. I think that'll take awhile. Too many investors made too much money during the big commodity party. Everyone's waiting for the music to start back up.
Government says it may buy 30-year Treasuries... Vanguard Extended Duration Treasury Index ETF hits all-time high, up 36% since January 2008 inception.
Oil drops below $50 a barrel on recession news... U.S. Oil Fund hits all-time low.