Four years is a long time in strategy. After paying double what Alcan was worth to become the dominant global force in aluminium, Rio Tinto has now placed about $8 billion worth of aluminium assets on the chopping block.
This volte-face is, on balance, probably a good thing. Indeed Rio shares ticked up nicely, and quite possibly because demergers are more likely to succeed than mergers.
And besides the fact that it won’t hurt to flick a few straggling assets. While they reside in ”assets for sale” Rio’s margins will look better when it comes to earnings season.
But if past performance was any indication of future returns – please excuse the sarcasm – now would be the time to pin the ears back and hurtle headlong into aluminium.
In 2007, the chief executive of Rio, Tom Albanese, announced his thumping $US38 billion bid for Canadian leviathan Alcan. It almost blew Rio Tinto to smithereens.
The rationale du jour was that ”strong demand fundamentals” made aluminium the place to be. Hindsight is a fine thing. Still, it’s painfully obvious that of almost all the commodities, aluminium was not the place to be.
Copper, yes. Gold, uranium, iron ore definitely. But not aluminium.
The Alcan deal was announced in July 2007, around the time of the credit crisis and some four months before the sharemarket touched its record high in November. It was the wrong time to bid, the wrong time to strap on a mother lode of debt and the wrong time to pile into aluminium.
The world’s biggest aluminium producer, Alcoa, already had an offer for Alcan on the table pitched at $US76 a share. But Rio blew it out of the water, offering $US101 a share – a ”knockout bid” as they call them in the mergers and acquisitions trade.
By the time the deal was done late that year, the sharemarket had peaked. The next year, the financial crisis hit and Rio, foundering under a mountain of debt, almost succumbed to a Chinese takeover by stealth.
It was only some deft political work by Albanese’s opposite number at BHP that helped scuttle a tie-up with Chinalco.
By the time Rio moved on Alcan, the BHP chief, Marius Kloppers, was itching to move on Rio itself – as he did later in 2007.
Albanese knew BHP was coming, the cynics say, and promptly went chasing a big deal with Alcan that would put Rio out of reach – a ”poison pill” if you like. It worked. Rio was now so full of debt – thanks to Alcan – that an acquisition became unpalatable for BHP.
Then the financial crisis arrived, throwing the world into chaos, wrecking BHP’s plans and sending Rio’s shares through the floor. It was hardly the time to have a lot of debt as commodity prices tanked.
Emboldened by Rio’s vulnerable state, the Chinese moved for control via a giant bond offer which would have delivered a stake of more than 20 per cent.
Kloppers, fearing the pricing power of a China-backed rival, exercised his lobby muscle in Canberra to get the Chinalco deal knocked out on competition grounds. He weighed in with a huge offer of his own: to marry the iron ore interests of Rio and BHP in the Pilbara region.
Neither was that deal to be, scuttled when Rio recovered and then recoiled against what would have been a superior outcome for BHP.
Two points emerge. One, Rio’s prosperity is squarely down to commodity prices – things beyond its control – rather than strategy. BHP is in the same boat.
Their share prices wax and wane on global risk factors and the prices of the commodities they export. And while it is true that, over time, adept operational and superior strategic management will lift profits, these are dwarfed by extraneous factors such as growth and inflation in China.
The only way then that management can have a meaningful effect on the fortunes of the company is to not blow up, not do anything stupid – like buying Alcan.
There is one other way, although counter-intuitive to ego and size-driven management as it is. And that is to demerge, to spin off.
Studies show that most big acquisitions fail to deliver value to shareholders, but most demergers do enhance value. Why then does Rio get all wild and throw a 60 per cent premium to Alcan, and that’s on top of an existing takeover premium from Alcoa?
Good question. Why does BHP try to buy an overpriced Rio at the top of the market, then have a $40 billion shot at Potash in Canada and get knocked back?
Equally good question. Both companies are too big now, especially in light of global regulation, to deliver by acquisition.
A few points: Rio’s aluminium sale is not a total backflip.
Jacynthe Cote, a former Alcan executive who now heads the division, wasn’t divulging much yesterday but the deal is spruiked as a ”streamlining” – selling the low-return stuff which includes the Australian mines and smelters.
Aluminium returned just 2 per cent on assets and 6 per cent on revenue last year – a $US773 million profit from $US38 billion worth of assets. Bear in mind that Alcan’s downstream packaging assets had already been flipped a couple of years ago.
Deutsche Bank says assets worth $US8 billion are up for sale. Goldman estimates the breakdown at 20 per cent of group bauxite production, 34 per cent of alumina production and 35 per cent of aluminium production. Massive numbers, yet for a company of this size, mere tinkering at the edges.