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 $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.
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 were any indication of future returns – please excuse the sarcasm – now would be the time to hurtle headlong into aluminium.
In 2007, Rio chief executive Tom Albanese unveiled 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 no, not aluminium.
The Alcan deal was announced in July, around the time of the credit crisis and some four months before the sharemarket touched its all-time 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 $76 a share. But Rio blew it out of the water with $US101 a share – a “knock-out bid” as they call them in the M&A 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 Chinese takeover by stealth.
It was only some deft political work by Albanese’s opposite number at BHP that helped to scuttle a tie-up with Chinalco.
By the time Rio moved on Alcan, BHP chief Marius Kloppers was itching to move on Rio itself – as he did later in 2007.
Albanese knew BHP was coming, say the cynics, and promptly went chasing a mega-deal in Alcan which would put Rio out of reach – a “poison pill” if you like. That it did. Rio was now so chock-full of debt thanks to Alcan that a Rio acquisition became unpalatable for BHP shareholders.
It surely made the takeover a tougher task. And so the global financial crisis arrived, throwing the world into chaos, wrecking BHP’s intentions and sending Rio shares through the floor.
It was hardly the time to have great debt as commodity prices tanked.
Emboldened by Rio’s vulnerable state, the Chinese then 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 mega offer of his own: to marry the iron ore interests of Rio and BHP in the Pilbara. Neither was that deal to be, scuttled too when Rio recovered and then recoiled against what would have been a superior financial outcome for BHP.
Two main points emerge from the recent history. One, Rio’s prosperity is squarely down to commodity prices – things beyond its control – rather than strategy. BHP is in the same boat.
Both share prices wax and wane on global risk factors and the price 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 things 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 – such as buy Alcan.
There is one other way, although counterintuitive to ego and size-driven management as it is. That is to demerge, to spin-off.
The studies show that most big acquisitions fail to deliver value to shareholders while 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. The former Alcan executive who now heads the division, Jacynthe Cote, wasn’t divulging much at the briefing yesterday but the deal is spruiked as a “streamlining” – selling the low-return stuff that includes the Australian mines and smelters.
Aluminium returned a mere 2 per cent on assets and 5 per cent on revenue last year – a $US773 million profit from $US38.3 worth of assets. Bear in mind that Alcan’s downstream packaging assets had already been flipped a couple of years ago.
We are talking $8 billion for sale according to Deutsche Bank. 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.