The Iron Giant That Could Challenge the Chinese Mega-Market

By Jason Simpkins
Associate Editor

With its landmark bid for fellow mining giant Rio Tinto PLC (RTP), BHP Billiton Ltd. (BHP) has made it clear it won't sit still and watch the surging global commodities boom from the sideline.

Instead, the Australia-based BHP intends to transform itself into a mega-giant that can stand toe-to-toe with some of the most powerful nations in the world over the next 50 to 100 years. That's a strategy that puts BHP on a collision course with China, the biggest consumer of commodities on the planet.

The rapid growth of such emerging economies as India, Taiwan, Brazil and Russia has resulted in a massive stampede for commodities ranging from wheat and dairy products to uranium and gold. As the new heavyweight on the global block, China has become the leader of the pack, heading the worldwide advance.

So far, mining and shipping companies have been content to accommodate China's massive appetite for commodities. But with no signs of this hunger for natural resources waning, BHP clearly saw the need to boost its efficiency and grab a bigger slice of the action at the same time. And who could blame it?

After all, just look at what commodity prices have done since 1999. And with China, India and other markets continuing to evolve, analysts expect these types of gains to continue over the long run.



1999 Price
2007 Price

% Increase





















Source: Money Morning Staff Research.

The Iron Giant That Has Beijing Quaking

BHP, in its attempt to woo Rio Tinto, has pointed out the tie up would save the newly combined company an aggregate $3.7 billion a year in operating costs.  It also tried to sweeten the deal buy announcing a $30 billion stock buyback, should Rio accept the merger. However, the potential benefits go beyond streamlining operations, cutting costs, and boosting the earnings per share with a simple share buyback plan.

This deal is about a reallocation of the world's most coveted resources - and on a massive global scale.

The assets of the merged company would include a stake in Chile's Escondida mine, the world's largest copper-mining operation, and would have holdings in uranium, aluminum, diamonds, silver, lead and nickel.

BHP's assets include the "trillion-dollar" Olympic Dam, Australia's largest underground mine acquired as part of the $8.1 billion [A$9.2 billion] purchase of WMC Resources Ltd. in 2005. BHP hasn't made a major acquisition since. The mine's resources include 79 million ounces of gold, making it the fifth-largest deposit in the world.

The BHP-Rio Tinto giant would have a market value of about $380 billion and annual sales of about $54.6 billion, based on 2006 figures. For a comparative illustration, rival Anglo American PLC (AAUK) had revenue of only $33.1 billion last year.

If the companies did combine operations, the new BHP would account for 14% of the global market for thermal coal. BHP-Rio Tinto would also control 38% of the seaborne iron ore trade, according to Australia & New Zealand Banking.

BHP would also gain control of the largest aluminum producer in the world, which Rio became by successfully bidding for Canada's Alcan Inc. for $38.1 billion this year. The deal, priced at 1.72 times Alcan's revenue, closed this month and will quadruple Rio's output of the light metal used in aircraft and automobile components.  BHP would control 13% of the worldwide copper supply as well.
In 2006, Rio Tinto produced 7,094 metric tons of uranium, accounting for 18% of total world production. BHP produced 2,868 metric tons, 7% of world output. Together, the two companies controlled a quarter of all the uranium in the world.

Also, Citigroup Inc. (C) analysts believe BHP could cut $540 million in costs by combining the two companies' iron ore and coal mines in Australia. The savings would be generated by the combination of cheaper production and higher retail prices.

All totaled, that would provide a very strong arm in negotiations for a commodity that Macquarie Group Ltd. already believes will soar 50% in price next year.

Roberto Castillo Branco, the director of investor relations at Companhia Vale do Rio Doce (RIO), also known as CVRD, surmised that China's share of global copper consumption would rise to 30% by 2011, up from 21% in 2006. Branco says China's share of the aluminum market will rise to 41% in 2011, up from 25.5% in 2006. It is already the worlds top consumer of light metal.

According to the Australian Foreign Ministry, with whom China has been negotiating, imports of uranium to China are set to increase from 2.5 million pounds per year, to the unprecedented level of 44 million pounds per year. That would be an increase of 1,760%, and amount to about one quarter of the world's total uranium supply.

‘It Makes Us Worried'

The market-power implications of this merger deal have both China and its mining companies scrambling for strategies to battle back. Chinese mining companies have wasted no time searching out acquisitions of their own. The International Herald Tribune reported that China Shenhua Energy Company Ltd., the country's largest coal producer, and Yunnan Copper Co. Ltd., its third-largest copper producer, are planning acquisitions in Mongolia and BHP's home turf of Australia, among other places.

"A takeover deal between BHP and Rio will trigger a new round of mining acquisitions, and that will be a challenge to Chinese mining companies," Shenhua President Ling Wen said at a forum last week, the IHT reported.

But any deals are certain to be particularly expensive, now, since commodity prices have soared threefold since 2002.

IHT also quotes Yunnan's deputy general manager, Yu Weiping, as saying Chinese buyers of copper ore would be squeezed by the merger. "After they become one, they will be [much tougher] in negotiations," he said. Weiping went on to say Yunnan, which buys copper concentrate from BHP, is accelerating its efforts to purchase a number of copper mines in Australia.

Officials with Aluminum Corp. of China Ltd. (ACH), China's largest maker of the lightweight metal, have also voiced major concerns about the merger.

"Yesterday, someone told me that if they combine copper ore and iron ore, prices may double next year," Chalco President Luo Jianchuan told Bloomberg. "It makes us worried."

The Empire Strikes Back

China's anxiety over diminishing negotiating leverage could force some of the nation's more influential players into action. One possibility might be a rival bid, in which case the most likely contenders would be consortiums headed by either the state-run China Investment Co. Ltd. (CIC) or the China Development Bank (CDB).

Britain's Daily Telegraph recently reported that CDB is already building up a stake in Rio Tinto, hoping to gain enough clout to veto any potential deal. Though, CDB has denied those reports.

And over the holiday weekend, both Reuters U.K., and the China Business Weekly - citing anonymous sources - reported that a consortium headed by China Investment Co. would bid $200 billion for Rio Tinto. The consortium would reportedly include such China steelmaking stalwarts as the Shanghai Baosteel Group Corp., Shougang Corp. and Angang Steel Co. Ltd.

One of a growing number of so-called "sovereign funds" that have sprung up around the world, the China Investment Co. was set up recently to invest the country's foreign exchange reserves, which totaled $1.33 trillion, as of its last report.

Rio Tinto denied both the Reuters and the China Business Weekly reports.

Other Ways to Play the Merger

Industry players don't have to make a play for the merger partners or even the merged company. They could wait until worldwide regulators force the company to shed assets in markets where the combined entity might enjoy an illegal monopoly - and scoop up those divested properties or business units.

Should China find itself unable to block the merger, another possibility would be for it to accelerate consolidation of its state-controlled steel and coal mining industries in the hopes of creating a stronger competitor to the newly merged BHP.

Another tactic that's been whispered about - apparently because it's been seriously considered - would have China artificially play down its demand for certain commodities for a time That bare-knuckles tactic would play financial havoc with the newly merged company at the precise time it needs to deliver solid financial results to build credibility with the financial community. Such tactics would create distortions in the supply chain, and create artificially low prices - none of which bodes well for the merged BHP.

Whatever the tactic, Rio Tinto has suddenly become a very popular target - for market scuttlebutt. And with the potential for a rivaling bid to emerge from China, BHP may well be forced to boost its offer, lest it let a very valuable opportunity slip through its fingers.  Meanwhile, interests in China will continue to plan counter-offensives. Their hope for now is that a higher offer will emerge for Rio, and anti-trust reviews will ensnare the deal in bureaucratic red tape - either of which will keep BHP at bay.

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