By Jason Simpkins
It's been something of an "open secret" that Chinese interests were considering countermeasures to the proposed takeover bid between BHP Billiton (NYSE:BHP) and Rio Tinto Plc (NYSE: RTP) Now China's largest steelmaker – Baoshan Iron & Steel Company, otherwise known as Baosteel – is ready to make its move with a counter-bid for Rio Tinto.
If BHP Billiton and Rio Tinto did merge, the combined company would have market value of about $380 billion and annual sales of about $54.6 billion, based on 2006 figures. Rival Anglo American PLC (NASDAQ:AAUK) had revenue of only $33.1 billion last year.
More importantly, the company would also control 38% of the seaborne iron ore trade, according to Australia & New Zealand Banking, and that's what really has China quaking.
Iron has been integral in the construction of China's skyscrapers, towers, bridges, railroads and ports. China's soaring demand for the raw material is part of the reason Macquarie Group Ltd. (ASX: MQG) believes iron ore will soar 50% in price next year. With escalating commodity prices and growing demand, China's steelmakers can't risk losing any leverage in negotiations. And a BHP-Rio Tinto conglomerate would control almost half the Asian market for iron ore.
"Yesterday, someone told me that if they combine copper ore and iron ore, prices may double next year," Aluminum Corp. of China (NYSE:ACH) President Luo Jianchuan told Bloomberg. "It makes us worried."
Now, after weeks of consideration, Baosteel is reportedly planning to launch a bid for Rio Tinto. In fact, Baosteel chairman Xu Lejiang publicly acknowledged such plans Monday in an interview with the 21st Century Business Herald.
"We are currently considering this and there's a strong possibility of launching a bid," Xu was quoted as saying. "We are still studying the plan and are discussing how to launch a bid."
It's important to note that Xu is asking how, not if. A Baosteel approach to Rio Tinto is close to certain. And, strategically, it makes sense. With the long-term interests of Chinese steelmakers in jeopardy, someone had to step up to the plate.
BHP's bid was worth $134 billion and Rio responded indignantly, saying the offer "significantly undervalued Rio Tinto and its prospects." In another statement, Rio Tinto's Chief Executive Tom Albanese said the board believes, "that the value in Rio Tinto is yet to be fully reflected by the market." The company then vowed to raise its dividend by 30%.
If Baosteel wants to show it's serious, it may have to bring $200 billion or more to the table. If that's the case, the company will need some help. It has long been rumored that Baosteel would combine forces with fellow steelmakers Angang and Shougang and sovereign fund China Investment Corporation to make ends meet on the deal. CIC was created in September with a $200 billion cache to improve returns on the $1.46 trillion China has in reserves.
Even if the Baosteel bid fails to woo Rio Tinto, it may still succeed in driving up share prices and putting the pressure back on BHP. The consortium may also have plans to acquire a substantial stake in Rio Tinto, which would give it the option of blocking any future merger attempt.
Britain's Daily Telegraph recently reported that China Development Bank, another state-owned investment arm, is already building up a stake in Rio Tinto, hoping to gain enough clout to veto any potential deal. CDB has denied those reports, however.
A Commodity Monopoly or Economic Insurance Policy?
Strategically, a takeover of Rio Tinto would fit well with China's economic and political agendas. China wants to ensure that its economic and industrial growth spurt continues unabated. And for it to do so, China will need a large and consistent supply of raw material, particularly iron.
Rio currently produces about 150 million tons of iron ore a year, according to Forbes. If China bought Rio it would take care of about 30% of its entire annual iron ore needs. Furthermore, at a price of $200 per ton- not taking into account a rise in price next year- it would cost China $30 billion annually to acquire the equivalent of all Rio Tinto's iron ore output. A $150 billion all-cash offer to Rio would only amount to five times China's annual iron ore spending.
This would also be the latest in a long line of strategic Chinese acquisitions. After being encouraged by President Hu Jintao to "go global" several Chinese companies have pounced on a multitude of foreign assets.
Aluminum Corp. of China bought Peru Copper Inc. for $860 million in August. The very next month, Anshan Iron & Steel Group agreed to a $1.6 billion joint venture with an Australian iron ore company. Last year, CNOOC Ltd. (CEO) invested $2.7 billion in the development of Nigerian oil fields. CNOOC was, however, thwarted by U.S. lawmakers in its attempt to buy Unocal Corp. in 2005.
China's investment arms are extending their reach as well. Earlier this week, the Industrial and Commercial Bank of China Ltd. announced it would buy a 20% stake in Africa's largest lender, Standard Bank Group Ltd. And last month, Ping An Insurance Co. bought a 4.2% stake in Fortis, Belgium's largest financial services company.
This string of acquisitions has left China with the reputation of a commodity hog trying to monopolize the planet's resources. But Money Morning's Keith Fitz-Gerald sees things differently.
"China isn't trying to seize control of the world's commodities," Fitz-Gerald said in a phone interview. "They're simply trying to ensure their own economic survival. There's nothing defensive or nefarious about it."
According to Fitz-Gerald, it's a subtlety nine out of ten Western investors are missing, but China isn't trying to achieve global dominance. It's simply trying to ensure long-term prosperity.
"If it looks like the rest of the world is going to be in short supply [of commodities], China will only be all too happy to sell to us," he said. "China just wants to make sure its needs are met first."