Costly Retreat Comes With A Challenging Message: Resources Boom Is Over
Sydney Morning Herald
Wednesday November 26, 2008
BHP Billiton's decision to abandon its pursuit of Rio Tinto is a massively negative call on the global economy.
Chief executive Marius Kloppers and his executive team and chairman Don Argus and the BHP board had spent more than a year and $US450 million of BHP money on the takeover attempt, arguing the merits of the combination endlessly with the markets and shareholders, and shepherding it through a succession of regulators.Despite that, the recommendation that came up to BHP's board yesterday afternoon from Kloppers generated a relatively quick and unanimous decision: BHP would walk away, and take the $US450 million loss on the chin.The call was forced by a looming deadline for BHP to decide whether to put up asset sales to clear the final regulatory hurdle to the deal, but the decision in the end was that the global economic descent that accelerated last month had made an acquisition of Rio too risky: a deal pitched initially as a natural profit maker had turned into one that might damage BHP and the board opted to close off that possibility.BHP would have inherited $US42 billion of debt from Rio on top of its $US6 billion debt load, the legacy of Rio's defensive takeover of the Alcan aluminium group last year.Its ability to service and repay that debt ($US9 billion is due to be paid next October) was weakening as the expanding economic downturn pulled commodity prices sharply lower. Rio has launched a $US10 billion asset sale program to reduce the debt load, but sales have stalled as buyers retreat in the face of the financial and economic crisis, and that problem would have been inherited by BHP. And the final competition regulator to review the deal, the European Commission, had also signalled that it needed major asset sales to clear the merger, including sales of significant lump iron ore production capacity in the Pilbara.BHP's initial belief this month was that it could frame a response that would satisfy the commission. But as the downturn intensified and commodity prices plunged, the list of potential buyers began to shrink.BHP needed to offer up asset sale remedies by the end of this week. If it had done so, and the commission had approved the deal on that basis, there would have been no going back.Even as things stand, there is a remote chance that the commission will clear the deal, even though BHP has decided not to offer up any asset sales. If it does, the deal must be put to shareholders, but BHP will recommend that they vote it down.The short-term market response might be positive for BHP, on relief that the takeover dice will not be rolled. It will be negative for Rio, which is likely to see a 20 per cent-plus takeover premium built into its shares evaporate.But BHP's quest for a union that would have created by far the world's largest resources group had significance that went beyond those two companies. It was a vote of confidence in the entire "stronger for longer" economic scenario that sees China's economic boom continuing through up and down cycles to power a long-term seller's market for all the major commodities. This retreat challenges that view, at least in the medium term. It is going to be difficult for the markets not to interpret BHP's expensive demobilisation as anything other than a call that the global economy is headed into a deep and protracted downturn: one that will generate significantly lower prices for a suite of commodities including oil, aluminium, copper, nickel, iron ore and coal than those that prevailed until the boom began to crack last year.If BHP's board believed that the global economy was capable of bouncing back quickly, then its original argument that BHP and Rio presented compelling merger potential would still stand.It doesn't - it has just told us so - and that sends a very challenging message.
© 2008 Sydney Morning Herald