11 December 2008
Rio Tinto did what it could yesterday to assure investors that it can turn its wagon around and drive out of the box canyon it finds itself in, but more details are needed before investors can be sure the plan will work as designed. The sweeping spending cuts, project cancellations, deferrals and asset sales Rio says will cut its debt load by $US10 billion ($15 billion) or 25 per cent by the end of next year are all in the mail, undelivered.
And one of the reasons Rio is cutting so hard now is that it failed this year to sell $US10 billion of surplus assets out of Alcan, which it bought with debt at the top of the market for $US38 billion a year and half ago.It failed to sell the Alcan assets because, in chief executive Tom Albanese's words yesterday, the world has changed: the financial markets crisis has spawned an economic downturn in the western world that has undermined exports from China and other industrialising nations, pulling down on their above-average growth, and interrupting the "stronger for longer" scenario that saw China underpinning elevated commodity prices for the foreseeable future.The same combination of sharply lower commodity prices and distressed debt markets has also dramatically culled the number of prospective buyers of resources projects and undeveloped prospects, and cut the sale price of assets that can be moved, often to levels that only a distressed seller would accept.Rio says now that the portfolio of assets it is targeting for sale has been widened.That drives home that the company owns some of the best resources assets in the world, and can, if pushed, hit its $US10 billion debt reduction target by selling them. But it also raises the disturbing prospect that in a market where buyers are scarce it may actually need to cut into its asset A list.By not unequivocally ruling out an equity raising, Rio also failed to answer a critical question that is hanging over it and its share price, which has fallen by 76 per cent since it peaked in mid May this year as BHP Billiton pursued its hostile takeover offer, and by 41 per cent in the fortnight since BHP abandoned its quest (BHP in contrast has been rewarded for quitting: Its shares are up almost 16 per cent since it scrapped the Rio offer, and have fallen by only 24.3 per cent this year).Asked about the chances of a share issue, Tom Albanese said yesterday that Rio had conducted a thorough review of its position and the external environment, had carefully canvassed its options, and on the basis of the review and the plan of action it had announced "we do not have any current need to raise equity".The qualifier of course is the word "current". Another way to put it is to say that if Rio's plans to slash capital expenditure and operational expenditure and sell assets do pan out as expected, a share issue will be avoided. If the plan falls short - and it is the asset sale outcomes that Rio has the least control over - then the odds on a share issue shorten.Absent a renegotiation and extension of the $US38 billion debt load that Rio took on when it bought Alcan, there was not much more Albanese could say. In this stressed environment even the renegotiation of the $US8.9 billion that is due to be repaid by Rio in October next year and the $US10 billion tranche that is due in October 2010 would have been prohibitively large, and extremely expensive.Rio's inability to totally rule out a share issue does mean, however, that the group's shares will continue to bear the weight of speculation that a discounted share issue is on the radar.A rare and venal combination of factors have brought Rio to this point.There is the market crisis and the economic downturn, its spread into the crucial China market and the slide in commodity prices this year - a slide that has outstripped the one that accompanied the Great Depression.They are factors that Rio's competitors are dealing with, too, but there are others that are entirely of Rio's making. In order to ignore the BHP offer, Rio needed to sell its own growth prospects. Now, it must dismantle the rhetoric and reach within itself to find $US10 billion within a year for debt repayment.Rio is a business of extreme quality. The question is what route it takes to the $US10 billion, and what the cost is to the group's momentum and strategic direction.