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December 7, 2008

Diggers, dealers and doubt - recipe for disaster

The Doubt Virus strikes again... (a winding tale, you might want to skip over it)

On November 8, 2007 Australian (and Global) mining giant BHP Billiton announced that it was going to make a bid for smaller rival Rio Tinto. A later hostile bid valued Rio Tinto at US$147 Billion.

The miner rejected this price stating that it significantly undervalued their assets.

But there was obviously a lot more to it than that. Any fool with even a small exposure to the mining industry (such as me for example) could see that the merger / acquisition would significantly shift the axis of power in the mining world.

A combined company would be able to negotiate higher prices for commodities that it dominated. A priceless position. regardless of the current slump in metals demand, there is no doubt that the Chinese and Indian middle classes will not stop until they have achieved an adequate quality of life.

It would give them incredible leverage over costs as they merged shared services, and it would have given them the ability to leverage each others infrastructure assets. In fact, it would have formed a company that had a significant impact on the global economy.

It was a shareholders dream come true !!

Far more so than they can as two separate entities.

But doubt came seeping in. These are old, almost ancient, rivals. They have had many hard fought battles, and there were plenty of reasons for distrust.

Rio doubted the larger rivals ability in industrial relations, they had watched their unmitigated disaster at the now defunct HBI plant, and they distrusted them with the future of their company.

Consider this from Tom Albanese, Rio's chairman:
"We believe we have a better growth pipeline than our competitors, which puts Rio Tinto in a strong position to supply the metal-hungry world. We have the people, execution capability and resources to work smarter, faster and better than our competitors. We also believe our track record of delivery is unrivaled and we look forward with confidence to a hugely exciting future."
They embarked on program after program to dramatically increase shareholder value. $2.4 billion expansion programs for Iron Ore, they hedged their revenue bets on the "continuing strong demand for commodities". And they tried to sell off around US$15 billion in assets to reduce their growing mountain of debt.

But, nobody is buying the assets.

The "continuing strong demand for commodities" has ended abruptly.

And 11 days ago BHP Billiton surprisingly pulled its bid. Refusing to take on the debt burden of Rio Tinto at a time when debt is deadly.

Its stock value is about half what it was when this all started. It suddenly finds itself with debts of $US42 billion and a market capitalization of just $US35 billion.

At that price they are being picked apart by rivals. (Some of whom are state funded enterprises from nations whose governments don't exactly inspire trust.)

Oh yes, and the press is baying for blood at the Rio Tinto board room level.

The doubt virus continues its silent value destroying march...