rio's trouble at the register

I plan to hold my riv shares for the moment, a few scenarios to play out before I off load to Rio...or sell on market, current sp $16.00

hcr

FYI Article in todays Business Spectator

Stephen Bartholomeusz

Published 12:16 PM, 2 Feb 2011


With a board recommendation in its back pocket and an acknowledgement from its most likely rival that it was out of the game Rio Tinto might have expected its path to control of Riversdale Mining to be smooth. It may yet be, but the $US3.9 billion offer has yet to develop any momentum and the peculiarities of Riversdale�s register means that its outcome remains uncertain.

When International Coal Ventures, a consortium of Indian state-owned steel and energy companies, disclosed a week ago that after seriously considering a counter-bid it had decided not to proceed, Rio presumably saw the outcome of the bid, with its minimum acceptance condition of 50.1 per cent, as a foregone conclusion.

Riversdale, which controls a vast but largely undeveloped coking coal resource in Mozambique, has, however, a rather tight share register. India�s Tata Steel holds 24.36 per cent of its capital and Brazil�s number two steelmaker, CSN 13 per cent.

A US hedge fund, Pass Port Capital, also owns about 13 per cent, but has given Rio a call option over 7.9 per cent as part of pre-bid arrangements that enabled Rio to put its foot on 15 per cent of Riversdale�s capital.

That means that 40 per cent of Riversdale�s capital is held by two shareholders that are on the register to protect their access to the output from Riversdale�s Zambeze project rather than as conventional shareholders seeking investment profits. Tata has described its stake as "strategic."

If Tata and CSN were to ignore the offer and sit on their shareholdings, Rio could still achieve its minimum acceptance condition and gain control � but it would need to attract acceptances from more than 83 per cent of the other shareholdings. If Passport were to use the apparent leverage provided by the nature of the other major shareholders to hold out for something better, Rio would need more than 90 per cent of all the other shares.

The degree of difficulty Rio faces in obtaining control without them means it is difficult for it to exert any pressure on Tata and CSN to sell some or all of their shares to it.

It is conceivable that Tata and/or CSN might be prepared to sell down sufficient shares to help Rio gain control without threatening the leverage their shareholdings give them to obtain off-take agreements. Rio would bring the depth of management and project expertise that will be required to develop the project.

They would presumably be aware, however, that they, too, have options and leverage. If they sit pat Rio�s bid might fail or Rio might end up alongside them as just another strategic but minority shareholder. Or they might be able to force Rio to bid against itself. In any event, at present they aren�t under any pressure to do anything.

Rio therefore faces a dilemma and a deadline of sorts. Under the pre-bid arrangements it can exercise the call options it has over the 15 per cent of capital and inject some momentum into an offer which has yet to attract acceptances on the latter of the 28th day of the offer period � 8 February � or the day on which it declares the offer unconditional. Until the offer is unconditional there is no incentive for any of the non-strategic shareholders to accept.

The dilemma is that if it were to declare the offer unconditional and Tata and CSN, and perhaps Passport, were to hold out, it would be outlaying a minimum of $US585 million of cash to exercise the call options, and probably significantly more as other shareholders accepted, with no guarantee it could achieve control.

An alternate tactic might be to lower the minimum acceptance condition to, say, 40 per cent, but that also wouldn�t guarantee control unless Tata and CSN were prepared to sell down some of their holdings and could mean Passport emerged with the decisive slice of the register, a position it would presumably seek to exploit. There is also the risk that an opportunistic investor decided to accumulate a similarly strategic stake, which would make the equations even tougher.

Rio would need to be careful in any discussions with Tata and CSN not to promise any special benefits to them. It is, however, conceivable that it could convince them that the Zambeze project, and their own interests, would be advantaged if it were in control of Riversdale.

It presumably would also be trying to calculate whether an increase in the offer price, the dropping of its minimum acceptance condition and the exercising of its options would ignite the offer and, if it looked likely that it would sneak over 50 per cent, give it some leverage over the steelmakers, which would have to contemplate being large locked-in minorities in a Rio-controlled vehicle. Rio would, in those circumstances, owe them no favours.

The Zambeze resource is highly strategic, given that it is a very large coking coal resource, close to India, which hasn�t been controlled by the dominant Australia producers, hence the interest the Indian state-owned enterprises showed in considering a counter-bid. Rio�s increasing closeness and relationships with China would be of concern to Tata and CSN, which wouldn�t want Zambeze�s output dedicated to Chinese mills.

That introduces an unpredictable element into their decision-making and into the outcome of a bid that conventionally would now roll smoothly into a successful outcome for Rio, which faces an interesting week as it considers its tactics as the offer moves towards its notional expiry next Tuesday.