BHP Billiton /Rio Tinto Merger: Is It Good for Shareholders?

“Broken Tinto” - that’s what one analyst suggests would be a good name for a combination of BHP Billiton Ltd. (BHP) and Rio Tinto PLC (RTP).

Already the world’s biggest mining and petroleum company with a market cap in the $180-billion range, Australia’s BHP would be better off on its own, says Tony Robson of BMO Capital Markets. He initiated coverage of the company with an “outperform” rating and a target of A$45 on Wednesday, but insisted that BHP is overpriced when compared to its peers and may fall if its takeover bid fails.

BMO joins RBC Capital Markets and Canaccord Adams as the Canadian firms that cover BHP, which launched the second-biggest takeover ever in February, when it was valued at nearly $150-billion. The merger would create one of the world’s largest companies with an estimated value of roughly $315-billion.

While prospects for wealth destruction remain, given the possibility of a higher bid for Rio, BHP shares are nonetheless attractive, Mr. Robson said in a report. He estimates the merged entity will make $33-billion in net profit in 2008/2009, and said BHP’s balance sheet will become stronger in the long-term, positioning the company for future “predatory actions” or a return of cash to shareholders.

The analyst suggested that a reasonable bid for Rio would be 2.32 BHP shares for every Rio share. The most recent offer was 3.4-for-1. But if you take into account $1.7-billion in annual synergies, BMO’s estimate rises to 2.55-for-1, or 2.73-for-1 with an additional US$2-billion of annual gains indicated by BHP’s extra output.

But BHP’s bid is destructive in terms of net present value [NPV] per share, earnings before interest, taxes, depreciation and amortization [EBITDA] and earnings per share [EPS] under a variety of commodity price scenarios, Mr. Robson said, adding that suggested synergies do not offset this dilution.

“BHP shareholders are missing out with the transfer of wealth to Rio,” he added. The analyst also thinks BHP shares could fall further if CEO Marius Kloppers raises the bid.

Meanwhile, Chinalco [Aluminum Corp. of China] (ACH) and Alcoa Inc. (AA), who jointly purchased a 9% stake in Rio, or 12% of its London-listed shares, for roughly $14-billion in February, may increase its stake.

At the same time, if Rio Tinto is broken up, Alcoa would likely be after Alcan’s (AL) smelters in Quebec, while Chinalco’s focus would be on things like base metals, alumina or coal, Mr. Robson suggested.

Comments

[gillyak:]

let me get this straight, one "analyst" suggests BHP should offer 2.32 shares for each share of Rio Tinto? That comes out to around $145/share with Rio trading currently trading all the way down to $386/share. But wait, BHP actually bid 3.4 shares of BHP for each share of Rio or $214/share. And Rio is earned $$22/share in 2007 and $34/share projected for 2008
Hello!? Am I or somebody else around here totally insane?

2008 Mar 21 11:35 AM

[goldlight1:]

I am rather naieve about take overs like this, what does this mean for BHP shareholders?? Is it time to sell? Anyone ???

2008 Mar 21 12:13 PM

[Theoldman59:]

The calculations are based on the London exchange. If you mix the ADR's on the American Exchange, the numbers are completely fouled up. If memory serves me correctly, the American ADR share for Rio is 4 London shares equals one New York Exchange share. I believe that BHP is one three London shares to one New York Exchange.

On Good Friday, the London prices are BHP 1361 pence and Rio was 4800 pence. That is a ratio of approximately 3.52 Rio shares to one BHP share.

I can't say whether it's a good buy for BHP or not, but use the London prices for comparison, not New York.

2008 Mar 21 11:46 PM

[gillyak:]

Thanks for the info Old Man. For some reason I thought this was an American site.

2008 Mar 23 11:46 AM

[jimmy46:]

bph adr = 2 London shares
if rtp adr = 4 "

then the ratio would be 6.8 bph adr's for 1 rtp for the merger

2008 Mar 24 03:33 PM

[OldMiner:]

With Chinalco telegraphing its next bite of Rio Tinto (with its lacky, Alcoa), the most logical move in this chess game is for BHP to buy Alcoa and edge Chinalco out of this cosy relationship. Once BHP is the majority stakeholder in the global aluminum market, Chinalco will be forced to partner with BHP to acquire and divide Rio to the benefit of both.

2008 Mar 25 12:12 PM