Published in the June 2007 Australia’s Mining Monthly

Imagine a possible future. It is June 2008 and there is no more BHP Billiton and no more Rio Tinto. What became of these mining giants? BHP got together with Rio Tinto and created a behemoth called BHP Tinto, an entity with a market capitalisation of more than $US250 billion.

At that size BHP Tinto was still adrift of the larger global companies such as Exxon Mobil at more than $US450 billion, GE at more than $US380 billion and Microsoft at more than $US300 billion – but considerably bigger than its fellow global miners. The largest of those, CVRD and Anglo American, had market caps below $US100 billion and Xstrata’s market cap was about $US50 billion.

However, not long after BHP and Rio got together a US private equity firm swooped and picked up the combined miner.

That buyer reaped the benefit of the huge economies of scale of the global mega miner. According to UBS there were also the benefits of several jointly held assets such as Escondida and Resolution. That is not to mention the iron ore synergies that could come from merging the two companies’ landholdings and infrastructure in Western Australia’s Pilbara.

Both companies had a similar plan, which is to focus on long-life, low cost assets that enable more stability through a cycle. UBS reckoned both companies would dominate the lower end of the cost curve for iron ore, alumina, coking coal and copper. Indeed, as a merged entity the two companies would reap considerable cost benefits.

According to a UBS research note synergies could add upwards of $US2 billion in annual cost savings.

“We would expect there to be significant cost synergies between BHP and Rio, particularly with the elimination of head office expenses and duplication with the business units,” it says. “We note that when BHP merged with Billiton the combined entity looked for $US270 million in merger synergies, which represented 2% of their cost base; and a further $US500 million in cost savings through operating excellence, portfolio mix and strategic sourcing.”

JB Were reckons the combined entity will boast earnings of $US16.9 billion in 2008.

There was the usual sabre rattling from Treasurer Peter Costello – yes the Liberal Party won the election and John Howard decided to stay on – but the decision by BHP Tinto to keep its head office in Melbourne helped assuage those concerns.

There were also surprisingly few anti-trust concerns given the location of most of BHP Tinto’s assets and customers. As UBS predicted, the combined market share in iron ore was 41%, just a tick above CVRD at 38%.

However, China was not happy, given the new entity has become such a powerhouse in terms of iron, coal and copper – all commodities China needs in abundance. Being the biggest fish in the pond means BHP Tinto has greater pricing power with customers and suppliers alike. It remains to be seen what China’s next move will be but the Asian nation has been muttering darkly about unfairly high commodity prices for some time.

All eyes are on BHP Tinto’s next steps with its private equity owner. Will the owner strip the company and sell it off, reaping a potential 30% or more return, or will it look for other acquisitions to bolt on first.

Watching the outcome with interest and not a little trepidation were the small suppliers to the mining sector who often seem to be squeezed out when a major player takes over a smaller one.

Fortunately for them the merger was at the top end of the market, leaving plenty of mid-tier and junior players looking for their services to take advantage of the mining boom that looks likely to stretch to at least 2020 based on China’s growth and India’s increasing demand for mining services. Providing no mid-tier players such as Straits Resources, Oxiana, Consolidated Minerals or Mincor are gobbled up they should be happy.

Back to reality

Okay, this is all purely speculation but there have been rumours circulating in the market that BHP and Rio were going to get together, either through BHP making a takeover bid for Rio or through a merger. There have also been suggestions that the private equity sector could gobble up BHP, which holds a market capitalisation of a little more than $US150 billion.

One thing that has perhaps scotched any play for Rio has been the appointment of Marius Kloppers as managing director Chip Goodyear’s replacement when Goodyear finishes with BHP in September.

If BHP was to merge with Rio some analysts felt Rio chief Tom Albanese would be offered the CEO’s position, just as Brian Gilbertson was when BHP merged with Billiton in 2001.

The takeover/merger talk certainly boosted Rio Tinto’s share price, which had been sitting at $US81.15 at the close of trading on May 1 and leapt to $97 a little more than a week later. At press time Rio’s shares were still close to the $97 mark.

The rapid price jump led to the inevitable “please explain” from the Australian Stock Exchange that provided the clearest indication that there were no takeover talks underway.

Rio clearly stated: “Rio Tinto is not aware of any takeover approach from BHP Billiton Limited” in answer to the ASX’s query. BHP, not surprisingly, chose to make no comment to the ASX on the rumours.

At a recent business breakfast in Perth, Goodyear played a straight bat to market speculation reportedly saying the company looked at everything “whether that is Rio Tinto or anybody else out there. That is our job.”

However, as Stock Resource co-founder Stephen Bartrop pointed out, while Rio definitively said there was no takeover, it did not rule out a merger.

“There was a denial of a takeover [by Rio] but no denial of a merger,” Bartrop said.

He said the recent appointment of Kloppers probably ruled out the merger option.

Bartrop also expects that the anti-trust dogs will remain silent.

“Historically you wouldn’t have been able to pull off a merger like this because of anti-trust issues,” he said. “But you now have CVRD doing it, Brian Gilbertson with Rusal doing it and Xstrata doing it.”

Bartrop also sees a number of benefits from the two global miners getting together. “They’ve already shown synergies in the Pilbara,” he said. “Then you have the Hunter Valley thermal coal with Rio Tinto and BHP’s coking coal in the Bowen Basin. Getting those together made a lot of sense to us.”

Bartrop suggested that the takeover/merger talk might have been Rio’s way of...click here to read on.