Rio Tinto Group

Experts favour mainland bid for Rio but recommend prudence

PUBLISHED : Monday, 10 December, 2007, 12:00am
UPDATED : Monday, 10 December, 2007, 12:00am

The possible merger of the world's two iron-ore giants has sparked serious concerns among mainland officials and the steel industry. But the magnitude of such a deal and likely resistance from the international community would have made mainland firms hesitant on whether to launch a counter-bid.

State-owned media have repeatedly reported that Baosteel Group Corp, the country's top steelmaker, was planning to join a bidding war for Rio Tinto.

This was swiftly met by Baosteel's denial, as well as a similar response from China Investment Corp and China Development Bank, which were among those speculated to join the consortium.

Still, analysts have read the repeated reports as more than mere market speculation but a reflection that state-owned firms - backed by the country's burgeoning foreign reserves - are capable of paying a premium to BHP Billiton's over US$130 billion takeover bid for Rio.

Some suggested that the gesture may be a strategy to wreck BHP's takeover attempt while serving as a litmus test to see how Australia and other western countries would react to a Chinese takeover bid for resources on such a scale.

The government and the steel industry fear that a combined BHP-Rio tie-up would control almost half of Asia's trade in iron ore, a move that will create a cartel capable of controlling prices.

Opinions are mixed on whether Baosteel or a mainland consortium should make a counter-bid for Rio, with some urging prudence.

Helen Lau, an analyst at Daiwa Securities, said the mainland should proceed and not adopt a wait-and-see attitude. 'China is the only country with the necessity to launch such a deal, which is in the best interests of [its] steel industry,' she said.

With US$1.46 trillion in foreign reserves, only the mainland had the war chest to launch a bid, Ms Lau said. She said that mainland firms should follow what Japanese steelmakers did in the 1980s - buying stakes in overseas mining firms to secure raw materials for domestic development.

He Weida, of the University of Science and Technology Beijing's school of economics and management, also favoured a bid but called for patience to avoid raising acquisition costs. 'Baosteel alone does not have enough financial strength but it could form a consortium, and Beijing is highly likely to support the deal [through] loans,' he said.

Mainland firms could also join BHP's bid to buy a stake in Rio to have some say in the combined group, he suggested.

However, Zhao Zhicheng, an analyst at Essence Securities, said it was risky to buy Rio as iron ore prices were currently at their cyclical high. Prices have risen for five straight years on increased demand from the mainland - the world's largest steelmaker.

Australia's benchmark iron ore price, which does not include shipping and insurance costs, is US$51.47 a tonne. Cash prices are four times higher than contract prices because of rising shipping costs and demand. 'It is a very long cyclical industry, nobody knows whether iron ore contract prices might fall to US$15 a tonne in the future,' Mr Zhao said.

He said buying overseas mining companies was not the only option. Mainland companies could build steel mills in countries that have both raw materials supply and steel demand, citing the iron ore pellet plant in India and the steel plant in Brazil that Baosteel has started to build.

There are also concerns that a bid by Baosteel may spark political resistance from Australia and other western countries amid worries about a 'China threat'.

Another worry is that mainland companies lack the experience and expertise to manage multinationals. But Professor He and Ms Lau said consultants as well as local management and expertise could help in running the firm. Lenovo Group's purchase of IBM's personal computer unit and the localisation drive showed how a mainland firm could succeed in [becoming] a multinational company, Ms Lau said.

Essence Securities' Mr Zhao said mainland companies needed to build up experience and failure should not affect their 'going out' strategy.