Riot Into

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Rio Tinto (RIO) What makes Rio Tinto so attractive?

Why the fight for Rio Tinto will continue?

Rio Tinto has come along way since a group of investors bought a single mine based on the Rio Tinto river in Spain. 136 years later and after many mergers and acquisitions, Rio Tinto is firmly placed as one of the world’s mining giants.

The price of anything comes down to supply and demand.

Rio has strong market positions in many of the world’s key commodities. Based on last year’s production, Rio’s ranked first in the world at bauxite, alumina and aluminium. It also ranked second in iron ore, third in diamonds and uranium and fourth in copper. While Rio’s assets are spread throughout the world, 80% are located in just three countries – Australia, Canada and the US. This is an important point. All three countries are economically developed and politically stable, which means their transportation infrastructure and engineering capabilities are advanced. They also happen to be very large land masses, so there is plenty of potential for adding to future reserves. In summary, Rio Tinto is sat on a huge and high quality asset base.

The world population grows by another billion people every 11 years or so, which adds to the demand for commodities. As planet Earth is not getting any bigger, we are gradually working our way through the scarce supply of natural resources. Despite these two facts, the price of commodities remained quite constrained throughout the 1980s and 1990s. However, this decade has seen a surge in commodity prices. Why? Firstly, a lot of the world’s population has been living in relative poverty and so has not added very much to demand for commodities. Secondly, improvements in technology have allowed miners to dig cheaper and deeper allowing supply to keep pace with demand.

Galvan Research and Trading, CMA House, Newham Road, Truro, Cornwall, TR1 2SU Risk Warning Notice: Galvan Research And Trading Ltd is authorised and regulated by the Financial Services Authority (FSA). Whilst every attempt is made to ensure the accuracy of the information provided, no responsibility can be accepted for any inaccuracy. The information provided cannot be relied upon as constituting a recommendation, nor construed as any offer to sell, or any solicitation of any offer to buy investments. No liability is accepted for any loss whether direct or indirect, incidental or consequential, arising out of any of the information being untrue and / or inaccurate, except to the extent caused by the wilful default or gross negligence of Galvan Research And Trading, its employees, or which arises under the Financial Services And Markets Act 2000.

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Rio Tinto (RIO) Globalisation of world trade has allowed China and India (as well as many other emerging markets) to begin the process of industrialisation. Millions of people have laid down their farming tools and headed off to cities looking for work in factories. Big Western companies have set up factories in these cheap locations and end up producing more for less.

Inflation rates have fallen around the world as we have gobbled up the cheap imported goods. But the next step was inevitable. All the new jobs created in countries such as China and India have started to leave the locals with more money in their back pocket. They can now afford to buy more and want to live the way we do in the West. Globalisation is becoming a victim of its own success. The rise of international trade has indeed raised living standards. One clear side effect is a surge in demand for commodities and this time supply hasn’t been able to cope. Commodity bulls believe we have entered a commodity super-cycle, or a long period of price rises to you and me. What we do know is that the incremental demand for commodities has largely come from emerging economies, in particular China.

Even more important is that the transformation of China from Communism to Capitalism is still in its early stages. In the next 25 years, it has been predicted that as many as 350 million Chinese are going to move from the countryside to the cities. That’s around the entire population of Europe.

While near term demand has clearly taken a big knock due to the global recession, it will bounce back with a vengeance sooner rather than later. With interest rates almost zero in most major economies and Central banks flooding the credit markets with easy money, inflation is a certainty. Commodity prices react very well to inflation.

China – cash rich but resource light China in particular, has plenty of cash in the kitty and would much prefer to buy strategic assets such as resource-rich miners than throw billions at bloated banks. The problem for China is that its rapid economic development is dependent on being able to import raw materials. To secure its future, its government and agencies need to secure supply.

Galvan Research and Trading, CMA House, Newham Road, Truro, Cornwall, TR1 2SU Risk Warning Notice: Galvan Research And Trading Ltd is authorised and regulated by the Financial Services Authority (FSA). Whilst every attempt is made to ensure the accuracy of the information provided, no responsibility can be accepted for any inaccuracy. The information provided cannot be relied upon as constituting a recommendation, nor construed as any offer to sell, or any solicitation of any offer to buy investments. No liability is accepted for any loss whether direct or indirect, incidental or consequential, arising out of any of the information being untrue and / or inaccurate, except to the extent caused by the wilful default or gross negligence of Galvan Research And Trading, its employees, or which arises under the Financial Services And Markets Act 2000.

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Rio Tinto (RIO) One of the most important commodities is iron ore and 70% of production is controlled by three miners – Vale (of Brazil), Rio Tinto and BHP Billiton. Most other key commodities, such as oil, copper, aluminium and gold, are bought and sold on exchanges as there are plenty of buyers and sellers. Not so for iron ore. For nearly 40 years the price of iron ore has been negotiated over the table between the big miners and the steelmakers. This annual event has always caused a degree of tension.

The Japanese and Chinese steelmakers need bulk supplies and only a shrinking pool of industry giants can provide it. The Chinese were so alarmed by BHP’s proposed takeover of Rio that they stepped into the market and bought a 9% stake in Rio back in early 2008. They already felt vulnerable with just three major iron ore producers, so the thought of having just two to choose from was terrifying. BHP and China were locked in a battle for Rio, but a third force emerged that ended the war – the credit crunch.

Don’t mention Plan B Rio is still fighting its way back after the poorly timed acquisition of Alcan. It agreed a bumper

price of $38 billion for Alcan at the height of the commodities boom in 2007. What’s worse, it paid for the deal by simply issuing more debt. Rio had hoped to sell a bunch of non-core assets shortly after the deal to reduce the mountain of debt. However the financial crisis hit asset prices hard. It was ironic that Rio was stuck with a debt burden of around $38 billion, the price it paid for Alcan. BHP decided to give up the fight for Rio as it got scared off by Rio’s debt. “It is just not the right time to be taking on the debt that is on Rio’s balance sheet,” Marius Kloppers, CEO of BHP Billiton said as he threw in the towel. With Rio’s disposal programme looking in serious doubt, the credit rating agencies were getting nervous. A combination of plummeting commodity prices and a huge debt burden was destroying Rio’s share price. The more the share price fell, the more difficult it would be to launch a rights issue. In the end, Rio had little choice but to approach their not-so-secret admirer – the Chinese. You can imagine Chinalco’s delight to receive the call for help. Not only had BHP walked away from a proposed merger with Rio, now Rio wanted Chinalco to increase its stake.

Galvan Research and Trading, CMA House, Newham Road, Truro, Cornwall, TR1 2SU Risk Warning Notice: Galvan Research And Trading Ltd is authorised and regulated by the Financial Services Authority (FSA). Whilst every attempt is made to ensure the accuracy of the information provided, no responsibility can be accepted for any inaccuracy. The information provided cannot be relied upon as constituting a recommendation, nor construed as any offer to sell, or any solicitation of any offer to buy investments. No liability is accepted for any loss whether direct or indirect, incidental or consequential, arising out of any of the information being untrue and / or inaccurate, except to the extent caused by the wilful default or gross negligence of Galvan Research And Trading, its employees, or which arises under the Financial Services And Markets Act 2000.

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Rio Tinto (RIO) Chinalco agreed to pump $19 billion into Rio in return for stakes in various key assets and convertible notes. It would give Chinalco plenty of power to block any future bids for its beloved Rio. The reaction elsewhere was not pleasant. In Australia there was political outrage given that a chunk of the country's best assets were being handed to the Chinese. In the UK, shareholders felt they should be offered a rights issue first (known as pre-emption rights). Rio’s Board of Directors weren’t in agreement on the deal either. In fact, the newly proposed Chairman, Jim Leng, decided to resign from the Board after just one meeting. Investor’s and government’s began to mount pressure on CEO, Tom Albanese to come up with another option. The new Chairman Jan du Plessis offered the CEO his support “I do not like referring to a ‘Plan B’, we continue to be committed to Chinalco.” He was about to look rather silly. When the stock market and commodity prices lifted in the spring, Rio started to see the light. They tested the water with a $3.5 billion bond issue and the credit markets snapped it all up at a modest interest rate.

Rio took the hint that the capital markets had re-opened for business. It was time to give Chinalco the flick. Rio launched a massive $15.2 billion rights issue priced at £14 a share. This time it was China’s turn to be outraged. The snub fuelled memories of Unocal. Just to recap, back in 2005 the US congress rejected a Chinese company from bidding for US oil company Unocal on grounds of its strategic importance. A few months later, Unocal merged with American oil company Chevron at a lower price that the Chinese offered. The message to China was clear. We are happy for you to keep funding our trade deficit by buying billions in US Treasuries, but hands off our assets. Now the UK and Australia were sending the Chinese the same message.

Despite the loss of face, Chinalco humbly snapped up its share of the rights issue. You can imagine it was done with gritted teeth, but it shows just how important Rio Tinto is as a strategic asset.

Galvan Research and Trading, CMA House, Newham Road, Truro, Cornwall, TR1 2SU Risk Warning Notice: Galvan Research And Trading Ltd is authorised and regulated by the Financial Services Authority (FSA). Whilst every attempt is made to ensure the accuracy of the information provided, no responsibility can be accepted for any inaccuracy. The information provided cannot be relied upon as constituting a recommendation, nor construed as any offer to sell, or any solicitation of any offer to buy investments. No liability is accepted for any loss whether direct or indirect, incidental or consequential, arising out of any of the information being untrue and / or inaccurate, except to the extent caused by the wilful default or gross negligence of Galvan Research And Trading, its employees, or which arises under the Financial Services And Markets Act 2000.

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Rio Tinto (RIO) How financially sound is Rio Tinto? Rio's rights issue has been a resounding success, having received around a 97% take up of the rights. The recent $1.2billion sale of Alcan's American food packaging arm brings the total raised from asset sales this year to $3.7billion. Other noncore assets are up for sale that may fetch another $2 billion or so. Combined with the rights issue, this would mean Rio would have raised over $20 billion, which was the magic number that was up for refinancing.

Our view is that Rio has now got itself back on firm financial footing. The market will start to shift its focus away from balance sheet concerns and look more closely at its underlying assets. To get the most from mining assets usually involves investment upfront. Rio is in a much better position to do this now.

Rio’s new best friend Rio and BHPs plan to join their massive iron ore operations in Western Australia has caused quite a stir. Only last year they were sworn

enemies. It’s been estimated the joint venture would supply up to 75% of China's iron-ore imports and 70% of global seaborne iron ore trade. Chinese and Japanese steelmakers are howling with protest. As if Rio hadn’t insulted the Chinese enough recently. It goes with saying that regulators are looking into the deal. Rio and BHP claim it’s all about cost savings – some $10 billion in fact. The two companies claim they will sell their iron ore separately. The regulators have yet to approve the deal, but should it get the go ahead, Rio will be able to redirect the cost savings to help drive growth. It’s a potential catalyst to drive the shares higher, but regulators don’t tend to make decisions quickly.

What are the shares really worth? Near term we believe the shares can reach £20£21 on the back of recent positive news flow (rights issue, asset sales, BHP deal). The skirmish with the Chinese over this year’s iron ore price is holding back the shares. The arrest of Rio staff in China is the latest twist in the ongoing negotiations. An amicable resolution and removal of uncertainty could well push the shares higher near term.

Galvan Research and Trading, CMA House, Newham Road, Truro, Cornwall, TR1 2SU Risk Warning Notice: Galvan Research And Trading Ltd is authorised and regulated by the Financial Services Authority (FSA). Whilst every attempt is made to ensure the accuracy of the information provided, no responsibility can be accepted for any inaccuracy. The information provided cannot be relied upon as constituting a recommendation, nor construed as any offer to sell, or any solicitation of any offer to buy investments. No liability is accepted for any loss whether direct or indirect, incidental or consequential, arising out of any of the information being untrue and / or inaccurate, except to the extent caused by the wilful default or gross negligence of Galvan Research And Trading, its employees, or which arises under the Financial Services And Markets Act 2000.

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Rio Tinto (RIO) The value of mining companies, such as Rio, fluctuates over the short term with the movements in commodity prices. But this is a short sighted view. The long term assumptions on commodity prices will have a much bigger bearing on the value of mining companies.

Our medium term outlook for commodity prices is very bullish based primarily on the rising prosperity of emerging markets and the unprecedented inflationary policies being pursued by the world’s major governments. We do not see technological breakthroughs being able to overcome the demand side pressures. On this basis, we expect the share price to gradually return to the £40 pre-Billiton bid levels. A move back to the £70 level looks at least three years away and would obviously require a strong recovery in commodity prices or renewed bid interest.

Galvan Research and Trading, CMA House, Newham Road, Truro, Cornwall, TR1 2SU Risk Warning Notice: Galvan Research And Trading Ltd is authorised and regulated by the Financial Services Authority (FSA). Whilst every attempt is made to ensure the accuracy of the information provided, no responsibility can be accepted for any inaccuracy. The information provided cannot be relied upon as constituting a recommendation, nor construed as any offer to sell, or any solicitation of any offer to buy investments. No liability is accepted for any loss whether direct or indirect, incidental or consequential, arising out of any of the information being untrue and / or inaccurate, except to the extent caused by the wilful default or gross negligence of Galvan Research And Trading, its employees, or which arises under the Financial Services And Markets Act 2000.

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