Kloppers Lets Rio Do All The Talking - For Bhp

Sydney Morning Herald

Friday June 6, 2008

Malcolm Maiden

Marius Kloppers got on his feet in Melbourne yesterday and said as little about BHP's bid for Rio Tinto as possible, which is the way he and his advisers want to keep it for the moment. With BHP's first formal submission seeking clearance for a takeover now in front of Europe's Competition Commission, and the value of its share-exchange offering sitting about 8 per cent above Rio's share price, the reality is the less the mining behemoth says for the moment, the better.

Kloppers didn't entirely avoid the subject, though. After the formal address, he basically rejected suggestions that BHP was angling for quick anti-trust approval by offering up pre-emptive asset sale remedies in the first, one-month phase of the European review, saying BHP's proposition from the outset has been that a BHP-Rio merger will actually assist consumers, by bringing commodities to the market more quickly, and in higher volumes.

Asked about the specific rumour that BHP had offered to spin off Rio's Robe River iron ore business in the Pilbara to get the deal cleared quickly, he said his previous comments stood, adding that BHP had "every expectation" that after a month the European Commission would initiate the more detailed second phase of its investigation. Stage two examinations usually take several months, and any asset disposals tend to be offered up towards the end.

And he once again deployed BHP's passive resistance tactic in response to Rio's attempts to pump up investor perceptions of its growth options, and its value, most recently in a big presentation last week by its chief executive, Tom Albanese, chief financial officer, Guy Elliott, and its other top lieutenants.

Rio's presentation went something like this: the industrialisation of China and other emerging new powerhouses, including India, is fundamentally changing the commodities supply demand equation and the economics of highest quality, or Tier One, mineral deposits.

Before the commodities boom, supply continually threatened to overwhelm demand that was fairly sedately expanding. Low-cost, high-volume Tier One mines could be brought on stream, and were - but they created room for themselves by delivering commodities cheaper, and rendering the most expensive producers uneconomic. Elliott described it as a zero-sum game, in which new high-quality production exerted downward pressure on prices, and the value of large, long-life high-quality reserves was accordingly undervalued.

In the new era, demand is outstripping supply, and is likely to continue doing so for years. In that environment, it is the higher-cost producers that are setting price levels, and the profitability of long-life, lower-cost production has soared.

The thrust of Rio's argument is that the new environment should not only be reflected in a higher base value for its Tier One assets, iron ore and aluminium, for example, but in a higher valuation of their reserves, to reflect Rio's enhanced ability to control the rate at which it taps them.

Kung Fu fighters are told to avoid resisting force that is directed towards them and instead co-opt it and turn it to their advantage, and that is the tactic that BHP is deploying on Rio's argument.

Its mantra is that anything Rio says about value applies equally or more so to BHP itself - and Kloppers stayed on message yesterday, saying in his speech that since the BHP-Billiton merger in 2001 the group had focused consistently on "large, low-cost, expandable, export-oriented Tier One assets," and adding: "the real value of Tier One assets is exposed during times of high prices, such as now, when they can be expanded as needed to meet increased demand."

That was an epitome of the argument Rio put at length a week earlier, and Kloppers expanded on it during question time, saying Rio's presentation had helped people "understand what the value of Tier One assets is ... and we would always say that we have got the most Tier One assets with the most expansion opportunities."

It is on that point that Rio and BHP have some room for debate. BHP believes Rio overpaid for Alcan last year, for example, and thinks some of the prospects Rio is promoting including the Simandou iron ore prospect in Guinea are embryonic and over-hyped.

Rio believes that very high oil prices are masking structural weaknesses in BHP's petroleum division, queries the cost-benefit equation of BHP's planned open-cut Olympic Dam copper-gold- uranium mine expansion in South Australia, and claims BHP's Pilbara iron ore expansion options are tougher.

Measured for underlying earnings before interest, tax, depreciation and amortisation as a percentage of revenue, BHP's petroleum division starred for the group last year, with a return of 75 per cent, ahead of base metals (70 per cent), stainless steel materials (52 per cent), iron ore (52 per cent), and aluminium (43 per cent ).

But cash flow margin analysis, which includes capital expenditure and royalty taxes, produces a different picture, with BHP Petroleum returning an average of 13 per cent in the five years to June 30 last year, slightly below an average cash margin of 15 per cent for BHP's other, mining, divisions, and 16 per cent for Rio over the same period.

The super high oil price is a remedy, of course: even after falling from last month's high of $US135 a barrel, oil is still almost 23 per cent higher than it was at the end of last year.

The Maiden family owns BHP shares.

mmaiden@theage.com.au

© 2008 Sydney Morning Herald

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