kohler's view

Alan kohlers view below. The debt compared to its market cap scares is worrisome. Could shorters really jump on this?

Alan Kohler
Throwing Rio to the bears

Two things will reverberate long after the shock of BHP Billiton’s withdrawal of its bid for Rio Tinto has passed:

1. It is clear that BHP has changed its view about commodity prices from positive to negative – it now believes they will fall further;

2. Rio Tinto is overvalued and set to decline further than it has already today. It is certainly not a buy yet.

At today’s share price, Rio has a market capitalisation of $US35 billion and debt of $US39 billion – an enterprise value of $US74 billion.

BHP has an enterprise value of $US80 billion but its profit is 50 per cent larger than Rio’s and both its risk and project profile are superior.

And not only has Rio’s share price has been propped up the BHP bid, but so has its credit rating; it is now likely that both Standard and Poor’s and Moody’s will reduce its rating, possibly by two notches.

The refusal of Rio chairman Paul Skinner to engage with his counterpart at BHP, Don Argus, twice last year and instead choosing to buy Alcan with debt at the top of the market now looks like one of the most disastrous miscalculations ever made by a company chairman.

And it was capped off by Rio’s failure to sell the engineering and packaging divisions of Alcan, as planned, to reduce debt by $US10 billion.

Of course it is easy in hindsight to second these things, and Skinner and his CEO Tom Albanese naturally had robustly optimistic view of their company – especially in relation to their rivals at BHP.

But now they are facing a very difficult future, especially if BHP is right about commodity prices.

They must deal with falling cash flows from operations, an impossible environment in which to sell assets and too much debt.

What’s more, they seem to be stuck with an engineering and packaging business that employs 75,000 people under a defined benefit pension plan in a falling market. The Alcan pension liabilities could actually blow out horrendously.

BHP on the other hand now goes into a cheap asset cycle with low gearing.


Disclaimer: Alan Kohler owns BHP shares