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S P E C I A L R E P O R T

Rio Tinto (RIO)

What makes Rio Tinto so Why the fight for Rio
attractive? Tinto will continue?
Rio Tinto has come along way since a group of The price of anything comes
investors bought a single mine based on the down to supply and demand.
Rio Tinto river in Spain. 136 years later and
The world population grows by
after many mergers and acquisitions, Rio Tinto
another billion people every 11
is firmly placed as one of the world’s mining
years or so, which adds to the
giants.
demand for commodities. As
planet Earth is not getting
Rio has strong market positions in many of
any bigger, we are
the world’s key commodities. Based on last
gradually working
year’s production, Rio’s ranked first in the
our way through
world at bauxite, alumina and aluminium. It
the scarce supply
also ranked second in iron ore, third in
of natural
diamonds and uranium and fourth in copper.
resources. Despite
While Rio’s assets are spread throughout the these two facts, the price
world, 80% are located in just three countries – of commodities remained quite constrained
Australia, Canada and the US. This is an throughout the 1980s and 1990s.
important point. All three countries are However, this decade has seen a surge in
economically developed and politically stable, commodity prices. Why?
which means their transportation infrastructure
Firstly, a lot of the world’s population has been
and engineering capabilities are advanced.
living in relative poverty and so has not added
They also happen to be very large land masses,
very much to demand for commodities.
so there is plenty of potential for adding to
Secondly, improvements in technology have
future reserves. In summary, Rio Tinto is sat on
allowed miners to dig cheaper and deeper
a huge and high quality asset base.
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 Winner: Best Equity Derivatives
or gross negligence of Galvan Research And Trading, its employees, or which arises under the Financial Services Advisor, Best CFD Advisor
And Markets Act 2000.
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S P E C I A L R E P O R T

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.
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.

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.
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 Winner: Best Equity Derivatives
or gross negligence of Galvan Research And Trading, its employees, or which arises under the Financial Services Advisor, Best CFD Advisor
And Markets Act 2000.
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S P E C I A L R E P O R T

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 Winner: Best Equity Derivatives
or gross negligence of Galvan Research And Trading, its employees, or which arises under the Financial Services Advisor, Best CFD Advisor
And Markets Act 2000.
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S P E C I A L R E P O R T

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 Winner: Best Equity Derivatives
or gross negligence of Galvan Research And Trading, its employees, or which arises under the Financial Services Advisor, Best CFD Advisor
And Markets Act 2000.
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S P E C I A L R E P O R T

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 non-
core 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 Winner: Best Equity Derivatives
or gross negligence of Galvan Research And Trading, its employees, or which arises under the Financial Services Advisor, Best CFD Advisor
And Markets Act 2000.
 T: +44 (0) 1872 262620
F: +44 (0) 1872 265326
E: mail@galvan.co.uk
W: www.galvan.co.uk

S P E C I A L R E P O R T

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 Winner: Best Equity Derivatives
or gross negligence of Galvan Research And Trading, its employees, or which arises under the Financial Services Advisor, Best CFD Advisor
And Markets Act 2000.