Feb. 13 (Bloomberg) -- Rio Tinto Group shares fell and debt default risk jumped after the world’s third-largest mining company agreed to a $19.5 billion investment by its largest shareholder Aluminum Corp. of China.

“We don’t like this deal,” Goldman Sachs JBWere Pty analysts led by Neil Goodwill said in a report dated yesterday. “Rio is still in a weak position in terms of its balance sheet and would be unable to easily participate in expansions, acquisitions or increase dividend payments for some time.”

The deal gives Aluminum Corp., known as Chinalco, stakes in some of Rio’s biggest mines, sparking a rally in shares of the Chinese company’s listed unit. London-based Rio struck the deal with the state-owned company to reduce $38.9 billion of debt incurred when it bought Alcan Inc. before rejecting a $66 billion hostile takeover bid from BHP Billiton Ltd.

“The board painted themselves into a corner to do this deal just to show the Alcan deal wasn’t a turkey,” said Hugh Dive, who helps manage the equivalent of about $3 billion at Investors Mutual Ltd. “We haven’t worked out exactly how we’ll vote but I’ve got a pretty good idea it won’t be in a positive fashion.”

Rio Tinto, traded in Australia and London, dropped 1.9 percent to A$51 at the close of Sydney trading at 4:10 p.m. local time. Contracts protecting Rio Tinto’s bonds for five years from default jumped 25 basis points to 560, according to Citigroup Inc. prices.

Shares in Chalco, as Chinalco’s listed unit is known, climbed 7.3 percent to 11.26 yuan at 1:46 p.m. in Shanghai. The agreement with Chinalco needs the support of Rio shareholders as well as approval from Australia’s government to proceed.

Modest Premium

The market “may be disappointed by the modest premium” paid for Rio’s assets, UBS AG analysts led by Glyn Lawcock said in a report yesterday. “Management had other options in our view,” he said.

Rio shareholders would have preferred a rights issue for all holders, Investors Mutual’s Dive said. Rio chairman-elect Jim Leng resigned this week after being the only board member to oppose the deal, Chairman Paul Skinner said yesterday.

Chinalco will buy $7.2 billion of convertible bonds and acquire stakes in projects for $12.3 billion in Australia, the U.S. and Chile. Chinalco’s proposal was “far superior” to other options Rio’s board had considered and represented “better value” than BHP’s takeover offer, Rio Chief Executive Officer Tom Albanese said yesterday.

“This deal is not the perfect deal. BHP was the perfect deal,” said Michael McCormick, who helps manage A$120 million at Leyland Private Asset Management. “It has given Rio an insurance policy for the next six to twelve months.”

Escondida Expensive

Chinalco paid $3.4 billion for 49.8 percent of Rio’s 30 percent stake in the Escondida copper mine in Chile, the world’s biggest producer of the metal. That’s 54 percent more than Goldman’s estimated value of the asset, according to the report.

“There is no doubt Chinalco had to pay a higher price to beat out BHP,” which had a pre-emptive right over the Escondida stake, said McCormick from Sydney today. He says Rio shareholders should withhold judgment on the Chinalco deal until it has approval from Australian Treasurer Wayne Swan.

Goldman Sachs JBWere, the Australian affiliate of the U.S. broking firm, has a “hold” recommendation on Rio Tinto, saying, “there is value in the asset base even if the strategic position of the company is irreversibly damaged in its current form.”

Goldman advised BHP on its failed bid for Rio Tinto.

Credit-default swaps pay the buyer face value if a company defaults in exchange for the underlying securities or the cash equivalent. A basis point on a credit-default swap contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.

To contact the reporter on this story: Rebecca Keenan in Melbourne at rkeenan5@bloomberg.net

Last Updated: February 13, 2009 00:49 EST