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Why Chinalco's Buying Into Rio Tinto

The Chinese giant's new stake in the mining outfit is seen as Beijing's attempt to head off a BHP Billiton takeover, to protect the mainland's supply of ores

Aluminum Corp. of China (Chinalco) (ACH) is a behemoth. Founded in 2001 in Beijing, it now has more than 200,000 employees, with 25 subsidiary companies. In 2007 it expanded its overseas investment into Australia, Peru, and Vietnam. And its Hong Kong-listed company has a market cap of $20.2 billion. Its revenues grew 24.1% to $18 billion last year, while profits reached $2.78 billion. Now Chinalco has set a new record for cash-flush China: The company, majority-controlled by the Chinese government, teamed up with Pittsburgh-based Alcoa (AA) on Feb. 1 to spend $14 billion for a 9% stake in Anglo-Australian iron ore producer Rio Tinto (RTP), making the largest overseas purchase by a Chinese company ever. Beijing-based Chinalco put up the lion's share, with Alcoa just pitching in $1.2 billion. The two paid $117.97 a share, a 21% premium over Rio's closing price the previous day.

Within China, there is plenty of speculation that Beijing had a hand in the Chinalco-Rio deal, which has cast uncertainty over Anglo-Australian resources giant BHP Billiton's plan to complete a hostile takeover of Rio Tinto for $100 billion. BHP must make a formal offer by Feb. 6 or withdraw its bid for at least six months (, 2/1/08). The assumption among some observers is that China is raising a warning flag to alert BHP that any move to take over Rio will not go unchallenged. "From what we understand, [Chinalco] is representing the Chinese government in this deal," says Ren Baifeng, an analyst with Antaike, a market research firm focused on the metals industry. "Two Fridays ago, there was word that Rio Tinto's management was secretly in Beijing for talks about this deal," he adds.

Protecting China's Steel Industry

Chinalco insists that it is not acting on behalf of the Chinese government. The company has strongly denied unconfirmed reports over the past few days that China's sovereign wealth fund, China Investment Corp., has assembled a $120 billion war chest for Chinalco to use in blocking any possible BHP bid for Rio Tinto. Speaking to reporters in Australia, Chinalco chief Xiao Yaqing said Feb. 4 that the investment in Rio was "entirely Chinalco's own" decision. Xiao met Feb. 5 with Australian government officials to reassure them about the deal.

Regardless of Xiao's denials, there is little doubt that Beijing has a strong interest in preventing a BHP-Rio Tinto deal, which was first proposed last November. If a merger were to go through it would create the largest single producer of iron ore, as well as of aluminum and other resources. The new company would have immense pricing power, potentially raising costs for Chinese steel producers such as Shanghai-based Baoshan Iron & Steel. This in turn could push up costs for a wide range of Chinese companies, from automakers to construction outfits, and have a significant impact on the overall Chinese economy, which already is struggling with an inflation rate that hit 6.5% in December.

By bringing Alcoa into the deal, the Chinese may be trying to prevent a protectionist backlash against Beijing. China certainly would like to avoid a repeat of the reaction that scuppered China oil and gas player CNOOC's (CEO) attempt to purchase Unocal in 2005 for $18.5 billion, when congressional critics claimed the purchase of the U.S.'s sixth-largest petro player by a Chinese state-controlled entity was a threat to U.S. strategic interests. San Ramon (Calif.)-based Chevron (CVX) ultimately prevailed, buying Unocal for less than CNOOC had offered.

Steadying the Supply of Resources

The Chinalco purchase is just one of a flurry of deals by Chinese companies buying resources overseas. Companies are buying because they want to lock in a stable supply of raw materials needed to fuel China's high-powered growth. Beijing, meanwhile, is encouraging this overseas shopping spree to help reduce its excessive foreign exchange reserves, which are $1.5 trillion. And with the steadily strengthening Chinese yuan, up 6.5% in 2007, overseas prizes are looking more and more like bargains ( 12/3/07).

Last year, for example, Zijin Mining Group, a Hong Kong-listed company based in the southeastern province of Fujian that in 2006 earned $236.8 million on $1.5 billion in sales, took a controlling stake in London-based Monterrico Metals, which has extensive gold, silver, and copper resources throughout Peru, for just under $190 million. And on Jan. 31, a subsidiary of Shougang, the Beijing-based company that is one of China's largest steelmakers, bought a 19.73% stake in Australian iron ore miner Mount Gibson Iron for close to $363 million. The deal is still awaiting regulatory approval in Australia.

Meanwhile, on Feb. 4, shares in Australia's iron ore producer Fortescue Metals Group shot upward following unconfirmed reports that the company was in talks with potential Chinese investors interested in taking a large equity stake. Chinalco too is already active in Australia, with a $2.5 billion investment it made in 2006 in a bauxite mining and aluminum smelting project in the Aurukun region of Queensland—the largest investment Down Under by any Chinese company.

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