Rio Tinto scraps Chinalco deal

MELBOURNE (Reuters) -- Miner Rio Tinto scrapped a planned $19.5 billion tie-up with China's Chinalco struck at the height of a global financial crisis, turning instead to an iron ore joint venture with rival BHP Billiton and a share sale to slash its debts.

The collapse of the Chinalco deal, put together in February in a bid to halve Rio's $38 billion of debt, leaves the world's biggest steel making nation vulnerable to just two suppliers -- a Rio/BHP combination and Brazil's Vale -- controlling 70% of global iron ore trade.

Shares in Rio (RTP) jumped as much as 13% to a 7-month high, while BHP (BHP) rose 10%, as investors welcomed an alternative route to resolving Rio's big debt burden.

"Rio has effectively been talking to BHP behind Chinalco's back and Chinalco is entitled to feel like a two-timed lover this morning," said Paul Bartholomew at Steel Business Briefing in Shanghai. "This is a big slap in the face for China."

The new plan represents a victory for Rio shareholders who had argued the Chinalco deal favored the Chinese state firm and could give China greater influence over pricing of key resources.

"We were not supporters of the Chinalco transaction. We're happy to see this alternative approach to solving Rio's issues with its debt," said Ross Barker, managing director of Australian Foundation Investment Co, Rio Tinto's sixth-largest shareholder in Australia and a BHP shareholder, according to Reuters data.

"A deal like this was really essential from Rio's point of view. And it's a good deal for BHP," he said.

Rio said it would pay Chinalco a $195 million break-up fee.

Rio and BHP, the world's second- and third-largest iron ore miners, agreed to combine their operations into a 50-50 joint venture, generating savings of at least $10 billion.

A Rio/BHP combination would supply around 270 million tons of ore a year, while Vale supplies around 240 million tons.

BHP will pay Rio Tinto $5.8 billion to take its equity interest in the venture to 50%, but stressed the agreement was non-binding at this stage.

"This deal has been 10 years in the making and well worth the wait," BHP Chief Executive Marius Kloppers told reporters.

To cut debt, Rio said it was raising $15.2 billion through a 21-for-40 rights offer, the fifth-largest rights issue on record, according to Thomson Reuters data.

Rio and BHP agreed to keep their iron ore marketing separate, a key factor designed to win approval from competition regulators, especially the European Commission, which last year raised concerns about BHP's proposed takeover of Rio due to the impact on iron ore markets.

Chinalco said it regretted Rio's decision after it had worked hard to try to revise the deal to reflect changed market conditions as well as shareholders' and regulators' concerns.

"As a result, we are very disappointed with this outcome," Chinalco President Xiong Weiping said in a statement.

Australia and China, which are trying to start free trade talks, played down the impact of the collapse of the deal, which would have been China's largest foreign investment, on diplomatic ties or the future of Chinese offshore investment.

"It is a commercial matter, and I think it's very important that our friends in China focus on that fact," Australian Prime Minister Kevin Rudd said.

In China, an official at the State-owned Assets Supervision and Administration Commission characterized the deal's failure as "normal market behavior", and state banks said they stood ready to back any future foreign investments by Chinalco.

"My initial reaction is that it will be overwhelmingly positive for both companies because of the cost savings (and) the synergies," said Michael Bentley, resources portfolio manager at Northward Capital.

The cost of insuring Rio Tinto's debt fell by more than a third, with the spread on its credit default swaps (CDS) narrowing to around 190 basis points from 290 bp.

"We consider these initiatives are a superior outcome for Rio's credit quality as opposed to the Chinalco deal," Monaural International said, adding it was better for Rio to sell equity instead of convertible bonds, maintain greater ownership of its assets and gain joint venture savings.

The prospects for Chinalco were less clear.

Chinalco Vice President Lou Outing said the firm had not decided whether to participate in the rights offer.

"This is a big thing and is not determined by a single person," Lou told Reuters, adding the decision not to revise the deal with Rio Tinto was made by both sides.

Under the deal agreed in February, Chinalco would have paid $12.3 billion for stakes in Rio's key iron ore, copper and aluminum assets and $7.2 billion for convertible notes that would have doubled its equity stake in Rio to 18%.

BHP launched a 3.4-for-1 share swap to take over Rio in February 2008, which Rio rejected saying it vastly undervalued the firm and its prospects. BHP dropped the deal last November after commodity markets collapsed.