September 18, 2008

Rio Share Discount to BHP Takeover Bid Deepens

By Reuters

LONDON (Reuters) - The deep discount of shares in miner Rio Tinto to the all-stock offer by predator BHP Billiton looks like an opportunity for investors who believe BHP will ultimately win a drawn-out anti-trust battle.

The discount in Rio shares has been as much as 18% this week as competition reviews by European and other regulators dragged on and investors dumped mining stocks.

"If you think that there's a pretty good chance of the E.U. approving it, you can say that's another example of mispricing and no one moving in to take advantage of the difference," said an analyst in London who declined to be named. "It may be that the E.U. will require some disposals, but it still seems to me it in the end it will go ahead and then you have to ask why is there this discount of more than 10%."

There has been little involvement by hedge funds in arbitrage trades since a decision from European Union competition authorities is not expected until December or early 2009.

"I think they'll (hedge funds) be waiting until things come closer, because it's now two, three, four months away," said a London hedge fund manager.

The recent turmoil on financial markets and tumble in metals prices has hammered mining shares, taking some of the speculative steam out of Rio shares. "Some of it is from hedge funds having to deal with redemptions," he added.

When the world's biggest miner BHP announced its formal offer of 3.4 of its shares to each Rio share in early February, Rio shares traded at a premium to the offer, currently worth $116 billion. But as the regulatory process crawled forward, the premium evaporated and the discount widened, touching a record low in the wake of the collapse of Lehman Brothers Holdings Inc.

On Wednesday morning [Sept. 17], the discount was around 16% after the mining sector rebounded after troubled insurance group AIG got a lifeline loan of $85 billion. Rio London shares gained 4.9% to 4,060 pence by 1115 GMT, outpacing BHP, which added 1.2% to 1,392 pence, and a 1.4% increase in the U.K. mining index .

E.U. Competition Hearings

Little news has emerged from the review process by the E.U., expected to be the toughest regulator scrutinizing how the merger would boost concentration in the iron ore sector.

The E.U., which has temporarily suspended its timetable as it awaits further information from BHP, is concerned that the combined firm would have a stronger grip in pricing iron ore, where some annual contract prices nearly doubled this year. The Commission previously said it was due to conclude the case by Dec. 9, but the suspension will push back the date.

The head of a trade body representing European steelmakers, who vehemently oppose the merger, told Reuters on Tuesday [Sept. 16] he was encouraged because E.U. investigators were asking tough questions during hearings.

BHP, however, has told the unnamed analyst that the E.U. hearings were going well. "Everything is panning out as they'd anticipated with the E.U. They haven't been asked any questions that they haven't anticipated," he said.

Analyst Michael Rawlinson at Liberum Capital also recently met with BHP and carried a similar message. "Importantly, BHP Billiton does not see the conclusion of the E.C. process as a 'binary' outcome, which may indicate greater flexibility on the company's part to engage with regulators with regard to a final outcome," he said in a note.

Mr. Rawlinson reckoned that there was an 80% chance that the deal would be completed at the current 3.4 share ratio. "We believe the spread presents an attractive investment opportunity, with limited downside should BHP Billiton not be successful in closing its acquisition of Rio," he added.

By Eric Onstad

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