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Resource Investing: What to make of the Rio Tinto - BHP Billiton merger plans

Posted November 14, 2007

“If BHP did indeed buy out Rio Tinto, the resulting company would control 36% of the seaborne iron ore market and it would hold a third of the global coal market (mostly the third that’s not powering China at the moment). And if nothing else, a company with a controlling stake in two of its key ingredients will find the steel industry fighting it from the start.” — Stephanie Grimmett

by Stephanie Grimmett, Today’sFinancialNews.com

Wednesday, November 14, 2007

Baltimore — (TFN): Rio Tinto just rejected BHP Billiton’s unsolicited bid in a letter it sent to the Australian Stock Exchange. As you will undoubtedly recall, BHP offered three of its shares for every one of Rio Tinto’s, valuing the company at $350 billion, saying a merger between it and Rio Tinto would generate a combined $3.7 billion each year in savings and extra earnings.

BHP must appreciate the fact that the new consolidated company would not only be larger than, but in a completely different weight class especially when compared to Companhia Vale do Rio Doce, the second-ranked miner in the world.

Despite the refusal, BHP plans to get its hands on Rio Tinto one way or another. The company’s CEO has talked about soliciting Tinto’s largest shareholders individually, or considering a hostile takeover of its rival.

But before BHP gets carried away , we should take a moment to consider the ramifications of the deal. Because this offer might just represent the first dust cloud of one horseman of the apocalypse when it comes to the global commodities supercycle. Could mega-mergers like BHP-Rio Tinto mean we’ll soon be able to see the top of Commodities Mountain.

We’ve watched the same thing happen before. Remember the AOL/Time Warner merger in January 2000? AOL stunk up the place for a couple of years after the merger, until it dried out and the company swept it under the rug as a subsidiary.

The merger caused what was, at the time, the largest net reported loss in history. The newly minted AOL Time Warner presented a $99 billion (that’s billion, with a “b”) loss to its investors in 2002. And as any shamefaced company should, it promptly fired its CEO, along with dropping the AOL out of the name. Turns out a losing corporation by another name did smell sweeter to investors.

The merger signaled the end of corporate America’s love affair with Internet start-ups, and the ensuing technology crash smacked everybody in the head.

If BHP did indeed buy out Rio Tinto, the resulting company would control 36% of the seaborne iron ore market and it would hold a third of the global coal market (mostly the third that’s not powering China at the moment). And if nothing else, a company with a controlling stake in two of its key ingredients will find the steel industry fighting it from the start.

But the two merger scenarios have an important difference. Where entertainment conglomerate Time Warner was adding an Internet company to its stable of venues, BHP is buying up its second largest competitor. It’s consolidation, not diversification.

And that difference is another nail in the coffin of the supercycle. Consolidation is always a sign of a topping industry. But that doesn’t mean you won’t bag anymore gains on commodities plays in the near future. The commodities supercycle still has a couple of good years left in it. This is only the beginning of the consolidation trend.

IF BHP does get its hands on Rio Tinto, don’t panic. Consolidation is a fantastic way to make gains. Knowing which companies are the most attractive and which ones are going to whither and die can bring in gains like never before. And that is what we’re here for.

Don’t Miss this Weekend’s Smart Trading Action Alert: Laura Cadden interviews Volume Spike Trader Stephen Oakes about how to leverage downward pressures on American equities into profits.image of Laura Cadden interviewing Stephen Oakes about how to use SPYDRs for profits


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