BHP Abandons $66 Billion Rio Bid as Commodities Slump

By Rebecca Keenan and Brett Foley

Nov. 25 (Bloomberg) -- BHP Billiton Ltd. abandoned its year-long pursuit of Rio Tinto Group, blaming the rout in commodities prices and the credit-market squeeze for derailing the biggest hostile takeover.

Marius Kloppers, chief executive officer of the world’s largest mining company, said the combination of $40 billion in new debt and regulatory hurdles made the $66 billion bid too risky at a time when the slowing world economy reduced demand for raw materials. Rio plunged as much as 43 percent in London trading, while Melbourne-based BHP shares jumped 21 percent.

When BHP announced the plan to buy Rio, commodity prices were heading to record highs and the Standard & Poor’s 500 Index was approaching its peak. Twelve months and $450 million of shareholder money later, Kloppers is confronting a 50 percent drop in copper prices and a 45 percent decline in oil as the world’s biggest economies face their first simultaneous recessions since World War II.

“The withdrawal of the bid paints a very gloomy picture,” Charles Cooper, an analyst at Evolution Securities Ltd. in London, wrote in a report. “The outlook for commodities is set to remain weak, inventories will build and prices will fall, adversely affecting company earnings and valuations.”

Rio shares traded below the offer price since April as investors speculated the transaction, valued last year at more than $150 billion, would fail. Tumbling commodity prices led Brazil’s Cia. Vale do Rio Doce to shelve its proposal to buy Switzerland’s Xstrata Plc in March. Earlier this month, Russian steelmaker OAO Novolipetsk terminated an agreement to buy John Maneely Co. of the U.S.

Copper, Aluminum

Rio fell 871 pence, or 36 percent, to 1,579 pence as of 12:07 p.m. in London trading, valuing the company at 28.1 billion pounds ($42.5 billion). BHP rose 15 percent to 1,128 pence.

The combination of BHP and London-based Rio would have created a company that matched Brazil’s Cia. Vale do Rio Doce as the world’s largest iron ore producer. It would also have been the biggest producer of copper with about 9 percent of the market and the leader in aluminum with about 7 percent.

The European Commission started probing the deal in July on concern that BHP would control too much of the iron ore market. While BHP was figuring out what assets it would have to sell to gain approval, the Reuters/Jefferies CRB Index of 19 raw materials dropped 48 percent and credit markets froze, reducing the value of those properties.

“BHP needs to focus on existing operations and I think going into an economic downturn they need to batten down the hatches and generate as much cash flow as they can,” said Jason Teh, who helps manage the equivalent of $5.7 billion at Investors Mutual Ltd. in Sydney. He holds BHP and Rio shares.

‘Difficult Situation’

“When you combine all those factors, along with the decreased cash flow, you get to a situation where this is very difficult,” Kloppers said today on a conference call from Melbourne. “We have an obligation to look at these value creating investments, but also we have an obligation to stop them when the conditions have deteriorated.”

Rio said it noted BHP’s move and will continue its growth strategy. Rio has “an exceptional portfolio of cash-generative assets and significant stand-alone growth opportunities,” it said in a statement.

BHP is the latest commodities producer to walk away from a deal this year. In March, Vale shelved a proposal to buy Switzerland’s Xstrata Plc. Earlier this month, Russian steelmaker OAO Novolipetsk terminated an agreement to buy John Maneely Co. of the U.S. from The Carlyle Group.

Economic Downturn

“I was expecting this,” said Sajjan Jindal, managing director of JSW Steel Ltd., India’s third-biggest producer. “The steel industry has many players but there are few in iron ore, so it would have created a monopolistic market.”

The European Commission was going to require so-called “remedies” from BHP to allow the bid to proceed, Kloppers said. The offer is still “live” until the commission decides to block it, he said.

“Even if they do approve it without remedies, we would ask our shareholders to vote against the deal,” he said.

The value of BHP’s offer slumped after peaking at $194 billion on May 19 as commodity prices dropped. Aluminum is heading for its biggest annual drop in 17 years. Contract iron ore prices are forecast to drop in 2009, according to analysts at UBS AG And Goldman Sachs JBWere Pty. Coal is also predicted to decline.

“We have concerns about the continued deterioration of the near term global economic conditions, the lack of any certainty as to the time it will take for conditions to improve and the risks that these issues imply for shareholder value,” Don Argus, BHP’s chairman, said today in a statement to the Australian stock exchange.

‘Good News’

Credit-default swaps on BHP tumbled 130 basis points to 320, according to Citigroup Inc. prices at 7:45 a.m. in London. Contracts on Rio jumped 50 basis points to 800.

The swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a country or company fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality; a decline the opposite.

Aluminum Corp. of China, the largest shareholder in Rio, said BHP’s dropped takeover bid would benefit Chinese steelmakers.

“This is definitely good news,” Lu Youqing, vice president of the Beijing-based company, said today by phone. “We respect BHP’s decision.”

Chinalco, as the company is known, bought a 9 percent stake in Rio with Alcoa Inc. in February.

To contact the reporters on this story: Rebecca Keenan in Melbourne at rkeenan5@bloomberg.net; Brett Foley in London at bfoley8@bloomberg.net