2007 Business Topics

August 2007
Business Topics by Myra Pinkham, Contributing Editor

Service Centers on the Sidelines
of Rio Tinto-Alcan Merger
In a move that would create the world’s largest aluminum company, mining giant Rio Tinto Plc announced last month that it planned to acquire Montreal-based Alcan Inc. for $38.1 billion in cash—an offer that received the unanimous support of Alcan’s board of directors. This offer came about two months after Pittsburgh-based Alcoa Inc. unsuccessfully attempted to pick up Alcan in a hostile bid that followed two years of negotiations.

The union of Alcan and Rio Tinto’s aluminum businesses, to be called Rio Tinto Alcan and based in Montreal, is not expected to affect aluminum service centers much, especially if the company structure remains as currently envisioned. “There would have been more of an impact had Alcoa acquired Alcan,” says Bill Sales, senior vice president for nonferrous operations for Reliance Steel & Aluminum Co., Los Angeles.

Rio Tinto is more active in the upstream end of the aluminum business, mainly in Australia, says Charles Bradford, metals analyst for Bradford Research-Soleil Inc., New York.

Even in Australia the company has been a relatively small player in aluminum, maintains Lourenco Goncalves, president and chief executive officer of Metals USA Inc., Houston. “It is primarily an iron ore company,” he says.

“This is just another step in a long line of consolidations going on in the aluminum industry,” says Robert Stiles, vice president of operations for Erickson Metals, Cheshire, Conn. This trend toward fewer producers has made supply-side negotiations more difficult for service centers, he adds.

The new company also may choose not to participate in certain markets, creating a need for service centers to find new sources of supply, notes Patrick Records, manager of rod, wire, bar and tube for Westlake Metal Industries, North Ridgeville, Ohio.

But on the positive side, observes Reliance’s Sales, increased industry consolidation could add stability to aluminum pricing.

Rio Tinto’s offer of $101 per share of Alcan common stock—a premium of 32.8 percent over Alcoa’s offer of $33 billion in cash and stock—is considered quite pricey. In fact, it was pricey enough that just hours after Rio Tinto and Alcan announced plans to merge their aluminum operations (minus Alcan’s packaging business, which is to be immediately divested), Alcoa withdrew its bid.

Alain Belda, Alcoa’s chairman and chief executive officer, explained, “At this price level, we have more attractive options for delivering additional value to shareholders. We will continue to deliver strong results, make targeted growth investments, trim under-performing businesses and further enhance returns to shareholders by resuming our share repurchase.”

Adds Bradford: “There are a number of risks to Rio Tinto paying so much for Alcan, especially if interest rates go up.”

Tom Albanese, Rio Tinto’s chief executive officer, admits that the deal leaves the company with substantial debt, but he maintains that Alcan provides “an exciting fit with Rio Tinto’s businesses by complementing our existing assets and transforming our aluminum products group into a sector leader.”

From the onset, Rio Tinto plans to divest Alcan’s packaging business while keeping its engineered products unit intact. After the deal closes (probably in fourth-quarter 2007), he says, there will be a broad review of the entire Rio Tinto/Alcan portfolio with an eye toward divesting those businesses that don’t meet the merged company’s “requirements of scale and competitive position.”

Rio Tinto’s bid came as no surprise, once Alcan’s board suggested that shareholders reject Alcoa’s hostile offer. Rio Tinto was just one in a long list of other heavy hitters in the global aluminum industry interested in Alcan, including BHP Billiton, CVRD, Xstrata, Rusal, Anglo American and Norsk Hydro.

Now, with this deal in the works, the rumor mill has turned to Alcoa and the possibility that it may be an acquisition target instead of an acquirer. Initially, there was speculation that BHP Billiton would make a play for Alcoa, especially since Marius Kloppers, who will become BHP’s chief executive officer in September when Chip Goodyear retires, has aluminum industry roots. However, recent reports from the Australian media indicate that BHP is turning its interest, and its money, elsewhere.

A new aluminum leader
“This transaction will make Rio Tinto [currently the No. 8 aluminum producer globally] the industry leader in aluminum,” says Albanese. “On a production basis we will be No. 1 in smelting, No. 1 in bauxite and in the top rank of alumina producers with a clear pathway for growth in that area.”

“Equally import, we will be the leader in low-cost production, which we know in commodity businesses is essential to superior shareholder returns,” says Dick Evans, currently Alcan’s president and chief executive officer, who will head Rio Tinto Alcan and report to Albanese.

“We also will be the undeniable leader in technology in the aluminum sector. That includes not only smelting technology, but also alumina refining technology and bauxite mining technology.”

The decision to endorse Rio Tinto’s bid was not an easy one for Alcan board members, says Yves Fortier, Alcan’s chairman. “Before May 7, and Alcoa’s offer, Alcan was really going forward very nicely.” But the hostile bid forced the board to consider all alternatives, including revisiting conversations with Rio Tinto (which had been going on for decades) and with others.

“We looked at all of the alternatives,” says Evans. “We looked at standing alone, recapitalizing the company, leveraging it and divesting certain assets. We looked at a Pac-Man strategy (putting in a bid to acquire Alcoa). We looked at non-control transactions. We looked at a number of control transactions. In my view, we did a very thorough job of coming up with the very best solution for Alcan shareholders, employees and our communities.”

“It is with a great deal of emotion that I see Alcan overtaken by a foreign company,” Fortier says, calling the merger “a marriage of reason.” He adds: “We are happy to walk hand in hand with our friends from Rio Tinto under the heading of Rio Tinto Alcan,” especially since the company remains in Montreal, “the community that made Alcan the jewel that it is.”

In addition to Montreal being the headquarters for the aluminum operations of the merged company, Rio Tinto plans to locate one of its regional shared service hubs in Montreal and maintain its aluminum smelting technology R&D center in Quebec. The company’s bauxite and alumina businesses and the associated R&D activities for bauxite and alumina, however, will be managed out of Brisbane, Australia.

The acquisition is expected to generate about $600 million in synergies by 2010 (less than estimates of $1 billion for the Alcoa/Alcan merger), says Guy Elliot. Most of these synergies will be derived from Rio Tinto and Alcan’s complementary assets in northern Australia. “In addition, there are synergies available in R&D, procurement, financial and fiscal arrangements and integration in corporate and overhead areas,” he says.

“The Alcan expansion will significantly rebalance Rio Tinto’s commodity portfolio, giving us more equal weighting between iron ore, copper and aluminum,” Albanese says. “The aluminum business is an excellent business to be in.”

The outlook for the aluminum sector is very strong with world demand forecasted to grow at more than 6 percent a year through 2011, he notes. Global demand growth over the last four years has been even higher at 7.7 percent per year, with China’s demand for aluminum, as well as steel and copper, picking up significantly in recent years. Demand in India is likely to follow the same path.

Once its balance sheet recovers from this very large expenditure, Rio Tinto Alcan intends “to continue to pursue both organic growth, where it is attractive, and value-added merger and acquisition activity in line with our stated strategy, focusing on quality and value,” Elliot says.

Rio Tinto still needs to clear a few hurdles before the deal closes, including acceptance by Alcan and Rio Tinto shareholders and a number of governmental and regulatory approvals.