JOHANNESBURG () -- Gavin Wendt, head of mining and resources at Fat Prophets, independent stock market information provider, analyzes BHP's bid for Rio Tinto in an interview with Lindsay Williams for Resource Investor.
RESOURCE INVESTOR: On the line from Sydney, Australia is Gavin Wendt, who is the head of mining and resources research at a company called Fat Prophets. Gavin, thanks for speaking to us. I know it's quite late in Sydney. Before we go on, what's Fat Prophets?
GAVIN WENDT: Well, we're an independent stock market information provider. We provide a couple of stock market reports, one focused on the industrial sector, the other on the mining sector, and I'm responsible for all their mining research.
RESOURCE INVESTOR: You must have been very busy recently because of what's been going on. Let's have a look at the numbers from BHP Billiton [NYSE:BHP; LSE:BHP] first of all, reported at 2.8% increase in basic earnings per share. But I think what the market focused on was the fact that attributable profit came in at $6 billion U.S. dollars. And that was down 2.8%. That's the first time we've had a decline for a quite a while from BHP.
GAVIN WENDT: Yes, it is. That would have had some impact on BHP's share price fall in Australia today. The market was looking for a better result. Look, at the end of the day, it was still a very robust result, but the key though was rising costs. That issue of rising costs is something, of course, that's not only peculiar to BHP, but it's a sector-wide trend.
But we're expecting a very strong second half from BHP. So all in all, the result wasn't too bad. It was fairly much in line with market expectations, but probably at the lower end you'd probably say.
RESOURCE INVESTOR: Yeah. An interim dividend of 29 U.S. cents per share was declared. That was quite pleasing for the market. That was up 45%. Let's quickly dwell on the cost if we can. 'Cause it says here net of non-cash costs increased by 1.9%. Now that doesn't sound a lot. Is that hiding the real truth?
GAVIN WENDT: Look, I don't think so. BHP has had a very strong run. This particular period, it was impacted by costs. And they do have a very strong portfolio of project which are coming on stream, most primarily on the petroleum side of things. So that's why we're expecting a strong second-half boost.
You can't look at the result too much in isolation in terms of the 6-month period. I think you have to look at them in the full context of a full year's result. It still was a tremendous profit result albeit slightly lower than the same period last year.
RESOURCE INVESTOR: Yeah. It doesn't quite explain the fact that the BHP Billiton share price in Sydney was down by its most I think in almost 20 years. I think the story there is that they've upped their bid for Rio [NYSE:RTP; LSE:RIO]. Making a formal bid of 3.4 BHP shares for each Rio share, and that's an offer worth, what, about $147-$148 billion U.S. dollars. The market doesn't like that one from what I can see.
GAVIN WENDT: Well, you've hit the nail on the head. Look, it's common in these sorts of situations where a takeover is under way that the bidding company's share price will fall, and of course, the target company, in this case Rio Tinto, its share price will rise. The issue, of course, is that as BHP has increased its offer, it's a pure script based offer at this stage, the marker is factoring in higher consideration price being paid, and also greater dilution if the bid is successful. On the other hand, of course, Rio Tinto is the beneficiary of all that.
The market is also concerned I think that BHP has been very determined it would seem, particularly Marius Kloppers seems almost been a personal crusade of his to acquire Rio Tinto. The market is concerned that BHP isn't over paying and isn't over stretching itself.
RESOURCE INVESTOR: Yeah. The revised offer would give Rio shareholders 44% of the combined company, said BHP, compared with 41% under the first proposal. Going back to your comments there which I find interesting about Marius Kloppers and a potential personal crusade coming into the equation here, I watched him - I think this is the first set of results he's presided over as CEO - he looks slightly tentative. Do you think he's maybe trying a bit too hard and trying to stamp his authority on the company that's been steered along by Chip Goodyear for so long?
GAVIN WENDT: Look, it's an interesting question and I think the answer to that one is yes. Chip Goodyear was a more conservative type of individual. He was from a finance background. I guess you could say he was an accountant. He was very good with numbers. He presided over, really for the last couple of years, BHP, which were fantastic years in terms of profitability and growth.
Marius has arrived on the scene. I think he's trying to make his mark very quickly. Of course, a former CEO of BHP built in - in fact, the first one, Brian Gilbertson, of course, is cast in the same mold. And I think Marius is a great admirer of Brian Gilbertson. And, of course, Brian is a very aggressive deal-maker, and of course, Marius hasn't been in the BHP hot seat for very long and already we've seen him embark on what would be one of the biggest corporate deals in history. He certainly wants to make his mark.
RESOURCE INVESTOR: Yeah. The development that has recently, of course, made the deal even more interesting is the intervention of the Chinese. Chinalco [NYSE:ACH], I think taking a fairly decent - was it 9% I think of Rio, just trying to goose up the price that BHP Billiton is willing to pay. That seems to be their tactic.
GAVIN WENDT: Look, absolutely. There's a couple of angles to the Chinese, and effectively the way I see it, there's not much downside for them. First of all, we're trying to throw a 'spanner' in the works, and it appears as though they've been successful so far. They're trying to force BHP if it's serious about Rio Tinto, which, of course, it is, to pay as high a price as possible.
It was only a couple of weeks ago that BHP were talking of the compelling nature of their 3-for-1 share bid, yet within a couple of days of the Chinese emerging, we see that bid enhances 3-for-1. So you could draw an inference that the Chinese were at least in some way responsible for the higher bid.
And, of course, even in the worst-case scenario for the Chinese, if a tie up between BHP and Rio were to occur, they had a seat at the table in terms of getting access to some of the assets that might have to be sold off in the event of the merger going through. And of course, Chinalco and Alcoa [NYSE:AA] are there to try and pick up some of the aluminium assets that BHP might look to sell off.
RESOURCE INVESTOR: Yeah. Quite a clever move I would have thought. And it's also something to do, I suppose, with trying to stave off excessive iron ore price hikes, that sort of thing. I mean that's what the Chinese are worried about, isn't it?
GAVIN WENDT: Absolutely. I mean, look, it's all about iron ore. They don't want to see the second and the third-biggest iron ore players in the world represented by Rio Tinto and BHP coming together. They're very fearful about what might happen in iron ore. But no, of course, not only iron ore, they're fearful about coal prices, they're fearful of copper price rises.
This whole deal is predicated on market and price control. You won't hear BHP say it, of course. You'll never hear Marius Kloppers admit it, because, of course, it's highly politically incorrect and would lead - well, already the bid is faced with all sorts of regulatory issues and competition issues. They'll never talk about that, but they'll talk about all sorts of things like synergies and cost-cutting and all that sort of politically correct stuff.
But the main issue is to create a mining company that has supreme market and price control.
RESOURCE INVESTOR: Yeah. Marius Kloppers said the deal would create annual synergies of $3.7 billion U.S. dollars within 7 years with large savings coming from the company's neighbouring iron ore mines in Western Australia. No doubt, there's an element of truth in that. But as you say, the real motive is hidden beneath the politically correct rhetoric. If it doesn't go ahead then, of course, the hedge funds are going to start selling their Rio and buying back their shorts in BHP Billiton. Any chance the regulators will say no?
GAVIN WENDT: I don't think there's any circumstance that will be a deal-killer. BHP, though, has a knowledge that it's going to take probably up to 12 months to jump through all of the regulatory hurdles and solve all the possible problems that might come up. I mean they're going to be asset sales along the way if this deal went through.
There's nothing that in our mind that would stop it. Of course, the Chinese, though, were determined to take actions, and there's all sorts of stories that they've got $120 billion U.S. dollar war chest with the backing of the Chinese government.
So the other interesting angle that I might just mention on this which I think is important is that the Chinese had said in Sydney on Monday that they weren't looking to increase their stake in Rio Tinto. But there was important proviso if BHP lobbed the bid on Rio Tinto, which it has now done, the Chinese and Alcoa reserve the right to increase their stake. It will be very interesting now to see what the Chinese do given that BHP now has lodged an offer.
RESOURCE INVESTOR: Yeah, it is going to be very interesting.
GAVIN WENDT: One would think that they'd be very keen to increase and improve their position.
RESOURCE INVESTOR: Sure. And let's say that - well, let's not seem anything's going through at the moment. What are you at Fat Prophets advising your clients to do, stand aside until it's all done, or do we get creative and have a look at the other companies like Xstrata [LSE:XTA], for example?
GAVIN WENDT: Well, that's a very interesting one. I mean on BHP and Rio Tinto, and particularly Rio Tinto, we're just advising our clients to sit tight. Obviously the company will come out and make comments in the next couple of days. It'll be also interesting to see what the Chinese have got to say and what particular action they might take.
I think Rio Tinto handled this whole affair very well. They've been on the front foot the whole time and effectively had BHP on the back foot. We still think that they've got a few tricks up their sleeves.