The rumour in the Australian that China Inc. is prepared to spend up to $22 billion to secure a 10% equity stake in BHP Billiton (ASX: BHP) remains just that, a rumour. If a Chinese-backed buyer was trying to buy BHP for a song, it's not working out very well. That makes you wonder again what the real purpose of such a move would be. Is it to own a piece of BHP so that when it does, eventually, acquire Rio Tinto (ASX: RIO), the Chinese shareholders have a call on Rio's assets?
Or, is it a feint? Is it tactical misdirection designed to depress Rio's share price so another less-than-friendly raid on Rio can be conducted at a slight discount? Indulge us. With enough leverage, we reckon a hedge fund could turn this into a trading strategy.
Theoretically, Rio's shares are now a derivative of BHP's. Investors know BHP has bid 3.4 of it shares for every one share of Rio. After BHP's strong performance yesterday, it would have taken just 3.29 BHP shares at $41.91 to buy one of Rio's shares at $137.88.
If the market takes BHP's offer as kind of "net asset value" of Rio, then any time the ratio drops below 3.41, Rio should be bought or BHP sold. On the other hand, if the ratio exceeds 3.41, either Rio is overvalued or BHP undervalued. Trade accordingly. In other words, you can use the ratio of BHP's offer to determine a premium or discount in both shares.
This, of course, is complete nonsense. You cannot determine the value of either company relative to the other without including a serious discussion of the value of what they produce: coal, oil, metals ores and so much more. And in any event, there is a pointed difference of opinion between BHP and Rio management over just what Rio's current production and future projects are worth today.
If you're China (or charged with representing China's national interests), perhaps the future cash flows from the assets don't matter as much as the actual possession of the assets. Perhaps it's the ownership of those assets that's more important, guaranteeing your domestic metals producing industries have raw materials.
But who knows? All we really know is that unlike the credit markets filled with garbage bonds and CDOs and fictitious assets, Australian companies have real assets on the balance sheets...and the market value of those assets (in addition the geopolitical value) is grinding relentlessly up. That's a good thing for us individual investors.
Dan Denning
The Daily Reckoning Australia
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About the Author
Dan Denning is the author of 2005's best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 and has covered financial markets form Baltimore, Paris, London and, beginning in 2005 Melbourne. He’s the editor of The Daily Reckoning Australia and the Publisher of Port Phillip Publishing.
Comment by Unpopular Truth on 11 April 2008:
China is terrified of having to buy all their coal and iron ore on the spot market, rather than having a contract with BHP and RIO for a set price each year (lower than spot market). They are also unhappy that BHP and RIO keep driving up the contract price (due to demand being so strong) however are fairly powerless to do anything about it.
They are seeking to take ownership of the companies which are costing them so much, for several reasons.
1) to recover some cost (profit, generated from itself. Zero sum situation).
2) to aquire controlling amounts of the company stock in order to hamstring the aggressive negotiations.
Current investors of BHP should be very against chinese ownership, as they will purposely generate lower profits because they'll start discounting their own product indirectly via special deals and not increasing the contract amount as much as they could.
Australian public should also be very against chinese ownership, as pretty much every single tax cut we've gained in the last 20 years has come on the back of strong profits from BHP and RIO.
The good news is that both sides of Australian politics understand this, and any move by Chinese soverign funds to take significant ownership of these companies (or any other outsider) will be blocked in the national interest.
Comment by Pete on 14 April 2008:
UT: Do you think we really have the guts/nerve to block China? I mean, Kevin will be in a tough spot then...
Good points though
Comment by Diggin it! on 14 April 2008:
Pete, i don`t think we have a choice, if we sell off any more of our export options we will lose what strength we have left in global trading and that would be a Ruddy mess!!!
Comment by Wills on 28 May 2008:
The Chinese are seeking security of supply - unlike of most Australian investors and fund managers who are hoping for long term appreciation of their BHP shares.
In the previous decades, it was common practice for Asian companies (especially Japanese) to have cross ownership share holdings in each other. That way they can influence prices, policies, etc of their counterparts, often to the detriment of the small shareholder. The Chinese being relatively new to the game believe they can do this. However, they do not understand that it is not possible in Australia because BHP (and other companies)have to consider the interests of ALL shareholders, not just the major ones. Most of the time, we'd like to think that there are clever brains behind big money - lately, we have witnessed these clever people are subject to the same horrendous mistakes as the average punter.
At the same time, China has about $1 trillion in reserves, most of which is in US$. $20 Billion is a drop in the ocean but if they can buy that much of BHP, that money is at least not tied to the US$.