You don't get the chance to exit at the top of the market too often. Rio did. It blew it. Now it pays the price for arrogance, poor judgement and most of all, debt, via a trashed share price.
As its credit default swaps went through the roof, Rio shares tanked another 10% at the close of the London market last night amid speculation of a rights issue and heavy switching into BHP. The shares were also down 10% locally in afternoon trade.
Rio denied it. Severe capex cutbacks are said to be in train though, local sources suggesting capital expenditure could be curtailed on any project which was not close to completion.
Conversely, its suitor BHP is sitting pretty, rewarded by the market for walking away from its $100 billion Rio bid. Ironically it now stands better placed than any other player to carve out a few bits of Rio.
What assets Rio will have to offload hinges on commodity prices, and whether it does opt to raise new equity.
It is due to repay $US9 billion in debt by October next year. So it either has to sell assets or raise a hefty chunk of equity, or both if things deteriorate further.
Riding high just weeks ago, Rio is now in a horribly weak position, hostage to commodity prices and one pervading market sentiment: that is that debt is anathema.
Banks are baulking on refinancings everywhere, just ask Andrew Michelmore at Oz Minerals or the crew from Babcock and Brown who received a brief reprieve from their bankers last night.
And nothing is sacred in this market, not even a company with the size, the pedigree and the first-rate assets of Rio.
Again, the drastic response of the market to leverage has been laid bare. Rio's problem was it loaded up with debt at the top of the cycle, $US40 billion worth of borrowings to fund a knock-out bid for Alcan near the top of the biggest resources boom the world has seen.
You could say it was reckless, but that is with the benefit of hindsight. Still directors and executives are paid a lot of money for their judgement and risk management expertise. There are no excuses, only the reality of change.
Not alone
Rio is not alone. Among others who loaded up at the top and now have the debt wobbles are Crown, Fairfax, Asciano, Wesfarmers and the banks (via their leveraged exposure to the economy and all lending). Still others who always toted heavy gearing such as the financial engineers, GPT, Goodman and the REITs - all stomped on hard.
The debt crisis is here to stay for a while. What needs to improve is the confidence of banks and other lenders.
Is Rio in denial? Can it muddle through with asset sales? Skinner has little choice but to deny a dilution in any case. Any hint of a big issue would only decimate his stock price.
All around though the brokers - who have all returned from research blackouts (almost every major broking house had a mandate in the BHP/Rio deal) - are mooting a raising and asset sales.
Credit Suisse reckons a $US7.5 billion rights issue would do the trick. A one-for-three would reduce the debt to $US30.5 billion, it noted, saying the gearing would be ''manageable'' at 41%.
JP Morgan has cut its price target by more than half - and it was a key defence advisor to Rio during the bid.
UBS however is estimating Rio will have US$6.7 billion in cash by October 2009, which is below the US$9 billion it needs to pay down the term loan.
''Nonetheless, we believe Rio has a number of ways of meeting these debt repayment commitments and it is likely that a combination of the following will be utilised including: US$6.9 billion in undrawn facilities, lower than forecast capital spend, and potentially reducing dividends.'' Continued…
