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"Terrorising" investor Carl Icahn (photo: Twitter)

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Rio Tinto's Bingham County copper mine in Utah after a massive landslide in April 2014

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Jim Bob Moffett in Indonesia (photo: RimaNews.com)

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Issue 150, December 2015

More than two years after a massive landslide at its Bingham County copper mine in Utah, Rio Tinto is still removing the debris. Three trucks remain buried under 150 million tonnes of waste rock, which Rio is cleaning-up, patiently rebuilding its position at the heart of America's giant copper porphyries.

Directly to the south in Arizona, its 1.6bn tonne Resolution copper deposit, co-owned by BHP Billiton, was given the green light by US Congress last year. And sitting in between are Morenci, Bagdad and Safford, the biggest copper mines in Arizona, owned by Freeport-McMoRan, the biggest miner in the US.

Increasingly, Rio and Freeport's copper assets are lining-up. Throwing in Grasberg in Indonesia, which the two companies already co-own, and their combined copper output totalled 2.4m tonnes last year, equal to 13 per cent of the global market.

Rio also recently signed a $75m joint-venture with explorer Reservoir Minerals on Serbia's emerging copper belt, a small but surprising move onto new territory, only 10km from a joint-venture Reservoir already holds with Freeport. Earlier this month, Rio followed-up the deal with a second, buying into a 132 sq km land package nearby.

Jim Bob Moffett

As Rio barges ahead, Freeport looks rudderless. After a $9bn oil acquisition in 2012, its debt has spiralled from $4bn to $20bn, the oil price has halved and its share price has tanked 80 per cent in the last 18 months.

Investors immediately hated the oil deal. On a conference call, BlackRock's Evy Hambro publicly attacked Freeport's former CEO Jim Bob Moffett. “Congratulations,” Hambro said. “I haven’t heard anything on this call that in any way justifies why these companies should be put together.”

Bizarrely, BlackRock held onto its stake (and Moffett is now Freeport's chairman), but the market has punished the company and in August, investor Carl Icahn disclosed an 8.5 per cent holding.

Icahn the Agitator

A former stockbroker born in New York, Icahn, 79, has fought his way to the top of America's investment tree.

Described as “competitive”, “pugnacious” and “terrorizing”, his investment style involves badgering management, firing chief executives and breaking companies apart. His specialist industry is any. He has done it with Texaco, Trans World Airlines and PayPal. He has also tried it with Motorola, Time Warner and US Steel.

Freeport's shares rose 28 per cent on news that Icahn had entered the stock, a typical market response to his interest in a company, known as “The Icahn Lift.”

 

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Rio Tinto's group CEO Sam Walsh (photo: Rio Tinto)

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From the outset, Icahn has made it plain that he will agitate for change, pledging to address Freeport's “executive compensation practices” and the “curtailment” of high cost production.

Within hours, Freeport revised its capital expenditure budget lower. The company has also axed its dividend and the size of its board (down from an outlandish 16) and has launched a strategic review of its oil business, including a “spinoff” or “separation”. Even within Icahn's portfolio, which includes Transocean and Chesapeake Energy, it is easy to find companies better suited to the oil assets, freeing-up Freeport's copper business.

Flipping the Switch

Rio Tinto, meanwhile, has quietly flipped the switch from asset sales to expansion.

Sam Walsh has sold $4.5bn of assets since becoming group chief executive in January 2013, but approved a $1.9bn bauxite investment in November and is planning a $500m investment in the Bunder diamond deposit in India. On a charm offensive with the Australian press in recent weeks, Walsh has said Rio is growing “because we can.”

Sources say that internally, Rio has been pre-occupied locking-in a $4.4bn financing package for an expansion of its giant Oyu Tolgoi copper


mine in Mongolia, but the agreement closed on Tuesday and Rio anyway runs its M&A division as a standalone unit. It also relies heavily on advice from Macquarie Bank's Sydney office.

Unique Standards

By any normal standards, 2015 has been a terrible year for Rio. China's steel industry has begun contracting and the price of iron ore, its mainstay commodity, has plunged from $70 to $38 per tonne, more than offsetting its aggressive output growth.

Rio has outdone peers by maintaining its dividend, plus a $2bn share buyback, but for shareholders, its impressive 8 per cent dividend yield has been shredded several times over by a 38 per cent drop in its share price.

Yet to its credit, by flooding the market, Rio has bludgeoned its way to winning a price war. The company is producing iron ore for $16 per tonne, versus $20 a year ago, and can squeeze that figure as low as $11 per tonne by 2017, according to Deutsche Bank. Even if prices go lower, Rio is still paying down debt.

“We have the strongest balance sheet of any of the major mining companies,” Walsh has boasted, reiterating that he plans to continue low-cost expansions. “Rio Tinto will play its own game. We’re in a very unique position.”

The company's turnaround, Walsh has said, will one day be studied as “a Harvard case study.”

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Freeport's Morenci mine in Arizona (above) has higher margins than either Grasberg or Bing-ham County

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Rio will be shipping iron ore to China for $11 per tonne by 2017, according to Deutsche Bank

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Poison Pill

At Freeport, Icahn has blocked the company from introducing a poison pill, making it more difficult for Jim Bob Moffett to defend a takeover bid. But according to one source, who has also considered buying Freeport, its Grasberg mine in Indonesia is enough to deter acquirers.

Accused of polluting rivers and funding politicians, Freeport has faced decades of controversy over the mine. In 2005, The New York Times uncovered a paper-trail of payments from Freeport to military bosses. The company also pays Henry Kissinger, the string-pulling US diplomat, who has longstanding interests in Indonesia, to advise on its continual renegotiations with the government.

Another obstacle for Rio would be winning Chinese regulatory approval, which Glencore vaulted, when it swallowed Xstrata in 2012, by selling its Las Bambas copper mine in Peru to China's MMG for $6bn. Selling Freeport's share of Grasberg to a Chinese company, such as Zijin Mining, would resolve both issues at once.

Earlier this year, Zijin bought into Barrick Gold's Porgera gold mine in Papua New Guinea, which is facing an almost identical cocktail of environmental liabilities and mining license disputes. Zijin's chairman has meanwhile said that he is prowling for up to $5bn of deals.

Costs & Scale

Selling Freeport's share in Grasberg would also trim Freeport's debt, much of which can be dumped with the oil business. Only $12bn of its borrowing is attributable to its mining assets, of which only $3.7bn is due to fall in the next 5 years. Rio's gearing is meanwhile sitting at 21 per cent, lower than peers and at the bottom of its guidance of 20 to 30 per cent.

Synergies could be compelling, or at least, compelling enough to get passed shareholders. Stripping out Freeport's overhead, which Icahn has also taken aim at, would save $592m each year. Sam Walsh, who has cut Rio's headcount in London from 600 to 250, could close Freeport's headquarters completely.

Cash costs at Freeport's copper mines in Arizona are higher than at Rio's Escondida mine in Chile, but in line with Oyu Tolgoi and below either Grasberg or Bingham County. And as Rio's case study in iron ore has re-emphasised, production costs and scale are everything in the commodities business.

The Top

A Rio-Freeport deal would be the largest in the mining industry for several years and would arguably end the industry's current phase of continual retrenchment. But the ultimate prize for Rio, after more than a decade in second-place, would be retaking the title of the world's largest mining company from BHP Billiton.

Rio's profitability is already higher, but un-encumbering Freeport's copper business from its oil assets could propel Walsh over the top. Perhaps there are too many moving parts. But Rio need not do the hustling. Carl Icahn is already hard at work, unlocking the value that is buried in Freeport's copper business.

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Grasberg in Indonesia, co-owned by Rio & Freeport

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Freeport's headquarters in Phoenix, Arizona. Its corporate overhead cost shareholders $592m last year, equal to 3 per cent of sales

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Freeport's Safford operation, which hit full production in 2008, is the largest new copper mine built in Arizona for 30 years

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