Rio wasn't the only loser in Alcan deal

KONRAD YAKABUSKI
Globe and Mail
December 11, 2008

MONTREAL -- Not long ago, Alcan chief executive Dick Evans hinted that he might have sold out too soon when he signed the record-setting, mid-2007 deal to surrender the Canadian icon to Rio Tinto PLC for $38.1-billion (U.S.). Only months later, he figured Alcan was already worth more than that.

It seemed overly optimistic, considering that BHP Billiton - which then still had an offer for Rio Tinto on the table - was pegging Alcan's worth at only $20-billion. Now, we know it was.

Almost every independent observer now concedes Rio Tinto overpaid for Alcan when it put up $101 a share in cash, a 66-per-cent premium over the price the stock was trading at before it had been put in play by an earlier, hostile bid from Alcoa Inc.

The price was a windfall beyond all contemplation for Alcan's shareholders, including top management, who rightly took advantage of multiple suitors' willingness to outbid each other for the company.

But the $39-billion in debt (almost all of it from that deal) on Rio Tinto's balance sheet - an amount that now surpasses Rio's own market capitalization - will now force Alcan to cut jobs, production and capital spending in Canada. Rio unveiled the bad news yesterday.

It means a host of long-promised projects - from Kitimat, B.C., to Saguenay, Que. - are in limbo.

Alcan says "it remains committed" to the expansion of its Kitimat smelter and will "honour all the obligations" of an agreement with the Quebec government that grandfather the company's vast and lucrative hydro operations in the province in exchange for jobs and investment. We just don't know when we'll ever see the money.

"Whenever anyone says 'we commit' it doesn't mean 'we've spent,' " notes one long-time Alcan observer in British Columbia. "They can change their minds, and they have many times in the past." So far, Alcan has "committed" only $500-million to the Kitimat modernization - a project expected to cost upwards of $2.5-billion. Should the overhaul be delayed much longer, the new smelter likely would not be up and running before the current 54-year-old facility dies of old age.

Many in Kitimat and on Bay Street alike think that would suit Alcan - and Rio, if it manages to hang on to its aluminum division - just fine. Alcan owns its own hydro generating facilities in B.C., and produces far more power than it needs to make metal. It sells the surpluses to BC Hydro. Even at lofty aluminum prices, its margins on energy sales surpass those earned in smelting.

As in Quebec, Alcan was initially granted the water rights by the B.C. government to produce power in exchange for building smelters that provide hundreds of jobs. But though you might make the case that Alcan has a moral obligation to proceed with the Kitimat expansion, B.C. courts have established that it has no legal one.

So, if it hasn't done so in the first quarter century since a new smelter was promised, what are the odds it will do so in the next?

As long as Rio Tinto is rationing capital, if not fighting for its life, the odds aren't high. Besides, instead of fetching the $4,000-a-tonne Mr. Evans was projecting just last spring that aluminum could command in the near term, the price of the lightweight metal is currently hovering at a five-year low of about $1,500.

Cheap hydro power makes Canada a great place to make aluminum, since, globally, energy accounts on average for about one-third of smelting costs. The near-free electricity Alcan produces for itself here means that it has an unbeatable advantage over competitors. But if Alcan can sell electricity to government-owned utilities, why, with capital already scarce, would Rio tie up new funds in more smelter capacity?

There are constraints on power sales - transmission capacity is restricted in B.C. (for now) and a more vigilant provincial government in Quebec seeks to protect the 6,000 Alcan jobs in the Saguenay region. But Rio Tinto's dire straits have given Alcan an excuse to buy time with governments.

In Quebec, that means the $3.5-billion (Canadian) that Alcan touts in slick TV ads that it is investing in the province will now be spent at a snail's pace, if at all. Premier Jean Charest can be thankful Rio Tinto waited until two days after the provincial election to drop the news. The government has extended advantages to the company that sell well in the Saguenay, but which are heavily criticized by economists in Montreal and beyond.

The Alcan deal remains the biggest corporate takeover the country has seen. It was a boon for the hundreds of lawyers and investment bankers working for Rio Tinto, Alcan, Alcoa and four other would-be buyers who kicked the tires. Shareholders were obviously winners. But as we're now finding out, there were losers, too.