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BHP Bails On Rio Tinto

Tina Wang and Javier Espinoza

Miner says efforts to build the world's largest iron ore producer were doomed in today's financial climate.

• Jilted Rio Drags On Europe
• E.U. Opens Fire On BHP
• Rio Tinto's Fortunes Tied To China's Deceleration

Miner says efforts to build the world's largest iron ore producer were doomed in today's financial climate.

Steelmakers and certain shareholders of mining giant BHP Billiton can break out the champagne: BHP walked away from its year-long pursuit of rival Rio Tinto on Tuesday, saying that the mega-merger would be too risky amid the global downturn.

Shares of Rio Tinto plunged 32.6%, to 16.52 pounds ($25.28), near the close in London, while BHP Billiton rose 12.5%, to $34.10, in New York.
Objections from European antitrust regulators for the proposed $66.0 billion, all-share takeover appeared to be a key issue. In a statement filed to the Australian Securities Exchange, BHP Billiton (nyse: BHP - news - people ) expressed concern that given the sharp drop in commodities prices and worldwide economic turmoil, it was uncertain whether it would be able to reap fair value for the assets that the European Commission wanted it to divest.

The miner also said it was put off the deal by the high levels of debt that it would it would need to service amid an environment of tight credit and diminished cash flows. BHP said it would write off approximately $450.0 million for the costs of its pursuit of Rio Tinto (nyse: RTP - news - people ) since last November, when it posts half-year earnings in December.

BHP Billiton chairman Don Argus said that the company still believed in the "basic industrial logic" of a merger and remained bullish on long-term resource demand from emerging economies. But it expected European regulators to require asset sales in iron ore and metallurgical coal that would be too costly to pursue (See "Europe May Balk At Mining Mega-Merger").

"In the normal range of economic conditions BHP would have been prepared to offer remedies which we believe would have been both acceptable and manageable," the statement read. But "uncertainty regarding our ability to achieve fair divestment values in the required time frames, add to costs and risks of transaction," hurting the interests of its shareholders.

Some analysts were surprised by the scrapped offer. "I always thought the bid was going to go ahead," said Kieran Daly, an analyst with Investec Securities in South Africa. "But uncertainty of BHP's ability to refinance the Rio debt and the uncertainty about cash flows because of commodity prices has made it more difficult. The bid was looking very expensive."

"My view is that the market's moved against the situation, plus Rio is saddled with debt," said Michael Komesaroff, an analyst with Urandiline Investments. "With the subprime crisis, nobody can get any money to buy anything. Rio's got problems but they're not of BHP's making. They've got a phenomenal amount of debt."

"The market has changed dramatically in the last six months. What made sense six months ago doesn't make sense now. People talked about synergies in iron ore. Those synergies are still there, but nobody is prepared to pay for them," the analyst said.

A sharp decline in commodity prices from their record highs in the first half of the year have been weighed by concerns about slowing demand from faltering economies and have also squeezed BHP Billiton's profit margins.

BHP Billiton also has its money earmarked for other things. Just moments after dropping its bid for Rio Tinto, BHP said it would take a $2.1 billion pre-tax impairment charge on two Australian nickel mines, and it also approved spending $5.0 billion on iron ore expansion.

BHP has meanwhile announced an approval of plans for a $4.8 billion investment to increase installed capacity across its western Australian iron ore operations by 50 million tons per year, to 205 million tons per year, including previously approved capital of $930 million.

In February, BHP made a formal offer of 3.4 shares for each Rio share, which was worth over $140 billion at the time. A combination of the two miners would have created the largest iron ore producer in the world, a prospect that raised fierce opposition from steelmakers around the world, who were worried that the resulting company would have inordinate power over prices. Chinese steelmakers were among the most outspoken, with Aluminum Corp. of China (nyse: ACH - news - people ), or Chinalco, going as far as buying a stake in Rio to influence the proposed deal (See "Australia Steps Out Of Chinalco's Way").