Rio Tinto to Favor Buybacks Over M&A to Fend Off Glencore

Rio Tinto Group (RIO) is under pressure to deliver on the chief executive officer’s promise to become a “cash machine” for investors as it justifies snubbing a merger approach from Glencore Plc.

With Glencore effectively barred from making a renewed bid until April, Rio has a window to woo shareholders through stock buybacks and selling non-core assets. In August, CEO Sam Walsh said his $3.2 billion cost-cutting drive increases the options for distributing excess capital.

Now, with Glencore CEO Ivan Glasenberg hovering, investors say it’s time for Rio to act on Walsh’s words. He’ll update hareholders on the company’s strategy at seminars in Sydney on Nov. 28 and London on Dec. 4. Rio will then post full-year results in February when analysts say it’s likely to announce the first buyback since 2012.

The possibility of a hostile offer next year will compel Rio to shore up investor support, Clive Burstow, an investment manager in global resources at Baring Asset Management, said.

“If Rio doesn’t deliver a buyback that the market is happy with investors will say ‘well why should we continue to back you as the management team?’” said Burstow, who helps oversee about $800 million and counts Rio as a top 10 holding.

Walsh, a 64-year-old Australian with a passion for collecting milk jugs, has cut costs and slashed debt incurred when Rio paid $38 billion for Alcan Inc. seven years ago. The company has a checkered history of acquisitions with more than half the value of the Alcan deal written off and a $3 billion writedown in 2013 on a Mozambique coal deal.

Poison Pill

Those failures led previous CEO Tom Albanese to quit and will probably deter London-based Rio from making another deal, even if it were to serve as a defensive move against Glencore, according to Citigroup Inc.

“Rio is unlikely to swallow a poison pill and make an acquisition after their experience with Alcan,” Citigroup analysts led by Clarke Wilkins wrote in an Oct. 23 report. “The most likely outcome is for the company to gear up and buy back stock and spin off non-core assets, such as Alcan.”

Spokesmen for Rio and Glencore declined to comment.

Asset Sales

Reviving previously scrapped or stalled asset sales may provide additional cash to appease investors.

In August last year, Rio deferred a 2011 plan to divest Australian and New Zealand assets known collectively as Pacific Aluminum as it didn’t get the price it wanted. Two months earlier, Rio said it would keep its diamond business after failing to find a buyer and deciding not to pursue an initial public offering. Rio was also seeking to sell its Canadian iron-ore operations, a person close to the matter said in March.

In rejecting Glasenberg’s July offer, Rio Chairman Jan du Plessis said the company was better off sticking with its strategy of reducing costs and returning cash. It’s also committed to cutting net debt to the mid-teens, a target it reached at the end of the first half when borrowing was lowered to $16.1 billion.

For Rio to keep that unchanged, it could fund a buyback of $1 billion to $1.7 billion, according to HSBC analyst Andrew Keen. Even with asset sales or reduced spending, Rio’s probably can’t afford a buyback of more than $5 billion “without accepting sustainably higher levels of financial leverage,” HSBC said.

Jefferies has predicted Rio will announce a buyback of $3 billion to $5 billion next year.

Veer Away

Richard Knights, the top-ranked analyst covering the company, according to Bloomberg data, doesn’t think Rio will veer off strategy merely to frustrate Glencore. Knights, who has a sell rating on the stock, expects the company will stick stick to the cost-cutting and buyback plan outlined by Walsh.

“I just don’t think Rio is sitting there looking over their shoulders thinking they’ve got to do something about the Glencore approach,” he said.

A continued slump in the price of iron ore may hamper Rio’s capacity for buybacks and play into the hands of Glencore’s dealmaking CEO who’s been critical of the mining company’s role in feeding a global glut of the steel-making raw material. Iron ore, which was responsible for almost 90 percent of Rio’s profit in 2013, has declined 40 percent this year.

Glencore “certainly does play a waiting game in terms of when is the right time in the cycle to be buying and selling,” Neil Gregson, who manages about $3 billion of natural resource stocks at JPMorgan Asset Management in London and counts both Rio and Glencore as top-five holdings. “It might play out over the next one to two years.”

(Source: Bloomberg)