The Commodity Investor Q&A
With Matt Badiali
December 3, 2008

Q: The Billiton takeover of Rio just fell though. Any comments on the effect of this on the future of the two? – H.S.

A: As I told my S&A Oil Report subscribers yesterday, the party is over. The biggest merger in commodity history, between BHP Billiton and Rio Tinto, died with a whimper last week.

These two companies are among the world's largest commodity producers. They mine everything from coal to iron ore to diamonds.

Last November, BHP Billiton offered to buy Rio Tinto for $127 billion. In February, it upped its bid to $147 billion, a 26% premium to the share price. It's no wonder BHP was willing to pay up. The combined company would have been a commodity juggernaut. Take a look at what it would have controlled:

A year ago, this looked like a great idea. Commodities were in the fifth year of the bull market. Prices were stronger than they had ever been. It would have been the second-largest merger in history, and banks were lining up for a piece of the deal.

Then the entire commodity sector tanked, and banks got scared. While they couldn't back out directly, a delay gave them an escape hatch...

The European Commission, which regulates mergers in Europe, held up the deal and ultimately suspended its review, claiming the companies weren't supplying requested documents. Of course, by then, all the commodity prices were in the toilet, and markets were heading that way as well.

On November 25, BHP withdrew its bid. BHP's shares, which were down 75% from its high this year, rallied 15% on the news. Rio Tinto is another story. Its share price fell 27% after BHP backed out. The company recently hit its 52-week low and is down 85% from its high.

It's possible BHP is merely biding its time, hoping to buy Rio for a much lower price. But I'm not so sure Rio will fall much farther. Let me explain...

Rio Tinto is the largest aluminum producer in the world and the second-largest iron-ore producer. Iron ore and aluminum account for half of Rio Tinto's earnings. Aluminum prices fell 48% from the high, and iron ore prices are down 63%. It sounds bad, but that's not nearly as far as zinc (-74%) or nickel (-82%).

As a geologist, I love Rio Tinto. It's a global mining company with an interesting suite of mines and products. However, as an investor, I can't get past one big problem on the balance sheet: $42 billion of debt.

Rio should earn $19.8 billion in 2009. With that kind of cash coming in, it can more than cover its interest expense ($1.26 billion) and possibly pay down the $15 billion coming due in October. But it's going to be a close call. If earnings come in low, the stock will be crushed.

Your Road Map to the Bull Market in Gold Something Terrible Is Headed for Royalty Trust Shareholders

So I'm not in a hurry to buy Rio Tinto. I want to wait for two things to happen. First, I want to see what the fourth-quarter earnings look like... We could be in for a big bad surprise. Second, I want to see the price trend turn positive.

That's not going to happen until every last investor holding on in hopes of a merger throws in the towel. I think that'll take awhile. Too many investors made too much money during the big commodity party. Everyone's waiting for the music to start back up.

Good investing,

Matt

P.S. I got a lot of questions wondering why I'm bearish about Penn West, a royalty trust I covered in last week's Q&A, when I was bullish on the company just two months ago. Check in next week for a full explanation. And send any other questions you have to editorialfeedback@growthstockwire.com.

Delinquent Mortgages to Double By 2010
The number of consumers with delinquent mortgages is poised to almost double by the end of next year, hitting its highest level in at least 16 years, according to a leading credit bureau.

TransUnion LLC, which analyzed about 27 million consumer records in its database, predicted that the proportion of consumers with mortgages that are 60 days or more past-due will hit 7.17% in the fourth quarter of 2009. WSJ ($) Read on...

States Want Government Bailout
U.S. states' budget shortfalls may be as much as $200 billion this year and next, Pennsylvania Governor Ed Rendell said, as officials press the federal government to boost construction spending and aid cash-strapped states.

A day before governors are set to meet with President-elect Barack Obama, Rendell, a Democrat who chairs the National Governors Association, said about $136 billion in construction projects are ready to begin if the federal government provides money under an economic stimulus plan. Read on...