Much has been written of the proposed deal between Rio Tinto and major shareholder Chinalco, which will allow the Chinese aluminum company to increase its stake in Rio to 18%. Unsurprisingly, virtually all the commentary on the deal has been highly critical. However, what is most remarkable is not necessarily that the terms of the panicked sale are unfavorable to Rio shareholders, but that Rio Chairman Paul Skinner and CEO Tom Albanese were even still employed by the company such that they were able to negotiate the sale.

Last week, Rio wrote down US$8.4 million of losses, mostly stemming from its calamitous acquisition of Alcan in October 2007. That means less than 18 months after the purchase (which was championed by Skinner and Albanese), Rio conceded that it overpaid by more than 20% (the figure appears conservative, with the likelihood that Rio will be forced to make further write-downs unless the aluminum price recovers).

Shortly after the Alcan acquisition, in November 2007, Albanese told shareholders:

The rise in global demand is a trend that we expect to continue for decades because of fundamental demographic and economic shifts, especially in developing countries like China and India. We believe that the value in Rio Tinto is yet to be fully reflected by the market.

Albanese was right about one thing — in November 2007, the true value of Rio Tinto had not yet been accurately reflected by the market. The only problem is that Albanese was completely deluded as to Rio’s actual value and the stage of the commodity cycle. Back then, Rio shares were trading at around $110 per share, compared with $51 today.

While Skinner and Albanese have shown what appears to be questionable judgment, they remain amongst the world’s highest paid mining executives. In fact, Skinner is close to the best paid non-executive chairman of any publicly-listed company, having been paid (based on current exchange rates) AUD$7.75 million over the past four years — an average of AUD$1.93 million annually.

By comparison, BHP Chairman Don Argus, was paid AUD$1.4 million last year to oversee a larger, and far more competent board, while Telstra chair, Donald McGauchie, was paid $602,500 in 2008. Similarly, last year, Albanese received remuneration of more than AUD$19 million for his first full year as CEO — almost $5 million of Albanese’s remuneration was in cash. Albanese’s counterpart at BHP, Marius Kloppers, was paid AUD$10.5 million.

Last week, Rio Chairman-elect, Jim Leng resigned from the Rio board, apparently in disgust at the deal secured by Skinner and Albanese. According to reports, Leng was furious at the Chinalco deal, preferring, along with what appears to be a swathe of institutional shareholders, that Rio conduct a rights issue and targeted assets sales

While the Chairman and CEO must carry much of the blame for Rio’s failings, that is not to excuse Rio’s other directors. Last week, following Leng’s resignation, Albanese told media that “Jim Leng was out of step with the rest of the board and he is gone”, while Skinner claimed that “had Leng stuck around, he would have ‘finished up in a minority of one’, given the board (minus Mr Leng) was unanimous that the China deal was the right strategic option.”

If Skinner’s comments are correct, the remaining 15 Rio directors who approved the Chinalco deal must also share a large degree of culpability. While the vast majority of Rio’s directors are Oxford and Cambridge educated British aristocracy, Rio’s board also includes two Australians — AFL Chairman Mike Fitzpatrick and “Teflon” Rod Eddington.

Teflon Rod is alleged to have one of the fiercest intellects in corporate Australia, having been hand-picked to oversee both Victorian and Australian infrastructure studies. Eddington was even known during his university days as “God”, due to his alleged vast intellectual capabilities. However, if Eddington is God, many shareholders will soon be becoming atheists. For Eddington’s record as a director is becoming increasingly clouded. After departing as CEO of Ansett a year before it slipped in bankruptcy, Eddington ran British Airways, which underperformed the broader market during his reign.

Since becoming a professional director, Eddington was one of three independent directors who signed off on Allco’s purchase of Rubicon (the acquisition led to Allco’s collapse but benefited other Allco directors such as David Coe and Gordon Fell). Eddington was also on the News Corp board when it undertook the costly acquisition of Dow Jones (News Corp last week conceded it paid US$5.7 billion a year ago for a business now worth US$2.9 billion) and was a Rio Tinto director at the time of the Alcan purchase. (In a final link, Eddington is the Chairman of JP Morgan Australia, which is advising Rio on the much-criticised Chinalco deal).

As for the Chinese, it looks like they appear to have negotiated a shrewd deal. Not only because they are acquiring interests in world-class assets like Escondida and Hamersley Iron at bargain prices (overlooking the fact that the notional sale price of Escondida has been artificially inflated to overcome BHP’s pre-emptive rights), but also due to the political implications of the deal. As Shan Shanghua of the China Iron and Steel Association claimed last Friday, the Rio deal “will help China break the duopoly in Australian iron-ore supply over the long-term.”

The Chinalco deal appears to be a disaster for Rio Tinto shareholders and a boon for China, negotiated by an overpaid Chairman and a CEO determined to avoid the embarrassment of a heavily discounted rights issue which would have served to reinforce their prior failings.

Peter Fray

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