• WSJ
  

• BUSINESS
• FEBRUARY 10, 2012

Alcan Proves Costly to Rio Tinto

By JOHN W. MILLER

Rio Tinto's $8.9 billion write-down on its Alcan aluminum division casts a pall over the struggling aluminum sector and offers a cautionary tale to mining companies contemplating big buys, the most significant being Glencore International AG and Xstrata PLC's current plans to combine into an $80 billion mining giant.

Rio Tinto has now written down $18.2 billion—nearly half of the $38 billion purchase price—since it bought Alcan Inc. in 2007, illustrating the risks of big acquisitions in such a cyclical industry. If the Glencore-Xstrata deal works out, it would be the biggest mining deal since the Alcan purchase.

Rio Tinto/European Pressphoto Agency

Rio Tinto took a hefty write-down in 2011 for its Alcan division. Excluding the item, the company's earnings was buoyed by iron ore. Shown, a truck deposits a load of iron ore at Luce Pit, Labrador City, Canada.

Rio Tinto Chief Executive Tom Albanese told reporters Thursday that the write-down "reflects the heavy price of acquiring Alcan for what we now know was the top of the market." As the takeover "happened on my watch," Mr. Albanese said he would forgo his 2011 bonus. He received a bonus of $2.5 million in 2010.

The company reported 2011 net earnings of $5.83 billion, down from $14.24 billion in 2010. But excluding items, the company's full-year underlying earnings rose 11% to a record $15.5 billion, driven by iron ore. Revenue increased 9.7% to $60.54 billion.

Analysts say there are several reasons for the bad bet. Rio Tinto outbid Alcoa Inc. during a dizzy M&A binge. "Mega acquisitions tend to destroy value because they tend to overpay," said Dan Rohr, an analyst with Morningstar Inc. in Chicago.

Aluminum prices, just under $3,000 a ton in 2007, were expected to continue their rise. Instead, the prices fell to under $1,500 a ton during 2009 before settling to around $2,200 today.

Alcoa, the world's biggest aluminum company, last month reported a fourth-quarter loss of $191 million, compared with a year-earlier profit of $258 million. It curtailed production at plants in the U.S., Italy and Spain, due to the recession in Europe and generally downbeat consumer confidence elsewhere.

Aluminum is more dependent than iron ore on ordinary consumer goods like food cans and household appliances. And China has emerged as a far greater force in aluminum than many in the industry thought. "All the big Western aluminum firms like Alcoa and Alcan have been saying for 10 years that the Chinese would disappear," said John Tumazos, an analyst for Very Independent Research LLC. "And they were wrong."

Chinese production has increased to 17.8 million tons in 2011 from 12.5 million tons in 2007, the year of the Alcan acquisition, according to the International Primary Aluminum Institute, a trade group.

During the first 10 months of 2011, the latest data available, China's $7.5 billion aluminum trade surplus was No. 1 in the world, according to data provider Global Trade Information Services. By comparison, the U.S. had a $2.4 billion aluminum deficit. And the U.S. was China's biggest customer during the first 10 months of 2011, buying $1.6 billion from China, according to GTIS.

Timothy Reyes, head of Alcoa's material management, said analysts have overestimated the effects of Chinese exports. Chinese production is "vulnerable because of high energy costs", and a large portion of its exports have been of semifinished goods made out of aluminum that was imported and then transformed into more valuable products like bars and strips, he said. The data support Mr. Reyes's point.

China's net trade surplus in total tonnage—not value—was 1.4 million tons in the first 10 months of 2011, according to GTIS. That's middle of the pack, behind Russia, for example, which had a surplus of three million tons. The U.S. was roughly flat.

Write to John W. Miller at john.miller@wsj.com