Tim Cohen
19 November 2007
column
Johannesburg — ACCORDING to the Wall Street Journal, Anglo- Australian mining giant Rio Tinto is considering the Pac-Man defence in its effort to ward off the bear hug of its rival BHP Billiton. Citing "people close to the matter", Rio is thought to be considering the option, which would entail effectively turning the tables on BHP in a rare manoeuvre coined in deference to the video game in which the pursued character can turn and eat its attackers.
Should we take this seriously? The short answer is probably not, and, certainly, people close to BHP are not taking it seriously.
Consider what such a manoeuvre would entail. Rio management would have to try to convince its shareholders that instead of accepting a premium for their shares, they should offer a premium to BHP's shareholders. It's a racing certainty that Rio shareholders will not be particularly enamoured with that idea. It's mainly because of this flaw in the mechanism that the Pac-Man defence has such a poor record. It's most attractive when the bidding company is smaller than the target, which is not the case here.
Or is it? The only way to make it work would be to contrive a way to magically make BHP smaller than Rio, and strange as it seems, this is not impossible. For years, analysts have been quizzical about BHP's continuing decision to remain wedded to its oil and gas assets, which entail a very different industrial methodology.
In recent years with the oil price rising dramatically, the decision looked like a good one for BHP shareholders. But oddly, the share price rise of oil companies has trailed that of the mining giants, despite the price of oil increasing faster than the average price of the collection of minerals typically mined by the giants. The reason partly has to do with an increase in oil nationalism which has made investors a little nervous and raised the risk of investing in oil companies.
So currently, the inclusion of the oil and gas in BHP's mix of products could conceivably be tempering its otherwise buoyant share price. Ah! say Rio's advisers. What if we offered to sell BHP's oil and gas assets as part of the merger? Now a possibility exists to realise value on the one hand, and to effectively decrease the notional size of BHP. This would make a bid less difficult for Rio to swallow, and might even hold some attraction for BHP shareholders beyond the premium Rio would offer.
Even better, what if the buyer of the oil and gas assets were Chinese? This would surely go a long way to assuaging likely Chinese concerns about the pricing power of a combined Rio-BHP. Suddenly, the idea of the Pac-Man defence is beginning to look a lot better. But this doesn't entirely do away with the downside risk of a Pac-Man defence, which by its nature plays into the hands to a large extent of the opponent. First, it effectively concedes that there is a clear rationale for the merger to take place. Any arguments that Rio might otherwise have suggested immediately go out the window. Second, the defence tends to press managements into an agreed bid because it effectively signals the danger that a tit-for-tat bidding war could begin. Suddenly, shareholders will get very itchy about getting the managements together because the risk of overpaying will quickly jump sky-high.
But a meeting of managements is exactly what BHP has been pressing for. Pac-Man is really designed for a context in which the bidding process is hostile, and this point has not been reached -- or has not yet been reached -- in this proposal. In this case there is a real danger from the point of view of Rio shareholders that BHP management might just accept the counteroffer.
The result would be that Rio shareholders would have to carry the burden of the premium rather than BHP shareholders, as is now proposed. This will not make Rio shareholders happy.
The Wall Street Journal article makes the point that the Pac-Man proposal suggests that just the fact that the company is considering this rather outlandish defence shows how limited Rio's options actually are.
It's too big to look around for white knights, the industrial logic of the deal is rather good, and the management culture is similar. Effectively, there is not a lot it can do, other than press on with its claim that the bid -- proposal we should say -- undervalues the company.
The Journal suggests that even if the Pac-Man defence is unsuccessful, it can have some beneficial side effects, such as helping Rio highlight its own value and perhaps helping preserve its management, should a friendly deal come together. The problem is that BHP's proposal is not hinged on deriding Rio's value or making extravagant claims about its superior management.
And then there is that other little thing: the Pac-Man defence has never actually worked before. That's always a downer.
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