COLUMN-A Leng road to rights for Rio investors: Alexander Smith

-- Alexander Smith is a Reuters columnist. The opinions expressed are his own --

LONDON, Feb 23 - If Rio Tinto shareholders were to recall Jim Leng to the board only two weeks after he walked out over the miner's unpopular $19.5 billion deal with Chinalco, chairman and chief executive Paul Skinner and Tom Albanese would have to go. But what would Leng do then?

Despite his opposition to the Chinese deal, Leng could not abandon it immediately. That would be reckless given Rio's groaning debt mountain and a deteriorating market environment. What Leng needs to do is to find alternative funding options with a view to replacing Chinalco with something better.

There aren't many other options open to Rio, assuming that its objective remains to pay down roughly half of its debt mountain. Leng could present shareholders with three although two of those would probably end up being squidged together.

The most obvious alternative to the Chinalco deal would be a massive rescue rights issue. Indeed, this option, which Albanese and Skinner claim was originally rejected by the shareholders, seems to be back on the table. The big snag is capacity. There is no certainty that Rio could raise the full $19 billion it needs to satisfy its lenders over the next two years.

True, were Rio to scrap any dividend payout in 2009, it could cut this by up to $2 billion. But that would still leave a daunting $17 billion to raise - a huge mouthful. Such a large rights issue would require Rio to more than double its issued share capital. Not only is this a huge ask of shareholders, but of the banks which would have to underwrite it at a time of rocky equity markets and wobbly banks.

If several "cornerstone" investors could be persuaded to step up and back the issue, it could probably be done despite this volatility, although the discount would probably have to be pretty large.

Asset sales would be the second option. But to raise the full $19bn would require Rio to dismember itself at a bad time. A mix and match approach could make a bit more sense. Selling off the prized iron ore, copper and aluminium assets which Chinalco is buying into could, for instance, be twinned with a smaller rights issue and a dividend cut.

There would certainly be interest. BHP Billiton craves assets in which Rio has a stake, most notably the world's largest copper mine, Escondida. Brazil's Vale would also be interested. But this still wouldn't get round the timing point and is only likely to be swallowed if shareholders wouldn't back a big enough rights issue.

This might seem to rule out a full sale of the company. And in the case of almost any likely buyer, valuation would be a big sticking point. The exception would be BHP which is relatively cash rich, could deliver huge synergies and could pay in Australian/UK shares.

BHP would get round the value problem because there is a huge overlap between the two companies' share registers. For those holding both, valuation wouldn't matter so much because what they lost on one side would be made up on the other.

The big hitch with this proposal is that a bid from BHP would almost certainly attract the attention of the competition authorities. Brussels was pretty hostile when BHP bid for Rio last year, and there is no reason to think it would be different this time round. There would be a real chance of a deal failing to complete, leaving Rio at the mercy of its bankers.

Realistically, there doesn't look to be a "get-out-of-jail" card. If Rio's shareholders don't want it to sell assets to the Chinese, they will have to stump up to a big rights issue.

There's no reason why Leng is needed to deliver this message: Skinner and Albanese could do it. And to judge by the mood music, they already seem to be doing so.

-- At the time of publication Alexander Smith did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns, Reuters' customers can click on --