Key points:
- Rio Tinto's bid for Turquoise Hill has been increased
- There's an 8% turn to be had on the TRQ price right now
- Is this free money or not?
Rio Tinto (NYSE: RIO) has returned to Turquoise Hill (NYSE: TRQ) with a sweetened takeover off for that portion of the company it does not already control. This new RIO offer for TRQ is pitched at $40 – but be careful, that's CAD$ 40, meaning some USD $30.75 or so. However, the Turquoise Hill share price is actually down a touch today after rising strongly yesterday, leaving a roughly 8% gap between the cash offer and what we can buy for in the market. So, is this simply free money on offer – should we fill our boots with TRQ stock?
There are two different sets of calculations to make here and it's the combination which leaves us with the final decision structure. There are – very occasionally – free money offers in stock markets and this may or may not be one of them. The most obvious point here is risk. Yes, we've got a cash offer and it's from RIO, who aren't going to back out. Partly simply because they're Rio Tinto and also because of the importance to Rio of the Oyu Tolgoi copper and gold project in Mongolia's ownership. Turquoise owns 66% of the project, Rio wants to own it all, therefore RIO wants to own all of TRQ.
However, there's still risk here. There was an earlier offer for TRQ from RIO and that was rejected by the Special Committee set up to consider it. As we said at the time this could just be the TRQ attempt to shake better terms out of RIO. That's clearly worked – but what if TRQ tries that again and thereby the entire bid fails?
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Over and above risk we've also got to think about the time value of money. There is that 8% gap between what we can buy TRQ at now and what we're pretty sure we can sell it to Rio Tinto at some future date. But how far in the future? That's the thing. This is not going to be something that gets wrapped up in a couple of weeks – even if the Special Committee now agrees. It will take months, at best, before selling shareholders have Rio's checks in their bank accounts.
One way to look at this is that 8% is better than anything we're getting off a bank account. So, buy, hold and we're getting free money. Assuming we value the risk lowly then this is close to free money and we should fill our boots.
The other way to look at this is that we're in an inflationary environment. The US inflation rate is some 8% or so at the moment. So, imagine that this Rio bid for TRQ takes 6 months to go through (just an easy set up to make the math simple) then we lose 4% just waiting for the money. That brings it down to a 4% profit. Then add in taxes – we'd be paying short term – ie, income rates – capital gains tax on any such move. And that, depending upon place of residence, could be 50% – but that's always 50% of the nominal gain, not 50% of the real gain after inflation.
It depends how we want to think thorough these things, our reactions to inflation, our tax position and so on. Before we even start considering the risk. 8% might not, in fact, be free money.