Pressure on miner BHP Billiton to lift its offer for rival Rio Tinto is likely to intensify as Rio's profits grow, its big Chinese shareholder mulls buying more shares and disposals reap healthy returns.
While BHP navigates through a process of up to a year to gain approval from global competition authorities, Rio is poised to post stronger earnings than its suitor in coming months.
The credit crisis was not expected to affect BHP's take-over plans since it has already raised $55 billion in loans it needs to refinance Rio's debt and carry out a promised share buy back.
"Rio Tinto shareholders deserve considerably more given their company's demonstrable growth potential," said analyst Charles Kernot with Seymour Pierce in London.
Ever since BHP announced last November it wanted to swallow Rio to forge a mega-mining group worth over $300 billion, Rio has said the all-share offer was much too low, even after it was sweetened last month.
BHP wants to buy Rio by paying 3.4 of its shares for each Rio share, up from an informal proposal of 3.0 shares.
It cannot send out formal offer documents, however, until it gets approval from anti-trust authorities, a process it has said would take nine to 12 months.
As BHP becomes embroiled in hearings with steel firms who have vowed to fight the creation of a firm that controls over a third of iron ore trade, Rio is poised to post rosy profits.
Mid-year, Rio is due to post a 51 percent jump in first-half earnings per share while BHP, whose fiscal year ends in June, is expected to only show a 12 percent rise in full-year EPS, according to analyst forecasts gathered by Reuters Estimates.
The tables are expected to turn next year when BHP's profits are due to outshine those of Rio's, but that is likely to be well after any merger is successful or not. BHP might also be confronted by more buying of Rio shares by Chinese aluminium group Chinalco, which said this week it was consulting US partner Alcoa about upping its stake.
The surprise purchase by state-owned Chinalco and Alcoa of a 9 percent stake in Rio in February sparked speculation about whether the move was designed by China to disrupt BHP's take-over plans. Officials in China, the world's largest buyer of metals, have said a combined firm would have too much pricing power.
The price Chinalco paid for its Rio stake - 60 pounds a share - was a 21 percent premium to the market price at the time, which some investors saw as a benchmark BHP would have to take into account upon any further sweetening of its offer.
BHP shares fell 2.7 percent to 14.02 pounds, compared to a 3.6 percent fall in the UK mining index. "If Chinalco wants to increase their stake further, then it suggests they're not rushing to accept whatever offer BHP has on the table," said a fund manager who declined to be named.
Another investor, a London hedge fund manager who holds both Rio and BHP stock, said BHP might seek to forge a behind-the-scenes deal with Rio on a higher bid to forestall any more interference from the Chinese.
"It would make sense to do it now because if they come to a friendly agreement it would be much harder for the Chinese to do something," he said. "Whether they are going to pay up now or later on, the price is not going to be materially different.
He estimated that BHP would have to boost its bid ratio to 4.0 shares from the current 3.4 to get a recommendation from Rio's board. Analyst Kernot has set a target price of 71.25 pounds for Rio.
Rio has a higher valuation than other miners, with a price earnings ratio of 18 versus 12 for BHP, 13 for Xstrata and 10 for Anglo American, according to Reuters 3000 Xtra.
The credit crisis was not expected to affect BHP's take-over plans since it has already raised $55 billion in loans it needs to refinance Rio's debt and carry out a promised share buy back.
While some shareholders, especially hedge funds, have called for BHP to add a cash element to its offer, that issue is secondary to the absolute level of a higher bid, analysts and fund managers said.
Prices of most commodities have shot up in recent months, confounding many predictions that a boom over the last several years had touched a cyclical peak and would taper off. While both BHP and Rio will enjoy the commodity gains, Rio has a stronger position in iron ore, which saw some of the sharpest price increases.
Iron ore contract price settlements between the biggest producer Vale of Brazil and Asian steel firms jumped 65-71 percent last month, but Rio Tinto has said it wants greater hikes to account for cheaper freight from Australia.
Rio ranks second in iron ore and produced 144.7 million tonnes in the 2007 calendar year, 40 percent more than BHP. The outlook for Rio has also been bolstered by a successful start to a disposal programme prompted by a need to whittle down $40 billion in debt it took on to pay for Alcan.
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