After taking a massive $14 billion non-cash impairment charge on the balance sheet for the year 2012, Rio Tinto (NYSE:RIO) may be considering selling off its Mozambican coal business. While the news is far from officially confirmed and based largely on information from an industry source, the merits of the move may be worth contemplating. 
Of the $14 billion, approximately $3 billion will be taken as a charge against the Mozambican coal assets while the aluminum business will account for an impairment charge of nearly $11 billion. The Mozambican assets were acquired as recently as 2011, when Rio acquired Riversdale for $4.2 billion. The writedown of $3 billion thus wiped out nearly 75% of the value of the acquisition.
There are infrastructure issues in Mozambique that will take a long time to resolve. The Mozambican government’s policies have also upset Rio Tinto’s earlier plans to transport its produce from pit to port. In addition, the quantity and quality of reserves at Rio’s Mozambican mines have had to be revised downwards, providing another reason to rethink further investments. Given scarce capital availability, pressure from investors, and the recent leadership changes, an outright sale of this business looks like an option worth considering.
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What Went Wrong?
To successfully carry out mining activity, supporting infrastructure is needed to transport the produce from the mine to the port. Mozambique has a severe deficit of transport infrastructure, the need for which wasn’t felt before the mining industry took off. Rio’s mines are located in the Tete province, and coal from here needs to be transported over 600 km to Beira. From here, the coal is loaded on small vessels and sent offshore where it is reloaded to a loading terminal. The entire journey costs a lot. 
Rio initially planned to transport coal by barge along the Zambezi river, but the government shot down the proposal on environmental grounds. While both the government and the private companies like Vale are planning to build transportation infrastructure, it will take at least five years before results are visible on the ground. Not just that, the government’s share of costs alone are estimated to be around $12 billion, which is equivalent to Mozambique’s current entire GDP. Both Rio Tinto and Vale have taken substantial writedowns in the last couple of months leading investors to insist on better capital allocation. This is bound to cause reluctance on the part of these companies’ managements to commit further funds for investments with long gestation periods and uncertain returns. The falling price of coking coal, which Rio’s mines are expected to produce, hasn’t helped matters either.
The falling price of coal, reduction in the quality and quantity of estimated reserves and lack of clarity over future production owing to infrastructure bottlenecks together caused Rio to take a hefty impairment charge.
What Are Rio’s Options?
Since all mining companies operating in Mozambique are facing the same issues, a collaboration with rival companies to build shared rail networks could be an option. It would lower capital expenditure while serving the purpose at least for the time being. Rio could also opt to sell a minority stake in its Mozambican assets to coking coal customer countries like Japan and Korea in order to fund its activities. 
The last option would be an outright sale of the business. This would make sense if Rio doesn’t wish capital to be tied up for a long time without generating returns on the same. Sam Walsh has been appointed CEO for just three years. He has promised to focus on consolidation, and we think that he would be keen to steady the boat in these three years. Doing so would be difficult if he fails to stem the bleeding from unprofitable businesses. Rio has been emphasizing for some time that it won’t invest in businesses which are not scalable, which is why it is keen to sell off the diamond business.
If Rio’s management takes a call that it cannot trust the Mozambican government to take favorable policy decisions or show commitment towards improving infrastructure quickly, it might decide that coal prospects are not enough for it to stay put.
We have a Trefis price estimate for Rio of $45 which will be revised once the fourth quarter earnings results are out.Notes: