SCENARIOS-Snubbed by Rio, what will Chinalco do next?

BEIJING, June 8 (Reuters) - China's state-owned metals conglomerate Chinalco suffered a major setback last week when Rio Tinto (RIO.L)(RIO.AX) spurned its planned $19.5 billion investment in favour of a tie-up with BHP Billiton (BHP.AX)(BLT.L). [ID:nSYD73514]

Chinalco is the largest shareholder in Rio with 9 percent.

Following is a summary of paths Chinalco could choose:

DO NOTHING: LIE LOW AND LICK ITS WOUNDS

Under former president Xiao Yaqing, who conceived both Rio deals, Chinalco had grand ambitions to diversify and expand. But he left to take up a promotion within the government and his plans unravelled under his successor, Xiong Weiping.

Previous Chinese firms that made unsuccessful stabs at major offshore M&A deals -- CNOOC's bid for Unocal, Minmetals for Noranda, Huawei for 3com -- subsequently shied away from the takeover scene for years.

But some analysts say Chinalco is unlikely to retreat into the shadows since its initial Rio purchase established it as China's top acquisition vehicle, giving it confidence and prestige where others had failed, even if the latest setback was a rude shock.

SELL ITS STAKE

Rio's shares have fallen by half since Chinalco bought into it, so selling out now would realise a $7 billion loss on top of the loss of face. Chinalco's former president Xiao repeatedly described the Rio deal as a financial investment.

INCREASE ITS STAKE IN RIO

Chinalco has Australian government permission to raise its stake to 14.99 percent of Rio's London shares. That would mean about 11 percent of its total equity. Chinalco could buy the shares via Rio's heavily discounted rights issue, at 14 pounds a share, less than a quarter of what it paid for its existing stake. But even if it lifts its holding to the maximum, it will not qualify for a seat on Rio's board.

BID FOR RIO TINTO

Chinalco is known to have contemplated making a bid for Rio since, at the time of the initial investment, Chinalco and Alcoa said they did not intend to bid but reserved the right to do so if BHP Billiton or another firm made a firm offer for Rio.

Although Chinalco has access to almost unlimited finance, analysts say Australia's foreign investment rules would make a full bid unthinkable.

"There's no way. They can't even take a minority interest, let alone a full takeover bid. I think a full takeover bid is going to be tough to get through the overseas regulators," said YeeMan Chin, an analyst with Macquarie.

A regional resource banker who has advised clients on Sino-Australian deals agreed it was unlikely.

"Do I think they would, based on the bruising experience they've been through? No. Do I think, given the circumstances of what has gone on, that they'd go out and make a hostile bid for Rio? I must say it hasn't crossed my mind."

FIND A NEW IRON ORE PARTNER

With Rio in BHP's embrace, Chinalco could look for another iron ore supplier to invest in.

Chin said this was possible, without naming any potential targets. "Countries are quite cautious about Chinese investment. Chinalco will try to seek for other overseas investments, but they recognise now that it's challenging."

The world's top iron ore miner, Vale (VALE5.SA) of Brazil, has stayed away from annual iron ore price talks with China this year, letting BHP and Rio negotiate first, although its ferrous metals head will be in Beijing for a conference later this week.

Vale Chief Financial Officer Fabio Barbosa said in March he would welcome sovereign wealth fund investment -- exactly the kind of funding that requires intense scrutiny in Australia.

"You should not demonise this trend. It is part of the natural change of the world scene where we will be less Western centric, where we will interact more intensively with players like sovereign wealth funds, governments," he said.

Chinalco has also said it might buy into BHP if it was barred from investing more in Rio Tinto.

Another Australian iron ore firm, Fortescue Metals Group (FMG.AX), saw its share price perk up 14 percent on Friday as Rio ditched Chinalco. But it is already 17.55 percent owned by Chinese state-owned steelmaker Hunan Valin Iron & Steel Group, which has been barred from raising its stake further.

TURN ITS BACK ON IRON ORE

Although China wants iron ore assets and Chinalco wants to diversify, the company is not in need of iron ore specifically. Its main investments are in aluminium and copper, so these metals or other resources of interest to China, such as uranium, could potentially give it other targets elsewhere.

(Editing by David Holmes)