The Wall Street Journal-20080212-Brazil Frets Over Vale-s Wanderlust- Possible Purchase of Switzerland-s Xstrata Elicits Concern About Domestic Cost

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Brazil Frets Over Vale's Wanderlust; Possible Purchase of Switzerland's Xstrata Elicits Concern About Domestic Cost

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Rio de Janeiro -- AS BRAZIL'S Cia. Vale do Rio Doce ponders a European acquisition valued at as much as $90 billion, a debate at home is simmering about whether the deal would serve Brazil's best interests.

A deal would create a mining giant in a time of industry consolidation, with strong positions in nickel, copper and zinc. To stay competitive, the company says, it must expand overseas.

But some politicians fret that Vale's move to buy Swiss miner Xstrata PLC would divert Vale's focus and financial resources away from home, making it a less reliable corporate citizen.

The debate isn't esoteric: Under Vale's share structure, a product of its privatization in 1997, the government has the leverage to block any deal deemed contrary to national interests.

More than just a mining company in Brazil, Vale -- whose full name means Valley of the Sweet River -- is a powerful institution that controls vital railroads, operates health and literacy programs, and contributes money to candidates for Brazil's Congress. It is also a source of national pride.

The government of President Luis Inacio Lula da Silva is "very worried about maintaining it as a Brazilian company," says Brasilia- based political scientist David Fleischer. Officials say they haven't forgotten that after the merger of Brazilian brewer Ambev with Belgium's Interbrew in 2004, the headquarters of the combined company, InBev SA, wound up in Belgium.

A Vale spokesman said whether a deal serves the national interest was a question for Brazil's government.

Representatives for Vale and Xstrata declined to comment on their negotiations. A person familiar with the matter said price is expected to be an issue, but that serious negotiations could begin only after a formal offer was made.

The concerns about Vale's overseas expansion add another wrinkle to a deal that is already complicated. Lining up financing for one of the biggest corporate acquisitions ever could prove difficult amid worries about a U.S. recession.

Vale's president, Roger Agnelli, a hard-charging 48-year-old former banker, has been working behind the scenes to reassure the government about the deal, politicians here say.

Analysts say Mr. da Silva, a former union leader who has worked hard to establish his credibility with the private sector, faces pressure to go along with the deal to keep peace with the business community. On Jan. 24, as he was preparing to have dinner at Mr. Agnelli's residence in Rio's elegant Ipanema neighborhood, Mr. da Silva said he was "neutral for now" on the deal.

On Thursday, Luciano Coutinho, president of Brazil's national development bank and a Vale director, told reporters it was possible to structure the deal in such a way that was compatible with Brazil's interests. He added that there were also risks to not doing the deal, allowing China to assert greater control over mining reserves and drive down prices.

The government wields power via a holding company, Valepar SA, which was created after Vale was privatized in 1997 and which holds a majority voting stake. The biggest shareholders of Valepar, which also include investors like Japan's Mitsui Co., are arms of Brazil's government, including Previ, a large pension fund. (Any deal will also depend on Xstrata's largest shareholder, Glencore International AG, a trading firm based in Baar, Switzerland.)

In addition, the government holds golden shares that give it veto power over certain operations, like selling off mines and railroads, or moving corporate headquarters.

Vale's interest in Xstrata comes amid a wave of mining-industry consolidation, including BHP Billiton Ltd.'s recent offer for rival Rio Tinto PLC. In a position paper, Vale says "a high degree of internationalization will allow Vale to keep growing, keep investing."

But even some businesspeople question whether a potential Xstrata acquisition is favorable for the country as a whole. Igor Cornelsen, a private investment manager, says Vale would have to transfer a lot of capital out of the country and take on greater debt to complete the deal. He doesn't see any offsetting benefits for the country, "no new jobs, no new businesses, no anything within Brazil."

Vale has been under a political microscope since its privatization more than a decade ago by Mr. da Silva's longtime rival, the centrist President Fernando Henrique Cardoso. The privatized company has thrived financially, especially since Mr. Agnelli took over in 2001 and launched a series of acquisitions. Revenue grew fivefold from 2002 to 2006. The stock price has soared, and by September, Vale had become the 33rd-largest company in the world by market capitalization.

But during the 2006 re-election campaign of Mr. da Silva, his leftist Worker's Party forcefully argued that privatizing Vale was a mistake. Mr. Agnelli has disputed that, saying that "Vale would never be in its current position if it were still state-run."

In September, a coalition of leftist unions and social groups held a plebiscite on whether Vale should be renationalized. No one saw the vote as a scientific survey, but the results made for effective propaganda. More than 94% of the 3.7 million participants voted for renationalization.

Shortly after, Mr. Agnelli met with Mr. da Silva to highlight the company's contributions to Brazil. After the meeting, Mr. Agnelli made a point of telling reporters that about 80% of Vale's more than $10 billion in investments budgeted for 2007-08 was targeted within Brazil. Mr. Agnelli also said that 80% of the company's 141,000 workers were employed in Brazil.

Mr. Agnelli emphasized that Brazil's government red tape made it harder for businesses to invest at home even when they wanted to.

In Brazilian states where Vale operates, politicians often tend to look to the company to solve problems as much as they do to the federal government. Some local politicians are already squawking about what the Xstrata acquisition could mean to Brazil.

"Before trying to become the biggest mining company in the world, Vale needs to pay back the enormous social debt it has with populations affected by its operations in Brazil," says Senator Jose Nery, of the leftist Party of Socialism and Liberty. He represents the Amazonian state of Para, where Vale has extensive mining operations. According to Vale, the company spent $72 million last year on social programs in the state, including on classrooms and sanitation projects.

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Ann Davis in Houston contributed to this article.