Shares in Rio Tinto Ltd surged above $90 for the first time today amid speculation that BHP Billiton Ltd could take out its rival in a $122 billion-plus deal.
The stock closed up more than five per cent after Citigroup analysts fuelled takeover talk about the company.
Citigroup said while Rio Tinto's strong cashflow could make it an attractive target for private equity firms, BHP Billiton was a more likely bidder given the synergies that could be generated.
"Rio Tinto's strong cashflow and nominal gearing may bring it into the crosshairs of private equity, but we think BHP Billiton is a much more likely bidder given synergies and nationalistic control issue of Australian assets," Citigroup said.
"Applying even a modest bid premium means that any party will need to finance $US100 billion ($A121.99 billion)-plus through debt and equity.
"The deal is highly earnings accretive using conservative assumptions, with the major obstacle being concentration iron ore/coking coal market share and lack of BHP CEO-elect."
Rio Tinto shares surged $4.53 or 5.22 per cent to end a closing high of $91.38 while BHP Billiton put on 96 cents or 3.14 per cent to $31.56.
Rio Tinto's closing price gives the company a market value of $105.92 billion.
A union between BHP Billiton and Rio Tinto would create the world's largest producer of coking coal, thermal coal, copper and position the company as the equal largest iron ore producer with Brazilian giant CVRD.
"The greatest gains would be achievable in the iron ore assets in the Pilbara through optimising product specifications, mining fleet, rail distances to the port, etc," Citigroup said.
"Considering the scale and importance of these businesses to both companies, it is hard not to see $US500 million ($A609.94 million)-plus in synergies and cost savings in this area alone."
The brokerage said cost savings and synergies would also be achieved at the Australian coal assets, Canadian diamond mines, product marketing, logistics and global procurement.
Apart from competition concerns, Citigroup listed the lack of an anointed chief executive to replace Chip Goodyear as a major near-term impediment to any bid.
The brokerage said the disposal of non-core assets could overcome the competition concerns.
Citigroup ruled out any interest in Rio Tinto from the major oil companies and suggested private equity would need to team up with an existing industry player like Xstrata to formulate a potential bid.
"From a pure market capitalisation perspective, the major oil companies like BP and Royal Dutch Shell have the size and balance sheet capability to entertain such a transaction, but we do not believe they are interested in returning to investing in the Metals & mining sector after exiting the space in the 1980s and 1990s," Citigroup said.
"Strategic and diversification drivers could prompt other corporates to bid, but ultimately BHPB can pay the most given it has the most synergies to extract."