Rio Tinto dumped plans for a landmark investment from China on Friday, opting instead to raise $21 billion through a rights issue and a joint venture with one-time suitor BHP Billiton.

Rio's $19.5 billion deal with Chinese metals group Chinalco was put together in February at the height of the financial crisis in a bid to halve Rio's $38 billion debt.

Its collapse on Friday under shareholder pressure left China, the world's biggest steel-making nation, vulnerable to just two suppliers -- the Rio/BHP combination and Brazil's Vale -- controlling 70 percent of global iron ore trade.

This is a big slap in the face for China, said Paul Bartholomew at Steel Business Briefing in Shanghai.

Rio has effectively been talking to BHP behind Chinalco's back and Chinalco is entitled to feel like a two-timed lover this morning, he said.

Rio is to pay Chinalco a $195 million break-up fee.

RIO DEALS

Rio is raising $15.2 billion in a fully-underwritten 21-for-40 rights issue, the fifth largest on record according to Thomson Reuters data.

The Australian portion was priced at A$28.29 per share, a 58 percent discount to Thursday's closing price, while the London leg was priced at 1,400 pence for a 49 percent discount.

Rio said it and BHP, the world's second- and third-largest iron ore miners respectively, would also combine their Western Australian iron ore operations into a 50-50 joint venture, generating savings of at least $10 billion.

BHP will pay Rio $5.8 billion on completion. The deal has a break fee of $275.5 million. Iron ore was key to a collapsed bid by BHP to take over Rio last year.

Rio shares were up 14 percent at 3,101 pence at 1307 GMT in London, while BHP shares were up 11 percent to 1,622 pence. The cost of insuring Rio's debt fell by more than a third.

NEW DEAL

The plans represent a victory for Rio shareholders who argued the Chinalco deal favored the Chinese state firm and could give China greater influence over prices for key resources.

We were not supporters of the Chinalco transaction. We're happy to see this alternative approach to solving Rio's issues with its debt, said Ross Barker, managing director of Australian Foundation Investment Co, Rio's sixth-largest shareholder in Australia and a BHP shareholder.

A BHP/Rio combination would supply around 270 million tons of ore a year, while Vale supplies around 240 million tons.

This deal has been 10 years in the making and well worth the wait, BHP Chief Executive Marius Kloppers told reporters.

Rio and BHP agreed to keep their iron ore marketing separate, a move aimed at winning approval from regulators such as the European Commission, which last year raised concerns about BHP's proposed takeover of Rio due to the potential impact on iron ore markets.

Steelmakers on Friday vowed to fight the joint venture over worries that the link-up would lead to higher prices.

At present we cannot see how this JV could be in the public interest and thus it should not be allowed to proceed, said Ian Christmas, director general of the World Steel Association, whose members produce 85 percent of global steel production.

CHINALCO REGRET

Chinalco said it regretted Rio's decision after it had worked hard to try to revise the deal to reflect changed market conditions as well as shareholder and regulator concerns.

We are very disappointed with this outcome, Chinalco president Xiong Weiping said in a statement.

Australia and China, which are trying to start free trade talks, played down the impact of the collapse of the deal, which would have been China's largest foreign investment.

It is a commercial matter, said Australian Prime Minister Kevin Rudd.

China's state banks said they stood ready to back any future foreign investments by Chinalco and an official at the state-owned Assets Supervision and Administration Commission characterized the deal's failure as normal market behavior.

Rio also released first quarter results, showing earnings per share slid 45 percent to 125 cents mainly due to the collapse in metals prices, with the aluminum division the worst performer, sinking to an underlying loss of $481 million.

Rio announced it would not pay an interim dividend this year but hoped to resume payouts for the full year.

MASSIVE SAVINGS

My initial reaction is that it will be overwhelmingly positive for both companies because of the cost savings (and) the synergies, said Michael Bentley, resources portfolio manager at Northward Capital.

We consider these initiatives are a superior outcome for Rio's credit quality as opposed to the Chinalco deal, Nomura International said, adding it was better for Rio to sell equity instead of convertible bonds, maintain greater ownership of its assets and gain joint venture savings.

Chinalco Vice President Lu Youqing said the firm, still a Rio shareholder, had not decided whether to participate in the rights offer.

This is a big thing and is not determined by a single person, Lu told Reuters, adding the decision not to revise the deal with Rio was made by both sides.

Under the February deal, Chinalco would have paid $12.3 billion for stakes in Rio's key iron ore, copper and aluminum assets and $7.2 billion for convertible notes that would have doubled its equity stake in Rio to 18 percent.

BHP launched a 3.4-for-1 share swap to take over Rio in February 2008, which Rio rejected saying it vastly undervalued the firm and its prospects. BHP dropped the deal last November after commodity markets collapsed.

(Additional reporting by Reuters reporters worldwide); Writing by Dan Lalor and Lincoln Feast; Editing by Ian Geoghegan and Jason Neely)

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