On the backdrop of Rio Tinto shareholders clamouring for a revised deal with Chinalco, or some even call for dumping the deal altogether, Merrill Lynch has joined the bandwagon, calling for a rights issue to fix Rio's debt.

In a report to clients on Friday, Merrill said a rights issue would be less dilutive than the Chinalco deal as it now stood. The earnings per share (EPS) dilution for a $10 billion rights issue of about 13 per cent on 2010 EPS forecasts was down from 21 per cent on the same calculations back in February, the report said.

The Rio-Chinalco deal had been attracting objections from various quarters, including the opposition parties as well as the shareholders, since it was signed in February.

 Cash-strapped Rio, which has almost $40 billion of debts, has to meet the October deadline to repay a $8.9 billion bond. This has prompted the company to opt for a capital injection from Chinalco, which promised the beleaguered miner $19.5 billion. (See: Chinalco invests $19.5 billion in Rio Tinto to raise stake to 18 per cent)

However, Rio's share prices started picking up from its abysmal depth at the beginning of the year when the deal was signed.

''The share prices have almost doubled since the deal with Chinalco was announced in February,'' the report noted.

The 13 per cent dilution from a $10 billion rights issue is now also substantially below the 17 per cent dilution in earnings that Merrill estimates would come from the Chinalco deal, it added.

According to Merrill, after the deal both the capital and debt markets had changed significantly, which make the deal less attractive in its current form either the short term or long term.

"Given this, we question why shareholders would now vote for the Chinalco deal in its current form," Merrill said.

"This is even more the case when we consider the amount of opposition to the deal that was already voiced when the Chinalco deal was more attractive than it is now," the report noted.

However, Rio chairman Jan Du Plessis and the Australian federal government are worried that blocking Chinalco could provoke a backlash from its biggest trading partner.

Plessis said Rio is concerned about the shareholders, but he has yet to concede that the Chinalco deal needs to be junked in preference to a rights issue.

 In their attempt to soothe the investors, Rio and Chinalco are drawing up new plans by which Rio might replace a $7.2-billion convertible bond sale to Chinalco with a capital raising to existing shareholders. (See: Rio may issue $7.2 billion bonds to existing shareholders). 

This may bring down Chinalco's ultimate shareholding in the global mining giant to 15 per cent from originally envisaged 18 per cent. The Chinese giant already holds a 9-per cent stake in the company.

British shareholders are angry they have not been given the chance to participate in a capital raising with Chinalco, while Australian investors are also concerned about the sale of key long-term iron ore, aluminium and copper assets.

 BHP chairman Don Argus, on the sidelines of the Australia-China Business Council meet on Thursday also said that "Australia needs to be most careful that it does not forfeit the economic merit of our resources sector."  (See: BHP chairman worried over growing Chinese investments). 

A spokesman for Rio said, "Shareholders are entitled to their views, but our chairman has listened to investors whose views range from strong support to those who are worried about pre-emption, and in Australia, where investors are worried over the influence they imagine Chinalco might have.''

"We still believe the Chinalco deal is the best way forward for Rio Tinto," he added.

Treasurer Wayne Swan is due to rule on the deal in the next three weeks.