Sent: 14-08-2012 12:02:07
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China Inc. Invites Investor Rethink
Investors will need to reappraise how they react to future Chinese involvement in Australian resources companies after China Inc. has shown how it can use its muscle to extract a better deal from Sundance Resources.
ASX listed west African iron ore mine developer Sundance Resources agreed to a 57 cents a share bid from Chinese miner Hanlong Mining in October 2011. The agreement required some conditions to be fulfilled before the transaction could be put to shareholders. The Australian, Cameroon, Congo and Chinese governments had to agree.
This was always a deal that favored the Chinese party. It was priced well before mining licenses and infrastructure permits had been granted. Existing shareholders continued to carry the downside risk because Hanlong had an option to walk away but the shareholders lost the upside that should have come from proving-up the resource and getting the African governments onside.
Sundance was waiting for an approval from China's National Development and Reform Commission (NDRC) that was due at the end of July, after being postponed. The approval came with a shock new condition: Sundance had to reopen negotiations over the price that had been set nine months earlier.
Sundance is out on a commercial limb. The only deal in town is with Hanlong but, now, the company is also up against the Chinese government itself.
Pluton Resources is another ASX listed iron ore mine developer to find itself at the mercy of Chinese investors. It had agreements with Chinese joint venture partners to help fund its takeover of the Cockatoo Island iron ore mine from Cliffs Asia Pacific Iron Ore and, later, develop another mine on the adjacent Irvine Island.
In Pluton's case, its putative Chinese investor dropped out on the morning of the shareholder meeting called to approve the deal, also leaving Pluton out on a limb. The company has not traded since the end of June as it tries to cobble together a substitute agreement with other investors. Meanwhile, a director of the Chinese company with which Pluton thought it had a binding agreement remains on its board as a director.
China's steel production growth has slumped, prices are down and the strategic panic that had led any number of Chinese entrepreneurs to go looking for iron ore investments has abated.
Despite the change in market conditions, the two Australian companies could have reasonably believed they had firm deals, at least by normal Australian standards.
Unfortunately, Sundance and Pluton directors may have been a tad too naïve. The Chinese parties grabbed an opening that was offered to them. In this sense, their ruthless use of economic power has not been surprising.
The sale of Sundance to a Chinese party is of little consequence within Australia because its assets are in Africa. Nonetheless, the experiences of Sundance and Pluton could help to inform the reaction of investors toward Chinese capital in the future.
It might appear unfair to tar all Chinese investors with the same brush and not discriminate between the behaviour of different Chinese companies or businessmen. In any other case, we would talk about specific companies not generically about Americans or Germans or British.
However, the intervention of the NDRC does make a difference. The conditional approval of the Sundance deal by the NDRC shows that Chinese companies and government agencies are prepared to gang up on minority investors to get one last go at a better price.
For better or worse, investors cannot be oblivious to the consequences.
Firstly, they need to be very wary of any investment that must rely on Chinese-sourced funding. Chinese financial backing may no longer be a reason for others to invest. It may be an argument to sell.
Secondly, to the extent that Chinese money may be the only game in town, investment rates of return will be lower.
Thirdly, given a choice, Australian exploration companies should now have second thoughts about taking all the risks of looking for iron ore and getting the approvals if they cannot anticipate commensurate financial rewards.
If this is the reaction, the Chinese might find they are shooting themselves in the feet. Come the next cycle, Chinese industry might find itself hard put to source what its needs if Australian companies have not done the exploration.
Fourthly, Australian companies might have to lower their corporate ambitions. The best returns might come from selling after just enough exploration activity to suggest the basis for a mine. Knowing how Chinese investors are going to behave should make companies very cautious about raising capital to push any further ahead toward permitting and feasibility studies.
Fifthly, Australian mining investors and entrepreneurs might consider turning their skills to non mining endeavours. The Australian industry has been lubricated historically by the possibility of successful exploration being the foundation for another market leader like Western Mining.
The industry spent some $63 billion on exploration between 1985 and 2011 within Australia itself. If another Western Mining is no longer possible, why try? Australia would be better off with that spend going to technology, manufacturing or agriculture, where the returns are at least as good, to provide a highly desirable rebalancing of the national economy.
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