Rumours that British-Australian mining giant Rio Tinto is considering a takeover of Mongolian miner Turquoise Hill are putting pressure on it to make a definitive statement.
Rio owns 50.8% of the Canadian-listed project company (which in turn owns 66% of the $6 billion Oyu Tolgoi gold and copper project) and in early March was widely reported to be considering an offer for the remainder of the company. Shares in Turquoise Hill rose 20% during the week of March 3.
Such excitement is understandable — Oyu Tolgoi is the world’s biggest undeveloped copper-gold project and sits just 80 kilometres from the border with China, the world’s biggest buyer of both metals.
The open-pit phase of the project started production last year but disputes between the government and Rio Tinto have delayed approval of the second phase, which involves excavating deep underground and comprises roughly 85% of the project’s value.
Rumours about an acquisition are reasonable because a single owner of the asset would find it much easier to negotiate with the government. It would also make sense for Rio to own Turquoise Hill outright rather than share its spoils with unrelated shareholders, who are already at the mercy of Rio anyway.
“I love the asset but hate the corporate structure,” said Travis Hamilton, founder of Khan Investment Management, a fund that has specialised in Mongolian investments since 2010.
However, Rio’s desire to buy out other shareholders in Turquoise Hill, including founder Robert Friedman, puts it in a difficult position. The ideal timing would be to make an offer as soon as possible after the second phase is authorised. “The longer they leave it, the higher the price they're going to pay,” Hamilton said.
The company cannot make a bid before the government approval but it also cannot deny its interest because that would force it into standing down for at least a year, by which time the share price could be much higher. For now, it is trying to stay as quiet as possible.
“Since the trucks started rolling in July, Turquoise Hill could have easily raised equity capital but it hasn’t,” said Hamilton. “Every mining company knows that the way to promote is to have a big party at PDAC [an annual mining industry convention held this year on March 2-5], but they had no presence.”
The keeping-quiet strategy has worked so far. The share price, which was close to $30 in 2011 before the dispute with the government, is now less than $4 — representing a massive difference in terms of market capitalisation.
Stuck
So why hasn’t Rio done anything? The truth is that it is stuck. The second phase cannot start until it is authorised by the government and the government says it won’t do that without a feasibility study that Turquoise Hill says won’t be ready until the summer. Meanwhile, the project’s $4 billion syndicated financing expires on March 31 and cannot be released until the authorisation comes through.
That financing deal has already been extended once but the syndicate of banks is unlikely to do so again given the movement in interest rates since last year. Renegotiating a new package would further delay the process.
Most of the reports about a rumoured acquisition have mentioned “industry sources” or similar but the speculation seems to have started after a mining company advertised several senior positions for “the next phase of a major ... mining project in Mongolia.”
The details left little doubt about which project it was — Amec, the engineering and project management firm that posted the advert, has been working on Oyu Tolgoi’s feasibility study since 2010 and mentioned the progression to underground mining several times.
Foreign investors in Mongolia have become so used to frustration and delay that any sign of optimism out of Ulaanbaatar is taken as good news. “It’s encouraging to see preparations for success versus failure,” Hamilton said.
But in spite of Amec’s optimism, the project is still stuck in a quandary until either Rio or the government backs down.
In Mongolia's interest
The Mongolians will probably blink first. Their currency has weakened more than 25% since the start of 2013 and unemployment continues to be a problem. Were it ever to reach full production, the Oyu Tolgoi project would contribute as much as 30% of the country’s economic output.
“If the government says 'Yes', it’s a magic solution for them,” said Hamilton, who is optimistic that a newly pragmatic government will keep the project alive. “They did a roadshow through Hong Kong and Singapore last year and the president’s message was: ‘We made a mistake, but now it’s time to do the right thing.’”
That included a new foreign investment law that removed the distinction between domestic and foreign investors and a new securities law that will make it easier for foreigners to trade Mongolian securities.
These reforms have created a solid foundation for renewed foreign investment and with no elections due until 2016 the country has a window of opportunity to get things done. Even so, many are still waiting to see what happens with Oyu Tolgoi.
Hamilton says that the project’s success is critical for the country. If Rio Tinto can’t make it in Mongolia, what chance does anyone else have?
The government should be keen to dispel that idea.
