Lessons to be learnt from Oyu Tolgoi

How to get others to finance a USD 4.6bn copper-gold mine, and, separately, also make a billion, or two. Friedland driving for even bigger payday.

JOHANNESBURG - 

The world of mining finance is watching how a deposit rediscovery, leading to a USD 4.6bn mine build, financed by others, can potentially create billions of dollars worth of gains for the "finders" of the rediscovery. That seems to be the lesson from Mongolia's Oyu Tolgoi, in a saga that can be traced to 27 October 2006, when transnational miner Rio Tinto completed a first private placement with a cash-strapped Ivanhoe Mines.

Now the two parties are in something of a row. Rio Tinto announced on Monday this week that it had told Ivanhoe that it's taking to arbitration Ivanhoe's "breaches of the private placement agreement caused" by Ivanhoe's adoption of a shareholders rights plan on 5 April.

Ivanhoe reacted - in part - by declaring that it has "exercised its contractual right and given 60 days advance notice to Rio Tinto of a forthcoming change in the agreement governing Rio Tinto's investment in Ivanhoe Mines". That, in short, means termination of a covenant that's restricted Ivanhoe's ability to issue shares to "strategic investors".

Termination of the covenant means that Ivanhoe can issue more than 5% of its common shares to one or more third-party strategic investors, "which could include major mining companies". This may seem to be a strange way of thanking Rio Tinto for so far risking billions of dollars, and making available the skills and institutional memory of a transnational mining group.

To date, Rio Tinto, which agreed to the responsibility for developing and operating Oyu Tolgoi, has pushed, via Ivanhoe, a small fortune into developing the mine. On 29 June, a further USD 393m in cash went from Rio Tinto to Ivanhoe. To date, Rio Tinto has invested some USD 1.73bn in Ivanhoe, inclusive of convertible debt, and increased its ownership in Ivanhoe to 29.6%. 

On current agreements, Rio Tinto's past and potential future investments in Ivanhoe comprise some USD 2.5bn. Agreements (up to now) state that Rio Tinto's stake in Ivanhoe can increase up to 46.6% over the next 16 months or so.

Robert Friedland, the name synonymous with Ivanhoe, is no stranger to pushing for value. In 1994, one company he was invested in was looking for diamonds and instead discovered the Voisey's Bay nickel deposit in Labrador. Inco later paid CAD 3.1bn for the deposit, only to subsequently write off just over half that amount. In 2007, Vale, the Brazilian supergroup, followed suit in heavily overpaying for Inco (as a whole), when it splashed out nearly USD 19bn in cash.

Oyu Tolgoi is no Voisey's Bay. Amid the fracas this week, Andrew Harding, head of Rio Tinto's copper division, and one of three Rio Tinto names on the Ivanhoe board, quit the latter, to focus on the mine build. On 11 May Friedland, who is not known for understatement, had put it so: "Ivanhoe Mines believes . . . that Oyu Tolgoi will stand tall with established giants like Grasberg and Escondida in the pantheon of the world's greatest mines". On some golf courses, players sometimes mutter: "Drive for show, putt for dough".

Des Kilalea, an analyst in the London offices of RBC Capital Markets, says that the corporate dispute "is not affecting development of the project. Rio Tinto wants to remove limits on its ability to attract strategic partners and build its interest in Oyu Tolgoi. Ivanhoe wants to ensure a premium if control passes and has added the prospect of bidding competition and thus a higher price". The most likely name is Chinalco, Rio Tinto's biggest shareholder.

Ivanhoe's ongoing attempts to finance Oyu Tolgoi include apparent buy-ins from the International Finance Corporation, part of the World Bank, and the European Bank for Reconstruction and Development. Ivanhoe last month signed a mandate letter, where the IFC and EBRD may each consider providing a two part finance package, being USD 300m from each entity in the form of limited-recourse project financing, and a further USD 1.2bn in commercial loans under a "B loan structure".

According to recent updates from Ivanhoe, Phase I Oyu Tolgoi, which has been authorized and is underway, would cost an estimated USD 4.6bn. During 2013, production would start building up to an average annual production of some 1.2bn pounds of copper (about 544,000 tonnes) and 650,000 ounces of gold, for the first 10 years.

When the mines starts building up, Oyu Tolgoi's project debt could be in the region of USD 3bn. At that stage, with all the build capital spent, risks would be at something of a peak; Rio Tinto, the major financier, may choose to allow its exposure to remain relatively diversified (Ivanhoe has other interests) and relatively modest, until mine output is proven, debt starts diminishing, and possible dividends loom.

Ivanhoe's stake in Oyu Tolgoi has already been diluted to 66%, given the 34% held by the Mongolian government, which has been anything but a silent partner. In October 2009, Oyu Tolgoi LLC, the operating company, agreed to buy three T-Bills from the Mongolian government, with an aggregate face value of USD 288m, for USD 250m (the annual rate of interest on the T-Bills is set at 3%). The initial T-Bill, with a face-value of USD 115m, was purchased in October 2009 for USD 100m, to mature on 20 October 2014.

The government later wanted to waive the other T-Bills, and instead requested "tax prepayments", which Ivanhoe agreed to. USD 50m was paid on 7 April 2010; the second tax prepayment of USD 100m will be made within 14 days of Oyu Tolgoi LLC fully drawing down financing necessary to enable the complete construction of the mine, or 30 June 2011, whichever date is earlier. Apart from dividends, the government would also be anticipating "normal" tax, starting up in the years ahead.

Ivanhoe Mines re-discovered Oyu Tolgoi ("Turquoise Hill") in 2001 in the Gobi Desert; outcropping rocks in the area were smelted for copper some seven hundred years ago, during the times of Genghis Khan. At the time of rediscovery in 2001, Ivanhoe's stock price was around CAD 1.50 a share.

After the announcement of Rio Tinto's involvement in October 2006, the stock price soared from CAD 7.00 a share to CAD 17.00 a share in July 2007. The stock price has since almost touched CAD 19.00 a share. But it seems that these kinds of gains, compared to the price back in 2001, are simply not enough for certain Ivanhoe shareholders. Friedland, who may still hold around 101m shares in Ivanhoe, now worth USD 1.7bn, is driving for a yet bigger payday.

Ivanhoe has other interests, including 57% of Southgobi (full market value: USD 2.3bn), 81% of Ivanhoe Australia (USD 826m), and 50% of Altynalmas Gold, which holds 100% of the Kyzyl gold project in Kazakhstan. Like Oyu Tolgoi, each of these assets needs significant development capital, and, if it comes to that, build capital. For now, Ivanhoe Mines holds a market value of USD 8.3bn; even so, more than ever, it needs friends with big balance sheets, and clout in capital markets.

SUBSCRIBE to Mineweb.com's free daily newsletter now.

SHARE THIS ARTICLE

Disclaimer

MINEWEB is an interactive publication, with rolling deadlines through each day, commencing in the Sydney morning,  and concluding, 24 hours later,  in the Vancouver evening.  If you believe your side of an issue deserves inclusion, but has failed to meet one of our deadlines, you are invited to notify the Editor in Chief in Johannesburg, and we will include you in our editing and expanding on our stories. Email him at alechogg@gmail.com

Print story      Email story      Subscribe to free newsletter

Back

 

responses to this article

Name
Subject
Comment