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Mongolia is likely not to object to Southgobi/Chalco takeover

According to South Gobi on April 1, 2012, SouthGobi Resources Ltd. (TSX:SGQ)(HKSE:1878) announced “ that it has received notice that Aluminum Corporation of China Ltd. ("CHALCO") intends to make a proportional take-over bid for up to 60% of the issued and outstanding common shares of SouthGobi.

SouthGobi has been informed that CHALCO intends to make a take-over bid for up to 60% of the issued and outstanding common shares of SouthGobi at C$8.48 per share. SouthGobi has also been informed by its 57.6% major shareholder, Ivanhoe Mines Ltd, that Ivanhoe has signed a lock-up agreement with CHALCO, committing to tender all of its shares held or thereafter acquired by it during the Offer Period of CHALCO into the Proportional Offer. The Proportional Offer will be made by way of a takeover bid circular under British Columbia law and will be made to all SouthGobi shareholders. If shareholders tender more than 60% of the outstanding common shares of SouthGobi to the take-over bid, a proportional amount of shares will be taken up from each shareholder. “

According to Ivanhoe Mines on April 1,2012 “A sale of 60% of its current holding would realize proceeds of approximately C$533 million (US$538 million).”

According to Southgobi, “CHALCO has advised SouthGobi that it expects to mail the takeover bid circular in connection with the Proportional Offer on or July 5, 2012.” According to the current timetable, as reported by Finance Asia , “the offer is expected to open on or before July 5 and will remain open for at least 35 days”

Further according to Ivanhoe , “if individual shareholders elect to tender more than 60% of their common shares of SouthGobi to the takeover bid - and if CHALCO receives less than 60% of outstanding common shares of SouthGobi as a result of the offer - a proportional amount of shares will be taken up, on a pro rata basis, from each shareholder who has elected to tender those additional shares.”

  • SGQ closed at C$7.27 on April 4,2012. According to Southgobi, takeover bid price is C$8.48
  • 1878 closed at HK$56.60 on April 4,2012, according to ETNET.COM.HK. According to Reuters on April 2,2012 , Chalco said that “the Hong Kong price of the offer is HK$65.97”
  • As far as Mongolia is concerned, according to Financial Times on April 2, 2012, “the transaction will not require Mongolian approval because the share transfer will take place in Canada, but a representative of SouthGobi said the Mongolian government had been informally notified and was supportive”.

Further, according to Bloomberg on April 2, 2012 CEO of Southgobi Alexander Molyneux said  “It’s almost certainly going to happen, as long as the regulatory approvals happen and go forward.”

We believe that there is high likelihood that Mongolia has or is or will not object to the deal because , according to Ivanhoe Mines on April 1,2012  “Ivanhoe plans to use the proceeds from the sale of its shares in SouthGobi primarily to fund the continued development of its flagship Oyu Tolgoi copper, gold and silver mine in southern Mongolia, which is on track to meet the mine's targeted start of initial production in Q3'12.

Commercial production at the mine is projected to begin in the first half of 2013.”

More relevantly for Mongolia, Ivanhoe stated that “depending upon the uptake of the offer by other SouthGobi shareholders, Ivanhoe could receive up to approximately C$889 million (US$898 million) from the sale of all of its shares in SouthGobi. A sale of 60% of its current holding would realize proceeds of approximately C$533 million (US$538 million).”

Therefore, we believe in high likelihood of no objection from Mongolia despite this being highly sensitive transaction for Mongolia due to it being “the biggest investment yet by a Chinese mining company in Mongolia as China seeks to tap the vast resources of its neighbor”, according to Financial Times on April 2,2012 and “the fifth-largest announced outbound M&A deal by a Chinese company so far this year, according to Dealogic” as reported by Finance Asia.

And it is sensitive as indicated by Mongolian media coverage of the transaction.

Further to Financial Times, “the deal follows years of frustration for Chinese miners trying to gain access to Mongolia’s deposits of copper and coal. Although Mongolia has opened up to foreign investors over the past decade, Chinese companies have often found themselves sidelined because of historic mistrust between the two countries.”

Other deal finalization issues include

According to Ivanhoe, “CHALCO's bid also is subject to China Investment Corporation, SouthGobi's second largest shareholder, confirming that it does not intend to exercise its right of first offer over Ivanhoe's SouthGobi shares.”

Further, according to Financial Times on April 2, 2012 , “China’s sovereign wealth fund  holds a 13.7 per cent stake in SouthGobi and has a right of first refusal for Ivanhoe’s shares, but the fund is expected to give its approval to Chalco’s bid”

We believe that is it is no co-incidence that Chalco( and its 100% Chinese state-owned parent company's name Chinalco) and CIC are both in this transaction given the high level relationships that Southgobi has been cultivating over the years in China. 

According to Southgobi, “CHALCO is a joint stock limited company established in the PRC; its shares are listed on the Hong Kong Stock Exchange and the Shanghai Stock Exchange respectively, and its American depositary receipt is listed on the New York Stock Exchange. CHALCO is principally engaged in mining of bauxite; the production and sales of alumina, primary aluminum and aluminum fabrication products; and trading of other non-ferrous metal products. CHALCO is the largest producer of alumina, primary aluminum and aluminum fabrication products in the PRC, and also the second largest producer of alumina as well as the third largest producer of primary aluminum in the world.”

According to Reuters, “Chalco is debt heavy but it is a central government-owned company and should have no problem in terms of funding, and have no danger of default,” said BOCI Research’s Robin Tsui.” According to Financial Times , “Chalco has been eyeing assets in Mongolia for years as it seeks to expand beyond its core aluminium and bauxite business into base metals and energy. Previous discussions with Ivanhoe over a stake in the Oyu Tolgoi copper and gold mine did not come to fruition, bankers say.”

Furthermore, it could be also possibly related to Chalco’s parent Chinalco being” the largest shareholder in Rio Tinto with a 12.9-per-cent stake”, according to Reuters.” “Analysts said the SouthGobi stake sale could also remove a large asset that would be unwanted by Rio

Tinto as it pursues greater ownership of Oyu Tolgoi, possibly via an acquisition of Ivanhoe.

Furthermore, according to Reuters, “Ivanhoe Australia, owned 59 per cent by Ivanhoe Mines, has mandated UBS to evaluate proposals from potential strategic partners for it Cloncurry project portfolio.”

According to Ivanhoe, “the proportional offer by CHALCO is subject to all statutory and regulatory approvals, including Investment Canada Act and Competition Act approvals, as well as Chinese regulatory approvals and CHALCO shareholder approval. CHALCO has advised SouthGobi that it expects to mail the takeover-bid circular in connection with the Proportional Offer in early July 2012, by which time it expects to have secured all necessary regulatory approvals that are conditional to the closing of the offer.

According to SouthGobi,  its “ board of directors has established a special committee comprising independent directors to consider the Proportional Offer, when received. The special committee has engaged independent legal counsel and will engage an independent financial advisor to assist with its review of the Proportional Offer. SouthGobi is advising that Shareholders take no action in connection with the Proportional Offer until they receive further information and advice from the special committee.”

CONCLUSION:

  • We believe that, as far as Mongolia is concerned, there is high likelihood that the transaction will close as proposed. In case the transaction will close as proposed, the implied valuation upside related to takeover bid as of April 4,2012 is + 16.64% on TSX and +16.14% on HKSE. On the other hand, according to Finance Asia on 3 April 2012, “SouthGobi obtained a dual-listing in Hong Kong in January 2010, but the stock has struggled to perform. In the first four months after listing the share price fell 40%, and while it topped the IPO price briefly about a year ago, yesterday’s close puts it 52% below the IPO price of HK$126.04. So, even if the tender is at a premium to the current price, it offers little consolation for investors who came in at the time of the Hong Kong listing – if any of them are still hanging on to their shares.”
  • As far as Southgobi and Mongolia are concerned, transaction is beneficial , in our opinion, to both Southgobi and Mongolia. According to Chalco, it “ will be a long term investor with a strong commitment to investing in the coal sector, and intends to position SouthGobi as the platform to pursue its growth ambitions in the coal sector”
  • The transaction is in line with our  view of increasing M& A activity in  Mongolian coal sector as noted in our research note of September 23,2011 “  INCREASING COAL M&A ACTIVITY IS CONFIRMATION OF GLOBAL AND REGIONAL COAL COMPANIES' INTEREST IN POTENTIAL TARGETS IN MONGOLIAN COAL SECTOR
  • The transaction is beneficial for Mongolian valuation
  • Mongolian coal companies with valuation upside that would be targets for M&A by global and regional companies deserve a closer look