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Rio will complete takeover of IVN gradually with no premium, to benefit from lesser Mongolian political risk

EVENT

According to Ivanhoe Mines “, Ivanhoe Mines and Rio Tinto sign omnibus agreement  to ensure funding through to commercial production  and additional expansion at Oyu Tolgoi copper-gold-silver project . New plan includes US$1.8 billion in equity financing . Rio Tinto to provide additional bridge-loan financing  and completion support for US$3-4 billion project financing  being negotiated with multinational financial institutions and banks . Rio Tinto to nominate independent directors to Ivanhoe board and a new CEO and senior management team”

DETAILS

Ivanhoe press releases

http://www.ivanhoemines.com/i/pdf/2012-04-18_NR-ST.pdf

http://www.ivanhoemines.com/i/pdf/2012-04-18_NR-RO.pdf

Rio Tinto press release

http://www.riotinto.com/media/18435_media_releases_21949.asp

NO CONTROL TAKE OVER PREMIUM FOR IVN SHAREHOLDERS

  • Rio Tinto finally took over control of IVN in substance and in form.
  • However, shareholders of IVN did not receive any associated control takeover premium.
  • Furthermore, on 13 December 2011, when Rio Tinto announced its success in arbitration against Ivanhoe Mines, IVN share price was 16.01 in NYSE. Yesterday, April 19,2012, IVN closed in NY at 13.04
  • Investors who benefitted from the control takeover this year were investors who have bought IVN during the last 5 days or so
  • The Rio approach is consistent with the view expressed by Research Analyst of Merrill Lynch (Canada) Oscar Cabrera, who wrote on 21 February 2012

“Where to next for Rio Tinto investment in IVN? No premium

RIO is already in control of OT at the company (51% of IVN) and project levels (Heads of Agreement, December 2010). Thus, our RIO analysts (Jason Fairclough and Peter O’Connor) do not believe RIO is in a hurry to acquire the balance of IVN. Our colleagues believe RIO will want economic control of OT (available with 76% of IVN shares). (underlined by Frontier Securities) RIO likely will increase its position on IVN gradually (5% every 12 months to prevent takeout triggers under Canadian law), unless another market downturn provides an opportunity, in our view. Our colleagues note that RIO took around 30 and 20 years to complete the takeovers of Comalco and Coal and Allied Industries, respectively. Thus, they do not expect RIO to pay a premium for the balance of IVN shares.”

In  this context Rio statement says

“Canadian early warning disclosure

Under the agreement, Ivanhoe and Rio Tinto's wholly-owned subsidiary, Rio Tinto International Holdings Limited ("RTIH") have agreed, among other things, that:

• Ivanhoe will undertake a US$1.8 billion rights offering with a subscription price of US$8.34 per common share of Ivanhoe ("Common Shares")

• RTIH will provide a standby commitment for the full amount of the US$1.8 billion rights offering and be paid a standby commitment fee equal to 4 per cent of the gross proceeds.  Under the standby commitment Rio Tinto is required to acquire any shares not taken up under the rights issue.

• RTIH may elect to invest the standby commitment fee in Common Shares and/or non-voting preferred shares convertible into Common Shares on a one-for-one basis (the "Standby Commitment Fee Shares"), in each case with a subscription price equal to the 5-day VWAP of the Common Shares immediately before their date of issue

• Ivanhoe will issue to RTIH an Anti-Dilution Subscription Right exercisable from time to time to acquire Common Shares so to maintain Rio Tinto's ownership of Ivanhoe, notwithstanding the exercise of stock options of Ivanhoe, with a subscription price equal to the 5-day VWAP of the Common Shares immediately before each date of exercise

• Ivanhoe will issue to RTIH 55,000,000 Series D Warrants, each exercisable for three years to acquire one Common Share at a price of US$12.79

Rio Tinto currently owns 377,397,658 Common Shares representing approximately 51 per cent of the outstanding Common Shares.(underlined by Frontier Securities)  Following closing of the rights offering, Rio Tinto will beneficially own the number of Common Shares as set out below, in each of the following circumstances:


Full Exercise of Rights by Shareholders

Assuming Rio Tinto and the other holders of rights under the rights offering exercise their rights in full and the standby commitment is not utilized, Rio Tinto would acquire 109,901,784 Common Shares under the rights offering and, following the closing of such offering, would beneficially own 487,299,442 Common Shares representing approximately 51 per cent of the then outstanding Common Shares.(underlined by Frontier Securities)  This would be the same percentage of outstanding Common Shares that Rio Tinto currently owns.

If Rio Tinto were to elect to fully invest the standby commitment fee in Standby Commitment Fee Shares at closing of the rights offering and using the TSX 5-day VWAP as at the date of this announcement as a proxy for the subscription price for these shares, Rio Tinto would acquire (or have the right to acquire upon conversion of Standby Commitment Fee Shares issued as non-voting convertible preferred shares) an additional 5,600,436  Common Shares.  In addition, if Rio Tinto were fully to exercise the Series D Warrants adjusted in accordance with their terms following closing of the rights offering, Rio Tinto would acquire an additional 71,016,523 Common Shares.  Assuming Rio Tinto were to acquire the maximum number of Common Shares issuable under each of these rights, following such issuances, Rio Tinto would beneficially own 563,916,400  Common Shares representing 54.6 per cent of the then outstanding Common Shares. (underlined by Frontier Securities) 

No Exercise of Rights by Shareholders

Assuming none of the holders of rights under the rights offering exercise their rights and the standby commitment is utilized in full, Rio Tinto would acquire 215,827,338  Common Shares under the rights offering and, following the closing of such offering, would beneficially own 593,224,996 Common Shares representing approximately 62.0 per cent of the then outstanding Common Shares. (underlined by Frontier Securities) 

If Rio Tinto were fully to elect to invest the standby commitment fee in Standby Commitment Fee Shares at closing of the rights offering, Rio Tinto would acquire (or have the right to acquire upon conversion of Standby Commitment Fee Shares issued as non-voting convertible preferred shares) an additional  5,600,436  Common Shares.  In addition, if Rio Tinto were fully to exercise the Series D Warrants adjusted in accordance with their terms following closing of the rights offering, Rio Tinto would acquire an additional 71,016,523 Common Shares.  Assuming Rio Tinto were to acquire the maximum number of Common Shares issuable under each of these rights, following such issuances, Rio Tinto would beneficially own 669,841,955  Common Shares representing 64.8 per cent of the then outstanding Common Shares. (underlined by Frontier Securities) 

The number of Common Shares and the percentage of the total outstanding Common Shares stated in the preceding paragraph (and the corresponding paragraph in the previous section) are based on (i) the number of Common Shares outstanding immediately prior to the record date for the rights offering being 741,141,128, (ii) the applicable adjustment being made to the number of Common Shares issuable upon exercise of the Series D Warrants as a result of the rights offering and (iii) the 5-day VWAP of the Common Shares immediately before the date of issue of the Standby Commitment Fee Shares is assumed to be US$12.86 per share being the TSX 5-day VWAP as at 16 April 2012 converted at the Bank of Canada closing exchange rate for 16 April 2012 for the purpose of estimating the ownership position of Rio Tinto under the scenarios described above.

The issuance of the Standby Commitment Fee Shares, the Anti-Dilution Subscription Right and the Series D Warrants and the underlying Common Shares is subject to regulatory approval.  All such Common Shares will be acquired by Rio Tinto from treasury.

In connection with its previously announced acquisition of more than 50 per cent of the Common Shares, Rio Tinto is deemed to have acquired indirect beneficial ownership over the securities of a number of public companies owned by Ivanhoe including (i) 326,155,332 common shares of Ivanhoe Australia Limited ("IVA") (ASX:IVA and TSX:IVA), representing approximately 59.0per cent of the outstanding common shares of IVA, (ii) 104,807,155 common shares of SouthGobi Resources Ltd. ("SouthGobi") (TSX:SGQ and HK:1878) representing approximately 57.6 per cent of the outstanding common shares of SouthGobi and (iii) 13,799,333 common shares of Entrée Gold Inc. ("Entrée") (TSX:ETG and NYSE AMEX:EGI) representing approximately 10.7 per cent of the outstanding common shares of Entrée.  Together with 16,566,796 common shares of Entrée already beneficially owned by Rio Tinto, Rio Tinto is now deemed to beneficially own 30,366,129 common shares of Entrée representing approximately 23.6per cent of the outstanding common shares of Entrée.

Rio Tinto has anti-dilution rights that permit it to acquire additional securities of Ivanhoe and Entrée so as to maintain its proportional equity interest in Ivanhoe and Entree. Rio Tinto also has the right until 24 October 2012 to acquire additional Ivanhoe securities under its equity financing right of first offer.

Except as required by its agreement with Ivanhoe, Rio Tinto has no present intention of acquiring additional securities of Ivanhoe, IVA, SouthGobi or Entrée. Depending upon its evaluation of the business, prospects and financial condition of Ivanhoe, IVA, SouthGobi or Entrée, the market for their securities, general economic and tax conditions and other factors, Rio Tinto may directly or indirectly acquire or sell some or all of the securities of Ivanhoe, IVA, SouthGobi or Entrée.”

Therefore, we believe that Rio will complete takeover of IVN gradually with no premium with all the associated implications for IVN shareholders.

RIO TINTO TAKEOVER OF MANAGEMENT WOULD BE BENEFICIAL FOR IVANHOE MINES

  • We view that expected and realized takeover of IVN management by Rio Tinto would be beneficial to the company due to lesser Mongolian political risk premium

We believe that Mongolia has preference for large multinational major miners, in this case, Rio Tinto, due to its reputation , underground mining expertise and various other its attributes and factors based on analysis of various public communications that Mongolian officials made.

For example, on March 30,2010 Minister of Finance of that time MP S.Bayartsogt in a public interview created impression that Government prefers more Rio Tinto by referring to it as "world's major company" as compared to IVN whose  stake in OT  is "even more decreasing". In our opinion, it could have been to create favorable impression for Mongolian public who are apprehensive to certain degree and respectful of "major world companies".

Note: Frontier Securities would like to make a note

  1. 1.Mr. Friedland has made great contribution to progress and development of modern Mongolian history
  2. 2.It would be wise for Mongolia to continue mutually beneficial relation with Mr.Friedland and utilize his valuable experience and expertise

RIGHTS ISSUE

              On April 3, 2012 TD Securities Equity Research’s  Craig Miller  and Craig Hutchison, P. Eng. wrote

“ Securing additional bridge financing has been a problem, and we cannot rule out an equity issue. Ivanhoe may be forced into financing options that could lower our valuation further.”

Bank financing delay issue appears to be essentially resolved

IVN press release said

Mr. Gordon, the Interim Chair and a member of the Ivanhoe Mines board for the past 18 months, acknowledged the contributions and achievements of the outgoing directors and management executives.

" Ivanhoe now assured of full funding"

Rio Tinto said

" The comprehensive financing package, together with the proceeds from any potential future asset sales by Ivanhoe, are intended to cover Ivanhoe's total funding needs to complete the development of Oyu Tolgoi. Rio Tinto will provide a standby commitment for the full amount of a US$1.8 billion rights offering by Ivanhoe. Rio Tinto will also provide US$1.5 billion of bridge financing to Ivanhoe, in addition to the US$1.8 billion interim funding facility that was agreed in December 2010.

Rio Tinto remains committed to continue working with Ivanhoe to secure project financing for the Oyu Tolgoi project and has agreed to provide a guarantee of certain obligations of Ivanhoe under the project financing. Once project financing is in place, both the US$1.5 billion of bridge financing and the US$1.8 billion interim funding facility will be repaid to Rio Tinto in full."

POWER ISSUE

According to Ivanhoe Mines, “Rio Tinto’s commitments will support”, among other things: 

“ The construction of a dedicated, coal-fired electrical power plant in Mongolia. The Investment Agreement requires Oyu Tolgoi to source all of its power requirements from within Mongolia within four years of the start of commercial production; the project plans to use power imported from China during its initial years of operation.”

Other than that we are not aware of any other new development on power issue since

According to Ivanhoe Mines  on March 30,2012 , “

Progress continuing to be made on supply of interim electrical power 

The long-term Investment Agreement for the development and operation of Oyu Tolgoi, signed by Ivanhoe Mines, Rio Tinto and the Government of Mongolia on October 6, 2009, recognized that the reliable supply of electrical power is critical to the project. The agreement also confirmed that Ivanhoe Mines has the right to obtain electrical power from inside or outside Mongolia, including China, to meet its initial electrical power requirements for up to four years after Oyu Tolgoi begins commercial production. The agreement established that a) Ivanhoe Mines has the right to build or sub-contract construction of a coal-fired power plant at an appropriate site in Mongolia’s South Gobi Region to supply Oyu Tolgoi; and b) all of the project’s power requirements would be sourced from within Mongolia no later than four years after the start of commercial production.   Oyu Tolgoi LLC is proceeding with arrangements to ensure that electrical power from China will be available for the start of initial production that is expected in Q3’12. In early March 2012, Chinese contractors began construction of the power line and switching station as part of the 87-kilometre, 220kilovolt power transmission line to be built from the electrical distribution grid in Inner Mongolia, China, to the China-Mongolia border. The construction of the transmission towers along the 95-kilometre section of the power line from the Oyu Tolgoi mine site to the Mongolia-China border was completed in October 2011.

A separate power-purchase agreement establishing a supply arrangement between Mongolian and Chinese authorities is required before Chinese electrical power can be imported into Mongolia. Oyu Tolgoi LLC will be a party to any agreement for the purchase and supply of electrical power.  Subject to negotiations and final agreement, commercial arrangements and power-purchase tariffs are expected to be expedited to ensure that imported power will be available at the Oyu Tolgoi site by Q3’12. In the meantime, additional diesel-powered generating capacity is being provided, with expansion planned for April 2012 to meet the project’s more immediate requirements during the remaining stages of construction.  In November 2011, the Mongolian government provided Oyu Tolgoi LLC with a cabinet resolution allowing for the future construction by Oyu Tolgoi LLC of a coal-fired power plant in Mongolia dedicated to the Oyu Tolgoi Project. Such a plant would require certain Mongolian government permits, the negotiation of commercial agreements with the Mongolian government and coal suppliers, and the arrangement of financing for the accelerated construction. If the establishment of a dedicated power plant is required for the early production at Oyu Tolgoi, the required revisions to the construction schedule for the Oyu Tolgoi Project could adversely affect the project’s ability to achieve the planned start of commercial production in 2013. Although construction of a power plant is expected as part of the Oyu Tolgoi Project’s future development, there is no provision for a plant in the current capital cost estimates for 2012 and the financing that would be required for such a plant is not contemplated as part of the Company’s current financing plan. The Heads of Agreement signed with Rio Tinto in December 2010 provided that if construction of a 50-megawatt, or greater, power plant was started before January 1, 2015, the construction would be funded by loans from Rio Tinto, with 40% of the outstanding balance to be repaid in 2015 and the remainder in 2016. “

Before that, Representative of Department of Energy Policy of Ministry of Mineral Resources and Energy(MMRE) of Mongolia briefed on 08/11/2011

·       Preliminary F/S for 600MWt Thermal Power Plant (TPP) to supply energy to Gobi region has been finished

·       Energy needs of major deposit projects will be resolved by TPP based on TT deposit coal, TPP is to be entered in concessions list, international tender announced and implemented

·       OT and Erdenes Tavantolgoi companies have cooperated and had foreign consultant prepare preliminary f/s and compare OT and TT locations for the TPP

·       The solution is to build a part of TPP at OT in order to save time at current condition of major infrastructure issues not being resolved

·       At the moment no specific decision has been made by MMRE or Government, the policy of MMRE remains the same

·       There are three clauses in OT IA related to energy supply however at the moment it is planned to extend 220 kWt powerline from PRC in order resolve electricity supply temporarily

·       When OT mine starts full production energy issue will be resolved by one of three clauses of OT IA

·       However recently OT company is making initiatives and has a position of transferring to permanent energy supply without mandatory four years

·       MMRE can manage to have TPP built at TT and implement energy supply policy in four years

·       When OT will be connected to permanent energy system, TPP at TT will be built long time ago

·       600 mWt TPP is  a major TPP, of strategic importance. The TPP is to supply energy to Gobi region, by 220kWt line to OT and further connect to energy system being built to border with PRC

·       Also this summer Dalanzadgad-TT 100kWt line is being started to be built, further Chinhua MAK can be connected by 110kWt

·       220kWt line is being built from Ulaanbaatar to Mandalgobi-TT, this is to supply Tsagaansuvarga by 220kwt, in another words the 600 MWt TPP will be a main nucleus

·       We cannot tell about  decision by the Government as far as policy is concerned it has been resolved long time ago.

Further, according to Government of Mongolia on June 17, 2011  MONGOLIA AND CHINA CONCLUDE STRATEGIC PARTNERSHIP

“HISTORIC PATHWAY BETWEEN MONGOLIA AND PRC

1960 – FRIENDSHIP AGREEMENT( YU.TSEDENBAL AND ZHOI ENLAI)

1994 – FRIENDLY RELATIONS AGREEMENT (P.JASRAI AND LI PENG)

2003 – GOOD NEIGHBORS STATEMENT(N.BAGABANDI AND HU JINTAO)

2011- STRATEGIC PARTNERSHIP STATEMENT ( S. BATBOLD AND WEN JIABAO)”

“OT

·      PM requested help to OT LLC on issue of getting power from PRC

·      Support mutual investment, a road has been opened for Mongolia to make investment into PRC

·      It has been agreed that negotiations immediately will start  between related organizations on supply power from PRC”

Copper outlook

According to Bloomberg on April 20, 2012 “ Copper traders are bullish for the first time in six weeks on mounting confidence that demand will accelerate in line with economies at a time when mining companies are already failing to keep up with consumption.

Eleven of 29 analysts surveyed by Bloomberg expect the metal to climb next week and 10 were neutral. Rio Tinto Group (RIO), based in London, said April 17 that its first-quarter copper output slid 18 percent because the ore mined contained less metal. Codelco, the largest copper producer, said the following day that it sees no weakening in Chinese buying. Barclays Capital is predicting a third consecutive year of shortages.

The International Monetary Fund raised its global growth forecast for the first time in more than a year on April 17. Industrial production in China, the biggest copper consumer, expanded 11.9 percent in March, exceeding economists’ forecasts, the government said April 13. The Bank of Japan is “committed” to monetary easing to shore up the economy, Governor Masaaki Shirakawa said April 18.”

Frontier Securities is making assessment of Ivanhoe Mines’s 2012 IDOP technical report.

 

 

CHIEF INVESTMENT STRATEGIST

Dale Choi

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