Hindsight is a wonderful thing. This time last year, iron ore spot prices were soaring and Australia’s miners were raising funds for expansion. Many of these companies owed their existence to a boom cycle that had begun barely three years ago due to an explosion in Chinese demand. China’s steelmakers took nearly half of Australia’s US$32.5 billion in iron ore exports in 2008.
Keen to offset their costs, these steelmakers became willing investors in Australia’s mining industry, adding their capital to the stream of debt and equity funding already open to the miners.
Much has changed. Iron ore spot prices were down 60% in February from March 2008 and analysts expect iron ore contract prices to fall 30% this year after six years of consecutive increases. The decline can be blamed on the worsening economic climate in general and falling Chinese steel demand in particular.
"Everyone thought demand would be stronger for longer," said Michael Komesaroff, principal at heavy industry consultancy Urandaline Investments and a former employee of China National Nonferrous Metals Corp. "China didn’t save the world – it saved itself and now it’s picking up the crumbling pieces."
These pieces include the crown jewels and the distressed assets of Australia’s mining sector. In February, Aluminum Corp of China (Chinalco) agreed to pump US$19.5 billion into debt-ridden Rio Tinto – US$7.2 billion in convertible bonds that will eventually see the Chinese company double its current 9% holding in Rio, and the rest in the direct acquisition of stakes in Rio assets. The deal is subject to approval by Australia’s Foreign Investment Review Board (FIRB) and Rio’s shareholders.
Days later, the board of OZ Minerals recommended shareholders accept a US$1.7 billion takeover bid from Beijing-based Minmetals. Given OZ Minerals was worth over US$7.5 billion last year when it was formed through the merger of two smaller miners, the Chinese side appears to have got itself a bargain. But OZ Minerals could have gone under had Minmetals not stepped in and agreed to clear a pile of debt – US$760 million of which was due on February 27.
"Certainly, the Chinese entities are in a strong bargaining position what with equity prices falling and companies’ cash positions being put under stress," said Andrew Caruso, managing director of Australasian Resources, which sold a 12.8% stake to Chinese steelmaker Shougang for US$53 million in 2007.
Better safe than sorry
Caruso says Shougang’s support has put Australasian in a strong position compared to many in the industry, enabling the company to focus on long-term development rather than worry about short-term funding. Still, Australasian is on the lookout for project financing and, although the topic has yet to be broached, Caruso admits it wouldn’t be a surprise if Shougang sought to increase its holding.
Australasian, like many other miners, is not teetering on the brink like OZ Minerals. Rather, Chinese backing is a necessary precaution at a time when debt markets are at a standstill and the outlook for commodities remains uncertain.
Fortescue Metals Group, Australia’s third-largest iron ore producer, accepted this reality in February when it sold a 16.5% stake to Hunan Valin Iron & Steel for US$771 million, pending approval from the FIRB. More funding could still come from other investors, including sovereign wealth fund China Investment Corp. Concern has been expressed at Fortescue’s debt level, which stood at US$3.1 billion on January 30, over a total market capitalization of US$5.1 billion. However, Graeme Rowley, executive director at the company, said the bulk of this debt won’t mature until 2013-2015, and that the Valin money will simply be used to boost the cash reserves.
"We wanted to strengthen our balance sheet as a necessary prudent measure in these uncertain financial times," Rowley said. "We are now well placed to consider expansion options as and when the market circumstances improve."
As it is, Fortescue’s ambitious infrastructure developments, including plans to increase capacity at its Port Hedland terminal this year from 55 million to 80 million metric tons, have been put on hold.
Prudence has also been the name of the game for Gindalbie Metals, which raised US$103 million via a share placement to Anshan Iron & Steel Group (Ansteel) at the end of last year. According to a Gindalbie spokesman, the company was supposed to raise the funds itself as its contribution to a joint venture mining project with Ansteel, but balked at taking on so much debt in the current climate. As a result, Ansteel will nearly triple its stake in Gindalbie to 36%.
Under the terms of its agreement with Gindalbie, Ansteel has promised to buy everything the joint venture mining operation produces – at market prices. This clause is typical of deals in which a customer invests in its supplier, committing money up front in exchange for a guaranteed share of the mined product. But it also reflects an awareness of the transaction’s sensitivity: There can be no suggestion that the investment has allowed Ansteel to shift iron ore to China at basement prices, thereby shortchanging its Australian partners.
For similar reasons, there is no place for Valin on Fortescue’s marketing or bid committees, and the Chinese company is not permitted to take its shareholding above 17.5%. "We constructed the equity arrangement following consideration of both Valin’s interests and Australia’s sovereign expectations," Rowley said.
While the FIRB has only ever rejected one deal, renewed Chinese interest in Australian miners has once again put the government under pressure. The worry is that Beijing is coordinating an asset grab. Not long after the Chinalco-Rio announcement, Canberra altered its foreign investment laws, giving convertible bonds equal billing to equity stakes. In doing so, it closed off a loophole that appeared to exempt Chinalco from the FIRB approvals process, which kicks in when potential foreign equity ownership passes 15%.
"Three major deals [Rio, OZ Minerals and Fortescue] have come almost in tandem," said Jin Xiong, a Beijing-based associate at Australian law firm Mallesons. "Some suggest the Chinese government is behind these transactions or they would not have come about in this way."
But far more likely, there is no conspiracy; there is not even a coordinated plan. A horde of Chinese steelmakers and metals traders, state-owned and private, hope to capitalize on competitive asset prices, sometimes vying against one another for deals. In their haste, they risk stirring up a wasp’s nest of political opposition. Much rests on the FIRB’s assessment of the three deals and the conditions it may impose on approval.
Viewed in a wider context, these Chinese investors are in fact following a well-trodden path. Australia has historically relied on foreign money to tap resources in the capital-heavy mining industry. Japan’s hunger for iron ore – and its steelmakers’ desire for vertical integration – helped forge Western Australia’s mining industry. Now China, which imports more than half its iron ore, is doing the same.
"China is coming in, perhaps more suddenly than the Japanese did, and that’s creating a lot of hype," said Peter Vaughan, a partner at law firm Blake Dawson in Perth. "One difference is the deals were being done by large Japanese trading companies with a global presence. For many Chinese companies, it is the first time they have invested overseas. It is a learning process for them."
Urandaline’s Komesaroff agrees that some Chinese companies lack commercial savvy, but he believes they are fast learners. He singles out Chinalco’s approach to its Rio investment for particular praise, arguing that this deal has laid the ground for a realignment of the global mining industry – to the point that Chinalco might one day take over Rio.
"This is a new model for China’s global giants," he said.