The mindset of Chinese resource investors

Acquire the producers, make long-term contracts and/or regulate against price speculation, were just some of the strategies suggested by a senior Chinese policy official at a meeting of the Boao Forum last month. This according to Stephen Allen, a director of investment advisory firm RFC Group, is significant for a number of reasons.
He explained to delegates of the AMEC mining congress on May 22nd, that the Boao Forum could be considered the Asian equivalent of the World Economic Forum, and as such the comments give an indication of alternatives being considered by the Chinese to the fluctuations in commodity prices.

By Paula Wallace

“Seeking to regulate against price speculation is unlikely to be achievable given that most of this happens outside Chinese borders,” said Allen.
“Long-term contracts have historically proven to not be the best solution. For example, Chinese steel manufacturers have had pain from coal and iron prices which are only agreed one year out.”
One can see how ownership therefore seems like an optimal solution from a Chinese point of view.
“…some of my colleagues have been advised during recent meetings with senior officers of some of the larger Chinese Banks that the Government has set them strategic objectives of assisting Chinese companies acquire offshore resource projects,” said Allen.
A prime example of this is the debt funding of Chinalco by China Development Bank and others of its proposed US$19.5b deal with Rio Tinto.
Allen reported that RFC is experiencing a greater level of interest from Chinese companies in investment in Australian resource companies.
“There are clearly an increasing number of deals being announced in the press,” he said.
“As evidenced by the substantial number of Chinese at this conference there is an ever increasing presence of Chinese parties coming into Australia.”
“And there have been several statements made by the Chinese about deploying foreign exchange reserves into resource projects,” he added.
Obviously, the lower commodity prices seen in recent months have presented an excellent environment for potential Chinese buyers.
“We believe that it is also fairly well understood by these enterprises that they are perhaps the only groups which are presently in a position to acquire a lot of the interests which are currently either looking for large capital injections or formally on the block,” said Allen.
Perhaps the widespread approval of Chinese investment by regulatory authorities here has proved somewhat of a ‘green light’ however there has been some dissent from this position by Australian investors in recent months.
There are other considerable challenges for Chinese groups seeking to make investments in Australia, according to RFC Group.
These include utilising skilled resources in relation to due diligence and knowledge of commercial, environmental, accounting, legal and technical issues. Allen said there is also a high risk of overpaying due to restricted knowledge of the local market, competitor’s positions and key value drivers “Specifically we have seen very substantial investments made in Australian companies with only very limited pre-acquisition due diligence having been completed - examples of key failings include not understanding substantial contingent environmental liabilities,” said Allen.
“With regards to valuations – we have seen on a number of occasions that Chinese parties have put up offers for assets which are substantially above the next highest bidder.”
He said they have also observed Chinese parties not fully capitalising on exceptionally strong negotiating positions because they haven’t fully understood the Australian landscape and their strength on a number of key points of leverage.
However, the recent deal between Hunan Valin and Australia’s Fortescue Metals Group was one instance where this wasn’t the case.
Overall, Chinese investments in Australian resources companies in the past few years have not performed well based on data provided by RFC Group.
The only real solid performance was Jinchuan’s investment in Tasmanian nickel play Allegiance Mining which was sold to Oz Minerals in 2008.
“You might say, that on the whole most investments made in the Australian resources sector or indeed Australia as a whole have not produced terrific returns, as evidenced by the overall fall in the core ASX200 index from about 5,600 to 3,800 over the same period, a fall of about 32 per cent,” said Allen.
He said that some investments made to date may yet demonstrate good returns by the time they are realised, particularly when the benefits of off-take arrangements are accounted for.
“Some might argue that Chinese investors look to the long-term and that these short-term under performances are not relevant,” said Allen, “In our view though a number of these investments demonstrate that the investor has failed to understand some fundamental differences between investing in projects in Australia relative to China and other parts of the world.”
It is clear that Chinese investors in some of these companies did no properly understand Australian cost structures because a number of the projects were widely not expected to produce positive cash flows.
RFC Group takes that view that Chinese investments in the Australian resource sector demonstrate significant similarities with those made by the Japanese in the 1970’s.
There are a number of Japanese investors from that era who remain invested in Australia and have produced solid returns over the past 30 years. These include Mitsubishi, Sumitomo and Mitsui.
“Each of these successful ones has in our opinion been successful largely because they formed solid partnerships with Australian operators and took minority positions,” said Allen.
“Those which sought control have by and large lost substantial sums of money and disappeared from the Australian scene.
“Unfortunately for them Chinese investors for the most part appear to also be seeking positions of control in Australia…they are not maximising their chances of success.”
In the current market, China represents one of the very few sources of meaningful capital for Australian resource projects. But it won’t be around for the long-term unless investment returns improve and projects technically prove up to the point that off-take expectations are met.
“We believe it’s important for the industry and indeed Australia as a whole that the Chinese investors do well,” said Allen, “we will all be better off if we are able preserve and enhance the “Australia” brand name in the eyes of Chinese commodity consumers.”