Jun 19, 2013 04:48 PM

Chinese Miners Suffer Hangover after Recent Binge Buying


(Beijing) -- The international mining industry saw mergers and acquisitions slow in 2012.

Accounting firm PricewaterhouseCoopers says a total of 1,803 M&As were reported in the international mining sector last year, down 30 percent from 2011 and the lowest level since 2005. The total transaction value was US$ 110 billion, down 26 percent from 2011. The slowdown has continued this year.

Over the past two years, commodity prices have fluctuated greatly, affecting investor confidence. Many in the industry believe that a period of fast growth for miners has reached an end. Companies have started to switch their focus from expansion to improving operating efficiency and cutting costs in order to improve their financial standing.

Chinese miners – the most active players in international mining acquisitions since 2009 – have also become more cautious about new deals.

Expansion Aftermath

Since September 2011, the price for high-grade iron ore has fallen from US$ 180 per ton to US$ 110. Prices for other commodities, like copper, aluminum and nickel, have also declined dramatically.

Frequently changing prices have made it difficult for companies to reach agreements in mining deals. Meanwhile, previous rapid expansion has boosted costs for project development, bringing higher risks to acquisition deals.

A report by Ernst & Young predicted that miners' enthusiasm for acquisitions will revive only after the commodity prices rebound and companies' capital pressure is alleviated.

Reducing production costs is crucial for miners. Richard Phillips, Goldman Sachs' head of natural resource M&As in Australia and New Zealand, said low profit margins have restricted companies' new investment projects and made them more willing to focus on existing projects.

"As prices have remained low, large mining companies can continue operations because they have larger profit margin," Phillips said. "But smaller companies will be more affected due to their higher costs."

Other factors have affected Chinese buyers. Andrew Michelmore, chief executive of MMG Ltd., said the country's leadership transition and the reshuffle in ministries and state-owned enterprises have also hindered companies' business decision-making.

Speculation on rising demand from China has boosted the global mining sector, but Zhu Hansong, director of the natural resources division of Goldman Sachs Asia-Pacific, said there are many uncertainties ahead.

"The global supply of iron ore will exceed actual demand in 2014, while the outlook for copper is also not quite optimistic," he said.

Wang Jianjun, deputy director of the Department of Foreign Capital and Overseas Investment under the National Development and Reform Commission, said that Chinese companies have invested more than US$ 10 billion in overseas iron ore assets over the past five years, mainly in West Africa, Canada and Western Australia, securing about 20 billion tons of ore supply.

However, most of the investments are still in the early stages of development.

"Many purchases are mining rights and require further exploration and feasibility studies, as well as environment assessments," he said. "Much capital is needed in the early stages of development and many companies have encountered problems."

Wang said the lack of infrastructure and supportive facilities are major restrictions for the country's overseas mining projects. "Some places lack railway and port capacities, while others need to build new infrastructure," Wang said.

He pointed out that spending on infrastructure sometimes exceed investment in ore production facilities.

One example is Sinosteel Group's AU$ 1.36 billion acquisition of 50.97 percent of Australian iron ore miner Midwest Corp. in 2009. However, production has been delayed due to a lack of ports and railway facilities.

Unexpectedly high production costs have also hindered some of the country's overseas mining projects. In 2006, CITIC Pacific bought 25-year mining rights to 2 billion tons of magnetite at Cape Preston, in Western Australia. The project was scheduled to start production in early 2009 with total investment of US$ 4.2 billion, but was delayed due to rising labor and construction costs.

Chang Zhenming, chairman of CITIC Pacific, said in February that investment in the project reached US$ 9.1 billion by the end of 2012, including US$ 6.8 billion in construction spending. It is still unclear that when the project will start production.

An Australian source close to the CITIC Pacific project said: "Everybody is disappointed because it missed the iron ore price peak."

Many Chinese miners are also having headaches regarding environmental issues in overseas operations. An executive in the overseas mining department at Wuhan Iron and Steel Corp. (Wugang) said that "there is mounting pressure due to environment concern about overseas mining development."

The executive cited strict inspection and continuous monitoring by local governments. 

Wugang owns mining interests in nine overseas projects with total reserves of 23 billion tons. But the company has recently faced environmental challenges in the Bloom Lake project in Canada after the local government last year raised the standard for mining projects' capacity to handle floods.

"To meet the new standards may result a financial loss for Wugang's Canadian projects," the Wugang executive said.

Policy changes presented another risk. Last year, Aluminum Corp. of China Ltd. (Chalco) backed out of an agreement to buy a majority stake in Mongolia-focused coal producer SouthGobi Resources Ltd. due to regulatory approval hurdles.

In Australia, a federal election in September is expected to pose uncertainties to foreign investors due to the possible change in the country's resource tax policies.

New Opportunities

"The lessons of Chinese steel mills' rush to invest in new iron ore projects is that they were too many and too fast," said Colin Barnett, Premier of Western Australia. "They failed to find high-quality assets and partners."

Nevertheless, many expect that a new round of Chinese shopping in international mining assets is on the way, as global mining giants are parting with non-core assets.

Sam Walsh, chief executive of Rio Tinto, said the company was studying its assets. "We are seeking to sell non-core assets and those have not performed very well," he said.

Another mining giant, BHP Billiton Ltd., is doing the same thing. Over the past month, it has sold assets in diamonds, copper and liquefied natural gas.

"This opportunity is very interesting," Phillips said. "Those assets are being disposed not because they are bad, but not fit the companies' strategies."

Some Chinese companies have acted. In December, Hebei Iron & Steel Group partnered with three companies from China and South Africa to buy 74.5 percent of South African copper miner Palabora Mining Co. for US$ 476 million.

The transaction would give Heibei Iron & Steel access to 62 million tons of copper and 240 million tons of magnetite.

Chinese buyers are being more cautious about paying high prices in this round of acquisitions, Goldman Sachs' Zhu said.

Meanwhile, competition from India, Japan and South Korea in bidding is expected to be stronger.

Over the past several years, Chinese buyers have been highly welcomed in international acquisitions, but this is changing.

"Compared to the previous situation, Chinese buyers are now more concerned about costs in acquisition deals," Zhu said. "They are more market-oriented and care about the efficiency."

Chinese companies are also more interested in developed projects, rather than greenfield endeavors.

"Previously, Chinese buyers believed that new projects are cheaper and they are capable of developing these projects with their technology and cheap labor," Zhu said. "However, several cases proved that developing new projects in Australia and other Western markets is even harder than in the domestic market."

Barnett suggested that Chinese companies should join hands with qualified partners in large acquisitions while targeting more listed companies.

"A project with annual production capacity of 10 million tons of iron ore requires investment from US$ 2 billion to US$ 3 billion, plus spending on railway and port construction," Wang said.

Considering the weak performance of the country's steel market, this is difficult for many companies to afford. "Chinese companies should partner with their domestic counterparts and make more efforts in feasibility studies and valuation," Wang said.

But some in the industry say such cooperation is difficult.

"It is impossible for Chinese steel companies to cooperate," said a large steel company executive. "For large state-owned companies, no one wants to play supporting role in a deal. That's why Chinese steel companies usually act alone, even paying higher prices."

But Chinese companies are expected to continue enjoying financial support from the government and commercial banks in overseas expansion. Zhu said SOEs will retain their advantage in financing for overseas acquisitions due to easier access to bank loans. Meanwhile, private companies can also expect more support from policy banks.

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