CHALCO Intends Takeover of SouthGobi Resources
Landmark corporate bond issue. SouthGobi Resources (TSX: SGQ, HK: 1878) has entered into a Cooperation Agreement with Aluminum Corporation of China Ltd. (“CHALCO”), and received notice that CHALCO intends to make a proportional take-over bid for up to 60%, but not less than 56%, of the issued and outstanding common shares of SouthGobi at C$8.48 per share, SouthGobi and Ivanhoe Mines announced today. The offer price for SGQ’s shares represents a 28% premium over the closing price of C$6.62 on the Toronto Stock Exchange on March 30, 2012. Ivanhoe Mines said that CHALCO expects to submit the takeover bid in early July 2012 after the Chinese company secures all necessary regulatory approvals conditional to the closing of the offer. SGQ shares surged 17.9% to HK$60.35 in Hong Kong trading today.
SGQ said that under the Cooperation Agreement it will benefit from 1) coal off-take by CHALCO (CHALCO will be committed to purchase up to 100% of SGQ coal at market prices for a period of 24 months), and 2) Infrastructure support (CHALCO will assist SGQ to procure electricity and provide support to SGQ’s coal-haul highway project).
SGQ as one of the largest coal producer in Mongolia. SouthGobi Resources is an integrated coal mining, development and exploration company. SGQ owns four significant coking and thermal coal projects in Mongolia’s South Gobi region: a producing mine, the Ovoot Tolgoi Mine; and three development projects, the Soumber Deposit, Zag Suuj Deposit and the Ovoot Tolgoi Underground Deposit. The company also holds seven mineral exploration licences in Mongolia. SGQ’s flagship Ovoot Tolgoi coal mine is located approximately 40km north of the Mongolia-China border. Following record exploration in 2011, the company has recently updated its NI 43-101 compliant estimates of coal resources and reserves. SGQ is estimated to hold overall measured plus indicated resources of 492.6Mt and inferred resources of 244Mt. Ovoot Tolgoi mine is estimated to have proven and probable reserves of 119.1Mt and 56.5Mt respectively. The mine currently produces semi-soft coking coal with calorific value over 7,200kcal/kg.
In line with Ivanhoe’s strategic options. Ivanhoe that owns approximately 57.6% of SGQ’s total shares has entered into a lock-up agreement with CHALCO and has agreed to tender all of its SGQ shares, on a pro-rata basis, to CHALCO. If the bid is executed, Ivanhoe could receive up to C$889mn (US$898mn). “...the value offered by this transaction is an excellent opportunity for our shareholders to realize significant value through our creation of what has become one of the fastest growing coal producers on China’s doorstep,” said Ivanhoe Mines Chairman David Huberman in the company’s accouncement today.
In our view, the sale of its SGQ shares is in line with Ivanhoe’s strategic options plan, especially after it was recently taken over by Rio Tinto, to focus on its key asset – the Oyu Tolgoi copper-gold project. Ivanhoe had announced before that it would consider sellig its subsidiaries to fund its core Oyu Tolgoi operations.
We believe that acquisition of a majority stake in SGQ is value accretive for CHALCO as valution is at significant discount to SGQ’s NAV and resource acqusition cost in global coking coal market. The CHALCO’s offer values SGQ at US$1.6bn in EV and US$2.2 per tonne of coal resources. According to our model, SGQ’s NAV is US$1.9bn and CHALCO’s offer implies a discount of 17%. In comparison to valuation of coking coal assets in recent M&A transactions of US$3.5 per tonne, SGQ is valued at 58% discount..
Reaction in Mongolia. If CHALCO\'s bid for a controlling stake in SGQ is successful, it would represent the largest foray by the major Chinese state-owned company into Mongolia. Other recent investments by Chinese SOEs include CNPC\'s extensive involvement in the oil exploration in the eastern Mongolia and the acquisition of Western Prospector, a uranium exploration company by China National Nuclear Corporation. The risk of the Mongolian authorities blocking the deal is low as Rio Tinto and Ivanhoe may have conducted consultations in advance. Moreover, the last year Chinalco signed US$250m off-take agreement with Erdenes Tavan Talgoi, the Mongolian state-owned company. However, the takeover of significant Mongolian coal producer by the Chinese company may still passionately play out during the election campaigning in coming weeks.
M&A driven value. This SGQ/CHALCO deal and others including US$500mn takeover of Hunnu Coal by Banpu are in line with our long held view articulated in Mergers & Acquisitions note on September 13, 2011 Mongolia Coal Companies Targeted in M&A Deals that Mongolian coal assets will be attracting increasing interest of strategic investors. Strong outlook for international commodity prices, proximity to China and attractive valuations make Mongolian assets lucrative to global and regional players. We expect strategic investors, including resource and energy companies, steel-makers and commodities traders to capitalize on investment opportunities in Mongolia.
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