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Crouching tiger, changing dragon

A VISIT to Mines and Money Beijing by Olive Capital managing director <b>Andrew Sparke</b> revealed China’s changing strategies, which will be pertinent ahead of Mines and Money Australia this week.

Staff Reporter
Crouching tiger, changing dragon

China has invested approximately $A30 billion into Australian resources projects in recent years. Anecdotal evidence suggests that about 70% of these investments are currently under water. This fact, coupled with the receding demand for commodities and recent bearish pricing sentiment, has led to a retraction in resources investment.

There is a general feeling throughout China and Asia that previous deals were not thoroughly assessed and more robust due diligence will need to be conducted for future investments. This means that future transactions are likely to be slower and more difficult to complete.

Over the past 12-18 months, we have seen a significant drop in resource transactions and investments out of the Asian region. Importantly, there was a general mood among most delegates at Mines and Money Beijing that those investment flows were starting to move again.

So what are they looking for?

The Chinese are starting to take a contrary view to current market conditions and investment cycles. They see value at current pricing levels.

Copper and gold were among the most highly sought, after commodities by state-owned enterprises (SOEs), fund managers and private investors. There was also interest in uranium, base metals, oil and gas and potash.

Coal was a commodity that was particularly on the nose due to falling demand, an expected increase in supply moving onstream and an emerging view within China of the need to improve the environment. There also seems to be a rejuvenated interest in investing in infrastructure to support mining operations such as ports, rail and processing plants.

Geographically, while there was some talk in China of diversifying its large Australian investments to other jurisdictions such as Africa and the Americas, there is a general consensus that Australia remains one of the preferred outbound investment destinations. The reasons for this are discussed later in this article.

There is still a reluctance to invest in early-stage companies, particularly greenfield exploration. The Chinese are still looking for companies and projects that are in production or as close to cash flow as possible.

Aside from the reduced risk profile of more advanced companies and their need to secure supply of resources, the Chinese understand that the transition from explorer to producer is generally were most investment gains are achieved. There is, however, an appetite for early-stage companies with high-quality projects and management, but this still remains a difficult place to raise funds.

Size of investments?

The Chinese investment market is generally seeking larger investments of greater than $A10-20 million. They are less likely to do smaller investments unless resources companies can show a path to production or a strong development pipeline. The Chinese are prepared to invest in a smaller way early if they can see a larger capital-raising at some future point to meet these production and development milestones.

The Chinese are also changing the way they structure their investments. In the past they have largely insisted on taking a controlling stake (ie 51% or more). This has obvious consequences in terms of incentivising on-ground management and in most cases hands operational accountability to the financier.

Due to a number of deals that have not performed in part due to the structuring of the deal, the Chinese are beginning to soften their stance and move towards a “partnership” model. This provides mining and exploration companies with the flexibility to manage and add value to their projects. It also hands back management of the projects and their operations to the mining company.

So for the first time in recent years, the Chinese are considering smaller investments at an earlier stage, but only for quality project and management teams that can demonstrate a path to production.

The justification here is that if they partner and grow with Australian resources companies at the exploration stage they will have a lot better understanding of the company’s management, structure and projects prior to larger investments. This is a newer methodology and is being cautiously trialled by a select group of Chinese investors.

On October 10, 2012, the China Securities Regulatory Commission extended a moratorium on initial public offerings on the main stock exchange in China, the Shanghai Stock Exchange (SSE), following claims by investors that a number of Chinese IPOs had cooked the books or embellished their prospects in their IPO disclosure documents.

Various reports indicate that there are over 700 Chinese companies queuing for the opportunity to list. With just 952 companies listed on the exchange, this highlights the size of the issue for China. This has led to a flood of Chinese companies seeking alternative stock exchanges and sources of funding.

It has prompted a lack of confidence in the regulatory system, and its ability to adequately control and supervise the market. Further exacerbating the problem, the Chinese market has performed poorly in 2013 when compared to other world exchanges. This, coupled with the fact that many Chinese IPOs are significantly under water, has added to an acute lack of confidence for Chinese listings.

Additional to this, and despite three years of government attempts to cool the property sector, many Chinese investors still see the property market as providing stronger gains over the longer term. Many market commentators are talking up the possibility of a housing bubble and say that a lack of confidence in Chinese stock markets is fuelling this threat.

The poor performance of the SSE this year is in part due to foreign investment receding from emerging markets, such as China. However, the problem with IPOs in China has more to do with credibility than a drain on market liquidity. The credibility of the exchange is also a function of foreign exchange controls.

The Australian Securities Exchange is not the only exchange that Chinese companies are targeting. The US, Singapore and Hong Kong exchanges have also seen a large influx of demand from Chinese companies looking to list. However, these exchanges have seen a number of recent Chinese listings perform poorly, thus reducing ongoing investor appetite in these regions.

One of attractions of the ASX is that the cost of listing is significantly lower than other exchanges.

The cost of a listing on the ASX is approximately $A500,000, compared with an estimated $A1 million in Singapore and Hong Kong, where you can expect to pay $A5 million. In Singapore and Hong Kong there is also a preference for larger and more established companies, while the ASX has a strong history of supporting smaller companies at an earlier stage in their development cycle.

Due to this, Australia is often a preferred destination for Chinese listings. Despite a crackdown by the Australian Securities and Investment Commission, there are still record numbers of Asian companies seeking a listing on the ASX. Of the 2162 companies listed on the ASX in August 2013, ASIC has identified that 571 listed companies are from the Asia Pacific region.

The other key driver of Australian listings is the credibility that an ASX listing brings to Chinese businesses on home soil. As the ASX has stringent admission and continuous and periodic disclosure requirements, the transparency of the market mechanism and the quality of companies listed on it is perceived by many Chinese investors as being superior.

How are Chinese IPOs being structured?

Many Chinese listings on the ASX are compliance listings, meaning they are only raising the minimum amount of capital required to meet the ASX listing rules and complete their IPOs. These small capital raisings also allow Chinese companies with large Chinese investor bases to meet the minimum spread requirements. This reinforces the fact that the primary aim of Chinese companies is to use the listing to build credibility in their home market and not to raise funds which is typically the prime motivation for most IPOs.

These Chinese listings typically only accept subscriptions for 5-25% of the issue capital with the balance being held by the original owners. This has obvious implications for control. As most people would be aware, under the Corporations Act, Australian companies require 75% of a shareholder vote to pass a special resolution. Thus providing the company complete control over their business affairs. Control, as discussed earlier, is also a common pre-requisite for Chinese investment into Australian resources companies.

This all bodes well for Australian resources companies and presents a number of opportunities. It will facilitate further investment flows to Australian resources companies over the medium to longer term and improve the perception among the Chinese investment community that Australia is a stable and robust jurisdiction for foreign investment.

*A version of this article was first published in the October-November edition of ILN's sister publication, RESOURCESTOCKS.

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