China’s Chalco Snookered On SouthGobi Acquisition

By:
on Sep 3, 2012
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As reported in the Financial Times, the deal between miner Turquoise Hill and Chalco for a controlling share in Mongolian coal producer SouthGobi Resources (HKG:1878) has been officially terminated. The decision was announced by Turquoise Hill on Monday, 3 September.

Chalco, China’s biggest aluminium producer, made a bid for the controlling stake in SouthGobi Resources earlier this year. The main focus of the deal was a coal mine in the Gobi desert, which is also SouthGobi’s biggest asset. Chalco was supposed to buy up to 60 percent of SouthGobi from Turquoise Hill, the mining company formerly known as Ivanhoe Mines. The $938 million on the table would have been China’s biggest investment in its northern neighbour. But the Mongolian government has intervened to stop the deal from closing.

Mongolian officials have been mostly concerned about the influence of Chinese state-owned companies over the country’s economy, which is highly dependent on natural resources. The worries are that Mongolia could become an economic outpost of Beijing and that deals like SouthGobi increase the chance of that happening.
!m[](/uploads/story/322/thumbs/pic1_inline.png)To block the deal the Mongolian parliament rushed through a new law on foreign mining investments restricting foreign ownership to 49 percent. The country is rich in resources and the desire to remain in control of this key sector of its economy is understandable to some degree.

The actions taken by the Mongolian lawmakers have served their purpose. On Monday, 3 September, Turquoise Hill, the largest shareholder in SouthGobi, announced that it had terminated its lock-up agreement with Chalco. The miner pointed out that the chances of getting approval for the deal were now very slim and that bleak prospect influenced the decision.

But while the new law has seen off this particular unwelcome foreign investment, it creates another, perhaps even bigger, issue for it’s unclear how other prospective foreign investors will respond to the new law’s insistence on local interests – very likely with a strong state influence – retaining control of any investment.
According to the Financial Times, the scuppering of the SouthGobi deal highlights the political risks involved in investing in Mongolia. Indeed, SouthGobi’s CEO Alexander Molyneux said in a statement that the company encountered “hostility” from Mongolian regulators after Chalco’s bid. The Mining Ministry had publically threatened the company with suspension of its mining licenses and its offices have been raided as part of an anti-corruption investigation.

Andrew Driscoll, a mining analyst at CLSA in Hong Kong, doubts that the new foreign investment law will adequately address Mongolia’s legitimate concerns. According to Driscoll, the failure of the SouthGobi deal indicates that the Mongolian government has yet to come up with a workable framework for large foreign investments which meet both domestic and investor needs.
If this problem is not addressed in near future, it could have a negative effect on the country’s economy. In the worst case scenario the new law could cause investment to dry up, with foreign investors opting to stay out of the country.

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