Chinese interest in Australian resources likely to shift to...

Chinese interest in Australian resources likely to shift to juniors
By Mike Ross in Sydney, Lisha Zhou and Yumin Wang in Shanghai, and Takashi Toyokawa in Tokyo

Published: December 18 2009 21:30 | Last updated: December 18 2009 21:30

Chinese deal flow into Australias resources sector has started to slow and 2010 is expected to bring activity in different forms and at the smaller end of the market, industry sources in Australia and China told dealReporter.

Australias foreign investment regime remains a regulatory hurdle with decisions in respect to investment by state-owned entities [SOE] being unpredictable to date. The Foreign Investment Review Board [FIRB] assesses investment proposals on a case-by-case basis. As part of the process conditions may be imposed, however in some instances, these conditions have been regarded as too arduous for Chinese entities to achieve their objectives. Last week Australian Treasurer Wayne Swan said that it will increase the FIRB to five members from four and it would release a guide of its framework for future investors to consider that will be produced in various languages including Chinese. The clarity that such an initiative will provide for prospective Chinese and foreign investors remains to be seen.

Of significant importance in understanding the Australian approach has been the approval of Yanzhou Coal to acquire 100% of Felix Resources, noted Malcolm Brennan, Special Counsel at Mallesons Stephen Jaques. Finally some consistency has appeared in the Australian Treasurers approach with the conditions attached to the approval similar to those imposed on Minmetals acquisition of assets from OZ Minerals, Brennan said. In effect, the Australian Treasurer is looking to ensure that an SOE acquisition retains an Australian connection to the assets being acquired, he observed. This includes using an Australian purchasing vehicle and looking to have an Australian resident CEO and CFO as well as retaining Australian management and control.

Other changes in general economic and resource specific conditions have also contributed to a slowing of Chinese inbound investment. The financial outlook for Australian resource companies is better than it was earlier this year as commodity prices have improved, noted one industry banker. The resurrection of the capital markets provides another alternative that has been absent for many companies for much of this year. Companies from other parts of the Western world are also becoming more inclined to engage in mergers and acquisitions, and although announced deals are few and far between at the moment, they will likely reemerge as another option for Australian companies, he added.

Yet China has not only performed a banking function through the hard times and potential strategic benefits will continue to drive deals, argued a second banker. I think you will see more joint ventures, more partial interests, less insistence on absolute control and some more compromise around structure, he said. Deal volume will depend heavily on the state of the global macroeconomic environment, but transactions are more likely to be scrip-based than cash, friendly and dependent on due diligence, he added. You will see fewer large hostile deals without due diligence.

The smaller end of the market is expected to be quite active as companies hit the capital markets to fund organic growth projects and mergers and acquisitions, said the first banker.

After seeing activity mainly from the large state-owned Chinese entities, private Chinese entities are beginning to consider forming consortiums to bid for assets in Australia, according to a Beijing-based banker. Deals pursued will likely be smaller than those seen in 2009, around AUD 100m, he said. Meanwhile state-owned Chinese steel makers are likely to seek out targets with resources other than iron ore as they look to increase production of specialty steel products. Targets with chromium, manganese, titanium and vanadium are likely to be a focus, he said.

A regulatory source close to the National Development Reform Commission [NDRC] noted that China still lacks certain resources and so while appetite has not decreased, the way deals are structured will change. He saw cooperative agreements such as joint ventures and minority stakes as likely deal drivers rather than corporate buyouts. However, Chinese investors will be more sensitive to price since the commodity markets have gained from their recent lows, a potential impediment to deal making, he added.

A Beijing-based corporate lawyer argued that although commodity prices have recovered significantly, they are still far off from the peaks seen in recent times. It will still be good timing for Chinese bidders to buy Australian resources.

In September, Australian listed lithium producer Galaxy Resources [ASX:GXY] announced a deal with Beijing-based Creat Group, a private investor. The deal saw Creat provide AUD 29m in equity financing and 130m in debt financing for asset development, in exchange for a 19.9% stake in the company. Meijin Energy, which submitted a counter-bid for Australian listed coke producer Rocklands Richfield [ASX:RCI] is also held privately.

As private Chinese entities seek deals, SOEs will look to establish off-shore companies as acquisition vehicles or invest in internationally focused private equity funds, the Beijing-based lawyer said.

Copper, iron ore and coking coal will likely remain in strong demand by Chinese firms in 2010, sources said.