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THE capital market equivalent of long running radio soap opera ‘Blue Hills’ has extended its run as the protracted takeover of Sundance Resources pushes into a third calendar year.
The way in which the Sundance Resources takeover has been conducted damages all parties involved. Shareholders have been taken for a ride. Directors come off looking like dopes. Hanlong Mining appears dodgy. Australian regulators have been made redundant. And, above all, the reputations of all potential Chinese business partners have been sullied.
"What had appeared a blazing opportunity has proven a commercial quagmire in which Sundance’s principal interlocutors are unable to meet their commitments, in part because they never could and, in part, because the ground rules have been changing."
The Sundance saga has been a classic case of a mining company making a find too big to develop. The capital cost – last estimated at $A4.6 billion but inevitably well north of $5 billion now – was always going to be too much for Sundance on its own.
Sundance directors did not help instil belief in their cause by making outrageously optimistic claims about their capacity to start production by 2011.
By the time Hanlong came along, the credibility elastic had already been stretched. There was a sense of relief that someone with access to enough capital might offer shareholders some respite. Back then, Chinese investors were perceived as white knights for an industry battling capital shortages in the aftermath of the 2008 financial crisis.
China had demonstrated an interest in direct investment. Several forays by state-owned enterprises had grabbed assets at historically low but still attractive prices. The prices Chinese investors paid were far more appealing than those western investment institutions, on whom the industry had relied in the past for its capital supplies, were offering.
The unease of China’s government over access to raw materials was also well known. So, too, was their anxiety over having to deal with a handful of economically powerful iron ore producers as their economy was sucking in unprecedentedly growing tonnages of metal.
Very quickly, a plethora of more entrepreneurial Chinese connected investors emerged to take advantage of the needs of both buyer and sellers. Hundreds, it seemed, had mandates to track down iron ore and coal. They were newly rich from non-resource backgrounds but seemingly well connected.
As capital streams from Europe and the USA were running dry, every budding miner wanted a Chinese benefactor and the Chinese intermediaries and direct investors were readily embraced.
Over time, the penny dropped for the Chinese authorities. There was no need for panic. National growth was slowing. Raw material supplies were catching up with demand reducing the risk of shortages affecting growth plans. China realised it was the only game in town. After all, where was a new Australian mine going to sell its output?
Importantly, too, for the reappraisal in tactics which began to occur, many of the earlier Chinese investments did not measure up. The Chinese had paid too much leading into a cyclical downturn causing authorities to become increasingly circumspect about the prices at which deals were being put forward for approval.
Despite some bold shows of economic liberalism, China remains a centrally controlled economy in many important respects. Central authorities remain highly committed to the roles of the state owned enterprises. News agencies are reporting out of China that Hanlong has been instructed to bring state-owned steel producers into the Sundance deal.
For all its recent dynamism, the Chinese economic system also remains highly corrupted by the influence of personal relationships capable of overriding commercial obligations and a decision making process that is ill matched to western business timetables.
Newly appointed head of the communist party Xi Jinping railed against “corruption and bribe taking” as the first of “many pressing problems” in his initial public address as party leader. His peeves included too much bureaucracy and formality.
If senior members of the central committee are finding it so difficult to cope with Chinese-style decision making that they feel compelled to vent their frustration publicly, naive western companies will be hard pushed to understand fully how to make a deal work.
Sundance was caught up in this dynamic. What had appeared a blazing opportunity has proven a commercial quagmire in which Sundance’s principal interlocutors are unable to meet their commitments, in part because they never could and, in part, because the ground rules have been changing.
So, one lesson from the Sundance experience is to be wary of the Chinese benefactor who appears ready to conjure billions of dollars. Directors need to look the gift horse in the mouth.
Even at the risk of insulting a potential benefactor, directors need to tell buyers, however well intentioned they may be, to go away and sort out their approvals before coming back ready to proceed. Unfortunately, investors have no protections against naive directors gulled into engaging with a Chinese counterparty except to sell at the first sign of a Sundance-type deal.
Sundance directors agreed to a price based on a project as it stood in 2011, prior to government approvals and completion of ongoing drilling programs, but conditional on those being completed and the project being substantially de-risked.
This deal structure transferred the upside potential from existing shareholders, since their exit price was capped, to the potential buyer who had a free option to walk away if the additional value did not arise leaving all the downside to existing shareholders.
This was a smart deal if, as a buyer, you could get it, but never a good one for ordinary shareholders. Meanwhile, Australian regulators could not offer any protections against the buyer taking full advantage of its relatively powerful position, including being able to use its influence in China to block expressions of interest from other sources to prevent a competitive bidding process.
Of course, this goes to the heart of the matters raised in 2012 by the High Court in the Fortescue Metals Group case in which the court opined that “tough, shrewd and sceptical” investors were not “an audience in whom the adjectives ‘Western Australian’, ‘mining’ and ‘Chinese’ would excite a sudden certainty about the imminent creation of wealth beyond the dreams of avarice”. The High Court effectively told shareholders they were on their own when it came to deal-making in the mining industry.
With the Sundance Resources share price running 25% below a bid supposedly a few days from completion, investors registered their opinions. Perhaps, therefore, the market is working as it should but the longer the Sundance saga goes on the more evidence mounts that Chinese investors are among the least desirable partners for Australian-listed mining companies.
Ultimately, this is the possibility to which Chinese authorities need to sensitise themselves. Otherwise, they will risk missing out on the best development opportunities to service their growing metal needs.
John Robertson is a director of E.I.M. Capital Managers, a Melbourne-based funds management group. He has worked as a policy economist, business strategist and investment market professional for nearly 30 years after starting his career as a federal treasury economist in Canberra.
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