From Sandton to Shanghai

(Australian Mining Stocks on the Decline: S&P ASX 300 Mining and Metals Index showing a 49% drop over 6 months ended 1 December 2008)

‘Be bold on expanding overseas’ is the near official line hailing from China Daily’s front page yesterday.

After years of battling to keep input costs down amid a rampant commodity boom, the current global economic marketplace has swung round 180 degrees in China’s favour.

A strong sense of risk aversion is definitely needed after China’s baptism of fire on the international investment scene. Recent overseas equity purchases at the height of the business cycle have definitely burnt deep holes in the balance sheet: Rio Tinto, Fortis, Barclays and Blackstone have all been far from pretty.

“These are rare opportunities for Chinese enterprises which want to expand overseas,” emphasized Zheng Xinli, vice-director of the Policy Research Office of the CPC Central Committee. You can almost sense the anticipation in the air. Hard lessons have been learnt, but we seem to be in a strategic pause before a concerted buying spree in 2009.

Australia will be one of the first destinations.

In the past 6 months, listed Australian resource stocks have lost up to 60% of their market capitalisation. Over the same period, the Australian Dollar currency depreciation has moved over 30% in China’s favour.

Australia is China’s most successful resource investment destination. The market is efficient, well managed and transparent. Its proximity to China keeps logistics costs down. Iron and high quality coal - bountiful in Australia - are staple products for China’s manufacturing economy and in short supply back home.

What will make this investment period different from before is the move to M&As and significant ownership levels. This is a sharp contrast from China’s previous preference for a more hands-off policy of minority stakes, off-take agreements and long term contracts.

Here are a few more tangibles to look out for:

• Iron Ore and Coal Companies are priorities
• China’s SOEs will take the lead like Sinosteel, Baosteel, Angang Steel, CITIC, Yangzhou Coal, Shenhua and Chinalco
• Keep tabs on smaller, more nimble and internationally adept Chinese resource players like Jiangsu Shagang , Zijin Mining, Western Mining, Jinchuan and Hunan Nonferrous
• Expect large equity stakes in companies part of recent large-scale M&As who are now saddled with a huge debt burden like Rio Tinto, Oz Minerals

(Platinum Ore. Source: DK Images)

Here is a straight forward prediction for years 2008 and 2009: A Chinese mining company will buy a minority stake in a major South African platinum mine.

China’s automobile production has skyrocketed in recent years. In Beijing if you are a successful government official you drive a black Audi and if you are a successful entrepreneur (or at least want your friends to think so), then your vehicle of choice is a black BMW. Driving a car is a great status symbol and the only difference with most of South Africa’s up and coming black professionals is that in China, you first buy your house, then a depreciating asset.

As China gets richer, so the local vehicle market is hotting up and major cities like Beijing are experiencing huge traffic congestion on roads that were predominated by bicycles a generation ago.

Shanghai is smarter on the car front. Firstly, people are happier to catch public transport as image is not as important is its political rival to the north. Elevated highways, sometimes 4 layers deep and stretching up to 10 floors above the hum drum of congested traffic lights spirit traffic along at a speedier rate. But probably the biggest deterrent is that while an entry level car will cost just over R30 000, you need to participate in an auction process to buy a Shanghai license plate. Without this you are relegated to driving along non arterial roads. At the end of 2007, buying your local Shanghai license plate was a whopping R55 000 - nearing double the price of your car!

China now produces in excess of 7 million cars per annum and is second only to the USA in vehicle manufacture. In 1999, China adopted the Euro 1 emission standard that required all domestically produced vehicles to be fitted with catalytic converters and almost all of China’s vehicle exports are to countries with emissions standards in place.

Currently, catalytic converters account for over 60% of platinum consumption. Only one Chinese mining company on the planet has a direct interest in a platinum mine and this is not even an operational development yet. South Africa has over 77% of the global platinum supply with 50% of this is processed locally.

While platinum was not one of China’s strategic resources, it is fast becoming more important as China powers up the global car manufacturing rankings. All this points to South Africa sooner than later…

Hot off the press news according to the Telegraph is the ‘Blackstone is planning an audacious break-up bid for miner Rio Tinto’ The Times is running the same story ‘Blackstone, the American private equity firm, is to join the battle for Rio Tinto with a break-up bid’

Should these reports be accurate, it presents in my mind a viable and political savvy way that China can:

a) halt BHP’s hostile takeover of Rio Tinto
b) make its first significant investment in the multinational mining sector

In 2007, The China Investment Corporation invested USD 3 billion in Blackstone to secure a 10% stake in one of the world’s top private equity companies. Blackstone’s Rio consortium includes China’s USD200 billion sovereign wealth fund.

(Post Script: Unfortunately the Daily Telegraph proved to be an unreliable source and Blackstone entering the Rio space was officially denied later on the day this news broke) 

(Its China’s encore for now as it leads the ‘Billion Club’ but will India and Africa come to the party? Photo: Ena Hewitt - Hangzhou, China )

The triple axis of China, India and Africa represent more than half of mankind and Africa is soon to become the newest addition to the world’s ‘1 Billion Club’. According to the latest data from the United Nations Population Division, Africa’s population currently stands at 962 million will climb beyond 1 billion people to join ranks with China and India in 2009.

After their troubled recent history, this massive emerging-market triumvir is slowly rotating into the global spotlight. China is leading the pack having sustained almost 3 decades of economic growth in excess of 10%. India’s economy is starting to pick up pace with its Asian rival and has seen impressive growth of over 8% since 2004.

Africa’s Economic Prognosis

Even Africa is starting to come to the party with its economy having expanded at a rate of 5.4% for the past decade. At a macro level, the continent is definitely heading on the right track. Step back in time 20 years in time and what is now SADC was a very troubled region. Angola, Mozambique and Namibia were all experiencing a civil war. The DRC was hardly any better and apartheid violence was peaking in South Africa. Fast forward to the present and outside of isolated issues in the DRC’s diamond and gold hotspots, it is just our northern neighbours that somewhat ruins a rosy picture.

With more and more democratic elections (the next step is working on more ‘free and fair’ democratic elections) and the advent of pan African ‘from-Africa for-Africa’ institutions such as NEPAD and the AU, the continent is slowly shaking off the doom and gloom shackles that is has been synonymous with for so long. Africa is showing signs of promise on the technological front too. Cell phone penetration has reached 17% of the continent leapfrogging cumbersome landline technology. A 10 000 km undersea cable is being built that will connect 21 countries to the digital age of cheap and fast bandwidth.

A note of caution is that Africa’s economic growth is still largely fuelled by the global commodity boom. Here, China is a key catalyst. Not only has China buoyed international demand for raw materials and is driving their price to all time highs, but China is also investing heavily in raw materials and oil in Africa. These two factors have also seen an increase in Indian and even recently Japanese investment suitors on the continent. This resource money is buffering the national coffers of Africa’s largely trade driven economy and smoothing over some of the more challenging aspects of African society today.

Africa still lacks large scale job creation and this is a pivotal factor needed to lift hundreds of millions above the poverty line. Most current economic growth is jobless and pure resource extraction minus the processing has limited community impact. Massive infrastructural investment is lacking to connect Africa not just to the rest of the world but to itself and this is a remnant of the serious conflict that has hamstrung the continent for so long. Education levels are still shocking inadequate and this is another area that needs urgent attention in parallel with other needs. Furthermore, formalising the informal sector and enshrining land ownership are two pillars of capitalism that Africa is still far, far behind on.

A positive sign is ‘Trade not Aid’ movement that is defining current African debates. Enabling business on the continent is where Africa’s redemption will come from. Making sure this trickles down will sustain this redemption. But if you are not a Chinese or South African company, or do not come from the FMCG, resources or communications sectors then a bit more patience might be prudent.

However, the writing is already on the wall. Continent-wide society political improvements and an enabling commodity surge have taken root and making it an ever more attractive investment destination. The question is now when not if…

(A picture paints a thousand words as to why a BHP-Rio merger is bad news for China. As testimony to the staggering growth of China’s steel industry, an armada of 60 bulk carriers wait patiently off Australia’s Newcastle Harbour to receive coal and iron ore payloads. In May 2007, the line of ships at off Newcastle Harbour stretched to a record 79 vessels. Photo: James Croucher, The Australian)

After my predictions of a looming Chinese investment in Rio Tinto 2-weeks ago (Prediction 2: Chinese Investment in a Multinational Mining Company, November 12th, 2007), China has already fired the first salvo depending on which sources you want to believe.

According to a Forbes article released yesterday, “Shares of Rio Tinto jumped 7.5% Monday in Sydney on a report that China’s new state investment fund and some of its largest state-owned steelmakers could enter a joint counterbid to BHP Billiton’s offer for its mining rival. A state-owned Chinese weekly, China Business, reported over the weekend based on unnamed sources that China Investment Corp., which has been tasked with managing the country’s burgeoning foreign-exchange reserves, and the steelmakers Baosteel, Shougang Group and Angang Steel, were working on a $200 billion bid for Rio Tinto.”

In my mind the response from the China Daily (which when necessary can be heavily influenced by the powers that be) was a bit too quick for comfort. In these instances I tend to favour reading between the lines. This is what they had to say 12 hours after the Forbes report:

“China Investment Corporate Ltd (CIC), the country’s newly launched state foreign exchange investment company, said in a statement Monday that it had never been involved in a bid for Rio Tinto. The statement was intended to dispel market rumors started by a report in Chinese weekly newspaper China Business saying the CIC was leading a group of Chinese steel makers in a bid for Rio Tinto.”

Personally, I am still happy to stick to my initial reaction. A merger between BHP and Rio is not good news for China however you look at it. It is an area of strategic national interest when one company controls 40% of the iron ore in the world and you import most of that. I can assure you that as I write this, Chinese decision makers are doing anything but sitting on the fence. They will be actively pursuing every possible angle necessary to alter the status quo in China’s favour.

BHP has already engaged in some ‘ungentlemanly’ iron ore price negotiations with China. In 2004, BHP lumped the Chinese Iron and Steel Association with a 71.5% year on year price increase. Rather patronizingly, BHP also demanded an unprecedented surcharge of up to USD10 per ton. Their reasoning was that importing steel from its Australian mines would save on transport costs for the Chinese companies importing Brazilian Steel.

If this was the leverage BHP thought it had as a ‘Rio Tinto-less’ entity, China will definitely not be going gently into that good night…

Rather strangely, China has made virtually no investments in major multinational miners. In 2006, Larry Yung made a small blimp on the radar screen by purchasing a 1.1% (USD800 mn) stake in Anglo through his company China Vision Resources.

Investing in a multinational mining company is a highly sensitive, politically challenging task for China. Any Chinese company that has the ability to do so also has strong government ownership and this turns an equity purchase into an issue of national interest rather than a pure business transaction.

At the same time, China is finding itself in a difficult position. It is still heavily reliant on companies such as Rio Tinto, BHP Billiton and Anglo American for its supply of key resources such as iron ore, high grade coal, copper and nickel. Rising commodity prices are placing pressure on manufacturing costs and resource sustainability – the backbone of China’s current economic rise to fame.

The ‘hot off the press’ news that the China Development Bank has bought a 1% stake in Rio Tinto. It comes at a very revealing time indeed. Rio is currently subject to a hostile take over by BHP Billiton. According to a Daily Telegraph article, if successful, this super-sized merger would give the company a 40% control of the iron ore market. As a crucial commodity to its manufacture-driven economy, China currently consumes half the world’s iron ore supply.

A merger of this magnitude would definitely be detrimental to China’s iron ore bargaining power. By purchasing a bigger stake in Rio, China Development Bank could thwart BHP’s acquisition plans. It would also as the perfect excuse for China to make its first big investment in a major mining stock. This would probably be one of the few times that a company like Rio would actually welcome China taking a significant stake in them.

There will be some hard bargaining and Mandarin translation going on in the Rio Tinto boardroom. And if that fails then attention will shift to the next most likely prospect…

Photo courtesy of China Daily

After ICBC opened Chinese and South African eyes to a new world of investment possibilities, there must to be a number of large Chinese companies taking a closer look at South African service sector companies with a large African footprint.

There is not a huge amount to choose from that satisfy these criteria while allowing for a significant level of investment , but here are two companies to keep eyes your on:

MTN

MTN’s name has already been bandied about by the South African press as a possible target for Chinese investment. It has the widest coverage of any cell phone company in Africa, its making a lot of money on the continent and has a strong presence in countries where China has already invested significantly. These countries include Nigeria, Zambia, South Africa, Angola and the DRC.

Sanlam

(Click here for the a report on Sanlam’s Developing Markets prospects)

Sanlam is another interesting prospect. It has a presence in Botswana, Kenya, Ghana, Tanzania, Zambia and is looking at expanding into Nigeria. While Sanlam’s Africa strategy is not yet properly developed, it does have the potential for African expansion to suit a Chinese emerging market focus. The Chinese insurance sector has also recently seen the IPO of two massive companies and this has given them capital to burn. Of course, the Chinese sector has much room for development, but China’s insurance heavy weights will already be contemplating international strategies.

(Shanghai’s impressive skyline viewed from the lofty heights of the Jin Mao Building Photo:Laurette Moolman)

Time to Return the Compliment

For too long, South Africa has viewed China as a nation of cheap textiles and import quotas. There are much bigger opportunities and threats to grapple with on the very near horizon. China has a pragmatic view of its relationship with Africa and it is time we returned the compliment.

When Standard Bank issued a recent cautionary that a transaction of material nature was soon to be announced, it was clear that a big shake up was headed the way of the South African banking industry.

A big deal was afoot. For it to be material, the imminent investment had to be over 25% of Standard Bank’s R150 billion market capitalization. The money market soon provided further clues. Since the notice was publicized, the Rand had strengthened considerably. It was a sure sign that the market was already pricing a foreign purchase into Standard Bank.

Standard Bank and ABSA have the largest African footprint of South Africa’s Big 4 banks, but ABSA had already been snapped up by Barclays. Most American and European banks were still recovering from the sub prime mortgage debacle and were in no mood for international acquisitions. It looked like a Chinese bank was in the running.

Since ABSA was already under foreign ownership, the Competition Commission loomed as a large obstacle for any company braving a majority purchase in Standard Bank. Chinese suitors have access to money and not international management expertise, so a minority stakeholding was most likely.

Armed with these facts, 2 days before the official announcement, it would have been possible to make an informed prediction that a Chinese bank was buying a minority stake in Standard Bank.

A Lesson in Pragmaticism

In a similar lesson in pragmaticism, any rudimentary analysis of mining opportunities in the DRC would have pointed to the fact that it would have had to be high on China’s wish list. After all, the DRC has the largest untapped mineral resources in the world and had a complete lack of infrastructure to mine it.

This was the perfect situation for an increasingly risk averse China with regards to exploiting mining situations in Africa. Given that China already has significant oil and raw material investments from Sudan and Zimbabwe to the most unstable parts of Nigeria and Ethiopia, a sizable investment in the DRC was only a matter of time.

Again, when China announced a USD5 billion mining development and infrastructure package to the DRC, the world seemed to have been caught off guard.

Rather than be astonished by China’s foreign investment strategies, it is essential for South African decision makers to step back and look at the situation from a rational perspective.

China’s first wave of investment in Africa was state-driven around national interests and focused on developing sustainable supply lines for oil and energy extraction. South Africa was largely left out of this investment loop as Chinese money flowed into Nigeria, Angola, Sudan and Zambia. In many ways China was a direct competitor to South African mining and construction companies with an African agenda

China has a very comprehensive investment plan for Africa. It has already invested heavily in continent-wide mining, construction and infrastructural projects. China’s assumption is that this will also equate to a bottom line impact on the economic development of the countries being invested in.

As it is, Africa’s recently strong economic growth rate is riding the wave of a largely Chinese-fueled commodity boom. Higher growth rates are supporting increased household spending on goods and services. South African companies boast a significant African footprint and are in a prime position to benefit for this. From China’s viewpoint, they make for attract investment vehicles.

The Second Wave is just Beginning

The second wave is just beginning. Massive Chinese state owned enterprises are listing for the first time. In the space of 5 years, the global capital market has shifted from New York to Shanghai and Hong Kong, buoyed by a rampant Chinese stock market.

Make no mistake of the size of these Chinese companies. Their market capitalization might be propped up by over exuberant mainland investors, but Standard Bank’s new partner – ICBC – is 60% larger than its closest USA banking rival. Keep in mind that China has 1.3 billion consumers to tap into - 400 million of whom own cell phones and another 100 million who surf the internet.

These huge enterprises are cash flush from recent listings. They have capital to burn and global ambitions to pursue. While most companies still have significant government ownership, the second wave of Chinese investment is driven by business opportunities.

For shrewd local investors and local business leaders, it is crucial to weigh up two important facets. Firstly, keeping tabs on big Chinese IPOs is important as this will inform the source and sector of future global and South African investments.

Prophetic Insight

Secondly, an analysis of South African service sector companies with a large African presence is essential to predict future Chinese investment patterns. Linking these companies and their sectors to their respective listed Chinese counterparts will provide prophetic insight.

ICBC’s investment in Standard Bank was the biggest international investment China had ever made. If Sasol’s USD6 billion Coal to Liquids programme sees the light of day in China, it will be the single largest FDI into the country. As a relatively small economy, South Africa has the scope to play a surprisingly influential role attached to the coattails of an emerging economic giant.

We do however need to get closer to the action and be less surprised by the possibilities that are emerging from China. A rather large second wave is already hitting our shores.

China changes rules of resource game

Julian Hewitt: COMMENT
13 February 2007

When I left South Africa, a talk by Clem Sunter titled “China’s Game” was ringing in
my ears. Clem talked about the rules of the game China is playing in its
unprecedented drive to industrialise a 1,3-billion strong population. What struck me
was China’s dependence on natural resources to continue its impressive growth
trajectory. One of the major rules of China’s game requires it to establish massive
and sustainable supply lines to secure resources that fuel its vast factory-floor
economic model.

Of course, this is the major pillar behind African-Chinese trade. Africa has the
undeveloped resources China so desperately wants. In testimony to this growing
trade and development cooperation, Chinese President Hu Jintao has visited Africa
five times since 1999 and Premier Wen Jiabao has already toured the continent on
three separate occasions. Depending on which side of the fence you sit on, much
has been said about China’s new “colonial” role in Africa or the massive development
opportunity for the continent to dovetail on China’s great economic ambitions.

There are a couple of interesting factors that make up China’s drive to secure
mineral resources and energy assets. The first is the sheer scale of the undertaking.
China has a massive population and burgeoning economy to support. The other is
the role of the state in securing these resources. This is a national prerogative, which
is not unique in itself. However, the fundamental difference is that the Chinese
government plays a prominent role in meeting these strategic requirements, while
most other governments rely largely on the invisible hand to meet a rising supply and
demand needs.

At China’s disposal is an army of state operated enterprises (SOEs). Long a
backbone of a previous, more socialistically inclined, era, the more effective SOEs
have subsequently embraced a world of initial public offerings (IPOs), international
acquisitions and foreign contracts.

China’s ruling party has entrusted them with a mandate to pursue resources deemed
to be of strategic national interest — iron ore, nickel, zinc, oil and gas and copper,
among others. The SOEs have political backing, massive credit lines from local
banking institutions and increasing international business acumen.

A sign of things to come is the Belinga Project in Gabon. Purported to be the largest
untapped iron-ore reserves in the world, a Chinese consortium came head to head in
the contract bidding with Brazil’s CVRD — the world’s largest iron-ore producer.
Because Gabon’s iron-ore reserves are situated deep in equatorial forests, massive
infrastructural costs have excluded previous iron-ore suitors. Enter the Chinese
consortium, which offered to a) build a new railway line 560km into the jungle, b)
construct a deep-water harbour from which to export the iron ore, c) develop a
hydro-electric dam to supply electricity to the project, d) finance the initiative, e) bring
in Chinese labourers to build it and f) offer to buy the entire mined output.

Not surprisingly, CVRD got blown out of the water in the bidding process — few
companies on Earth would be able to compete with such a comprehensive undertaking.

A recent “secret” meeting at the World Economic Forum in Davos, Switzerland, was
held between the heads of more than a dozen of the world’s largest mining
companies. The six-hour think tank highlighted what a growing concern Chinese
encroachment in Africa was becoming. The group — ironically given the
colonialesque title of “the governors” — sought to find ways of curtailing China’s
immense interest in Africa, which is rapidly displacing their exposure on the
continent. They are considering appealing to the World Bank and United Nations for
help. What “the governors” are rapidly realising is that competing with
government-backed Chinese companies is beyond their capacity. The World Bank
estimates that, last year alone, China spent more than $10-billion on infrastructural
projects in Africa as part of its capacity for-resources exchange.

There is a flip-side to China’s foreign mining exploits. The debate started in earnest
when in 2005 China’s Minmetals made an audacious takeover bid to acquire
Canadian miner Noranda — then the world’s ninth-largest copper and third-largest
zinc producer. A strong nationalistic Canadian backlash revolved around the
argument that Minmetals was a state-owned company and local officials were not
comfortable with a foreign SOE acquiring an important industry on home turf. The
deal was eventually scuppered and other Chinese SOEs have faced many similar
subsequent acquisition challenges.

Bear in mind that China has more than a trillion dollars in foreign reserves from
spiralingtrade surpluses. One of the reasons it is reluctant to completely open its
currency to market forces is the inevitable appreciation of the Chinese yuan against
major currencies such as the United States dollar. Even a “small” 10% depreciation
will wipe off $100-billion from Chinese reserves — enough to finance the estimated
project costs of Gabon’s Belinga Project 169 times over. It has to be tempting for
China to reduce currency exposure on its monolithic foreign reserves by investing in
foreign resources, killing the proverbial two birds with one stone.

Whatever the future holds for China’s quest to build its resource supplies, the rules of
the game will definitely be different from those of the corporate game being played at
present.

And Africa will be a key part of the playing field making us all rather interested
participants or observers.