From Sandton to Shanghai

(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…

I am happy to say that my first big prediction in this blog has come to fruition. On 12^th November 2007, I wrote that:

“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.”

Almost 2 months later this is exactly what happened. On 31^st January, according The Wall Street Journal: “Chinalco and Alcoa managed to snap up 9% of Rio by purchasing London-listed shares overnight Thursday, while avoiding leaks that might have alerted the market to their plans and given BHP time to respond.”

The deal was valued at massive USD14.1 and surpassed China’s previous international investment deals by a huge margin. While there is still the possibility of BHP upping the ante, China has a strong hand with its 9% stake in Rio Tinto. This makes future BHP efforts more financially risky and complex and significantly narrows their window of acquisition opportunity. Even if this happens, China will be happy in the knowledge that they have their first ‘super-stake’ in a global mining company.

Living in China is a fascinating experience and gives me an ear closer to the ground. Far from being a mysterious and opaque country that making foreigners perceive, many things are quite straight forward on a macro level in China. It is the micro level that defies comprehension.

On many accounts, China’s interests in thwarting a BHP - Rio takeover are very straight forward. If you understand the dynamics that drive China’s growth and the direct threat that a mining mega merger poses, then the outcome (but definitely not how the outcome is achieved) is more certain. Add to this China’s centralized decision making ability (which means that if something is of national importance it will be dealt with as a key prerogative) and China’s burgeoning foreign reserves mean that all but the biggest deals are out of their reach.

(China has gone from zero to significant international investor in 3 years. Source: Wall Street Journal)

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) 

(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.