China: From investee to investor

The past decade has seen China gradually shift from being a net recipient of overseas investment in the mining sector to being a net provider of mining investment overseas. Companies have to recognize that there has indeed been a drastic shift in China from investee to investor, and thus develop strategies to capitalize on this new reality.

In 1996, with a new mining and resource law promulgated, the Chinese government fully opened the country’s doors to foreign mining companies. Although time consuming, filled with “red tape” and necessitating considerable guanxi, or relationship building, the new law established important rules and rights for the mining industry. Under those rules, the state committed to protect mining rights and miners gained the rights to expatriate capital and profits; to mine and sell gold; and to transfer, merge or sell mining and exploration rights.

The typical foreign investment structures were Sino-foreign co-operative joint ventures, contractual joint ventures and more recently, wholly foreign-owned enterprises.

The Chinese mining industry at that time had limited foreign involvement. The Chinese were eager to adopt modern exploration practices and techniques. Most deposits had insufficient or inadequate exploration drilling and there were unique opportunities to acquire quality advanced exploration or near-production projects.

China needed mining capital, mining technology and Western management expertise and foreign investors were steered toward projects that were difficult to mine, low-grade, or that had complex metallurgy.

There were two major waves of mining investments into China. The first occurred around from 1996-99, while the second one was from 2001-04. In the first wave, “the early bird gets the worm” syndrome was clearly evident. In fact, the most successful foreign mining companies in China were established prior to or around this time. However, this wave stopped abruptly due to the Bre-X Minerals fiasco and prolonged low metal prices.

In the second wave, metal prices powered the rebound. Also, exploration funding once again became available, after the deep doldrums of the late 1990s. At the same time, China was beginning to be recognized as an economic power and becoming a magnet for foreign investment — not only in the mining sector but in other industries. In this more competitive wave, quality projects became more difficult to acquire.

In the past few years, some foreign mining companies have experienced hurdles operating in China. These include disputes with joint-venture partners, funding issues for their projects and changes in government policy that further limited the types of projects open for foreign investment. In addition to delays and time constraints in obtaining exploration and mining permits, operating and geological issues have dampened enthusiasm for foreign investment in the sector. In fact, our internal research shows that some Chinese-related mining companies listed on the Toronto Stock Exchange had disputes with their JV partners or authorities, had funding problems in their home country, ended up abandoning their projects in China, or became inactive in China.

At the same time, Chinese mining companies became more confident in their ability to invest overseas. While foreign direct investment (FDI) in China increased significantly since 2001, FDI in mining showed a gradual decline.

China -the Investor

Around the same time that foreign mining companies in China began to re-evaluate operating conditions in the country, Chinese companies began to move abroad. Chinese mining companies and state-owned mining enterprises were beginning to become richer, and the tide began to shift. Chinese mining companies began to make serious forays internationally, with China Minmetals’ aborted bid for Canadian mining giant Noranda in 2004 being one example.

By 2007, China’s foreign reserves had ballooned to about $1.5 trillion from about $143 million in 1997. Similarly, total investment by Chinese companies in its own mining sector increased significantly. For example, total investment in fixed assets in China’s mining industry increased to $67 billion from less than $10 billion at the beginning of the decade.

China’s corporate management learned modern capital markets techniques and management practices and are now ready to deploy their skills in foreign markets. Not only are the Chinese enterprises flush with cash but China itself is hungry for natural resources to feed its rapid growth. The emerging superpower requires a long-term predictable supply of raw materials. Agreements include long-term offtake contracts and structures to ensure future supplies. Chinese companies want secure metal supplies, hence Chinalco’s acquisition of 12% of Rio Tinto PLC — the target of a takeover bid by BHP Billiton. The country is seeking a proactive defence against near-monopoly giants controlling too much of the market. China is not only a key driver of the “commodity boom” but a key participant in influencing the market.

Chinese investors are targeting African countries, Canada, South America and Australia.

Africa is of particular note for Chinese investments. China has nurtured its relationships with Africa over the past several decades and is now capitalizing on its African guanxi. Investment structures include packaged infrastructure projects (including roads, power facilities and buildings) with mining investments and associated smelting facilities in some cases. Substantial investments have been made in the Democratic Republic of the Congo, Zambia, South Africa and Niger, among others.

Strategies

Miners need to acknowledge this shift in China’s position. Foreign mining companies operating in China should be prepared to seek financing from Chinese entities for their projects, especially in these current soft market conditions for mine financing. Additionally, foreign mining companies in China know their respective home countries well (geology, culture, sources of projects) and should consider joint-venture or partnering operations in those countries. Foreign mining companies in China should also consider co-investing with their Chinese JV partners in overseas projects where they have specific expertise or experience. Providing technology and management services for Chinese companies operating overseas as a value-added competitive advantage should also be considered.

In the future, expect: more Chinese miners investing abroad; competitive bidding for projects; and larger and more aggressive deals. Furthermore, it may not be far-fetched to envisage non-state Chinese companies competing against each other for overseas deals.

–The author is president of Global Mining Corp., a company in the process of establishing a private equity fund with sovereign fund backing to invest in overseas projects with Chinese (and other) enterprises. He has a geology degree and an MBA, was a corporate and investment banker, and has extensive experience in conducting business, negotiations and acquiring mining projects in China.