Change the only constant for Ivanhoe

VANCOUVER — Change and progress are the name of the game for Vancouver-based Ivanhoe Mines (IVN-T, IVN-N) as the company adjusts to a takeover by Rio Tinto (RIO-N, RIO-L, RIO-A) and approaches first production at its world-class Oyu Tolgoi copper-gold-silver mine in Mongolia.

Ivanhoe released its first quarter results on May 15, including an in-depth update on development progress at Oyu Tolgoi, as well as details on corporate governance changes in light of the takeover.  

During the first quarter Ivanhoe recorded a net loss of US$80.6 million, or 11¢ per share. The results marked a decrease of year-on-year quarterly losses by US$412 million, down from US$493 million in net losses during first quarter 2011. The earnings discrepancy was attributed to a US$433 million shortfall Ivanhoe suffered early last year on a change in the fair value of derivatives.

A US$30 million jump in first quarter exploration expenses, up to US$77 million, was offset by an US$20 million increase in coal revenues from Ivanhoe’s 60%-owned Ovoot Tolgoi mine, which totalled US$40 million. Ivanhoe also registered US$10 million in foreign exchange gains, and US$15 million in long-term investment and interest income. The company reported a consolidated cash position of US$750 million as of May 15.

Ivanhoe also offered a detailed update on its progress at Oyu Tolgoi, with 82% of the copper-gold mining complex’s first phase now complete. Development remains on track for an initial-production target in the second half of 2012, as mining and stockpiling of first ore from the open pit started-up in late April.

Ivanhoe has spent US$4.6 billion on Oyu Tolgoi’s development so far, with the mine’s phase-one budget now projected at roughly US$6 billion. Rio tightened its grip on the company last month when it took control of 51% of Ivanhoe’s shares, and ousted former president and CEO Bob Friedland.

As part of the takeover agreement, Rio will assist in negotiating US$3 billion to US$4 billion worth of financing for the project, and cover interim capital requirements via a US$1.8 billion non-revolving credit facility. According to the first-quarter update Ivanhoe has drawn down US$1.4 billion from the facility to date,

“We believe the fundamental outlook on the Oyu Tolgoi project remains very constructive with Rio Tinto in full control of building and operating the project,” wrote CIBC World Markets analyst Alec Kodatsky in a late-April research report. “It remains one of the best copper development projects in the world and is now fully financed and entering production this year.”

Kodatsky lowered his 18-month price target from $26 to $19 following the announcement of the financing deal due to potential share dilution stemming from Rio’s financing stipulations, but maintains Ivanhoe’s “Sector Outperformer” rating.

Under the bridge-financing terms Rio could increase its stake in Ivanhoe to as much as 62% if current shareholders do not exercise their rights to buy additional shares at a subscription price of US$8.34.

“The new financing package will be dilutive to NAV and Rio has gained further ownership and ability to defer a full takeout of the company,” Kodatsky notes. “However, we believe with this new agreement, any concerns about Rio’s view on the project or Ivanhoe’s financing risks should be alleviated.”

As part of Rio’s takeover bid, Ivanhoe’s management team has experienced a near-complete overhaul. Former chief financial officer for Rio’s copper group, Kay Priestly, was named Ivanhoe’s chief executive officer, while Chris Bateman — another Rio executive — earned Ivanhoe’s chief financial officer position. Rio also brought in Dr. David Klingner as chairman, replacing interim chairman Michael Gordon. Klinger is an Australian-based geologist who has held a number of positions with Rio, including head of exploration.

In a symbolic move, Rio is bringing a resolution before shareholders later this month to change Ivanhoe’s name. At the company’s annual general meeting shareholders will be asked to vote on a proposal to re-brand Ivanhoe as Turquoise Hill Resources — a direct translation of the Mongolian words “Oyu Tolgoi”. Rio has already indicated its intention to divest Ivanhoe’s non-core assets, and focus on Oyu Tolgoi’s development and operations,

“Further catalysts would include the divesture of the remaining subsidiaries, which the company has indicated as an ongoing process,” Kodatsky writes. “We believe Ivanhoe’s effort to daylight the value of its non-core assets should help further narrowing the discount implied by current share prices versus our NAV of the company.”

Ivanhoe’s two major-subsidiary holdings include its 58% stake in SouthGobi Resources (SGQ-T) and 59% share in Ivanhoe Australia (IVA-A). SouthGobi operates the Ovoot Tolgoi coal mine in Mongolia, which is being pursued by Aluminum Corp. of China, while Ivanhoe Australia’s main asset is the Osborne copper-gold project in northwestern Queensland.

Ivanhoe Australia has a reported market value of roughly US$552 million, and chief executive officer Peter Reeve recently told Reuters that up to eight bidders have expressed “preliminary interest” in the company, including Anglo American (AAL-L) and OZ Minerals (OZL-A).

Ivanhoe’s shares have taken a tumble since the Rio takeover was announced in late April, as prices have dropped roughly 32% or $4.21 to a presstime close of $8.74 on average trade volumes totalling 1.27 million shares per day.