Oyu Tolgoi rumours rattle Ivanhoe

Dale Choi, an analyst at Frontier Securities in Ulaanbaatar, is recommending to clients that they buy long-term call options on Ivanhoe Mines (IVN-T, IVN-N) due to the “panic” surrounding rumours of possible revisions to the Oyu Tolgoi investment agreement (IA).

Describing the “caving by the Government of Mongolia to anti-OT pressures of anti-Coalition Government MPs” as “unfortunate,” Choi says it nevertheless presents investors with a buying opportunity “for long-term call options, such as two years, as we do not believe that [the] situation will escalate out of control and Mongolia will derail the project.”

“Due to resulting uncertainty and global macro-weakening, we expect Ivanhoe to enter a period of short- and medium-term volatility,” he continued, “but we expect the stock to rebound to analyst consensus in the long-term, especially as the beginning of production will get closer.”

Shares of Ivanhoe tumbled $1.77 or 9.5% to $16.97 on 1.4 million shares traded on Sept. 21. The stock closed down another 37¢ or 2.2% to $16.60 today with 2.9 million shares changing hands. Over the last year Ivanhoe has traded within a 52-week range of $16.60 (Sept. 22) and $30.28 (Dec. 7 2010).

Ivanhoe’s shares started to slide after Mongolian Finance Minister Sangajav Bayartsogt said in an interview published earlier this week on Mongolian website News.mn that the government may seek to revise the terms of its investment agreement with Ivanhoe  ahead of parliamentary elections next year. Ivanhoe owns 66% of the project and spent more than six years negotiating its IA with the Mongolian government, which owns the remaining 34%. Rio Tinto (RIO-N, RIO-L) is the project operator and holds a 49% stake in Ivanhoe.

At an investment seminar in London on Sept. 20, Bloomberg reported that Andrew Harding, chief executive of Rio Tinto’s copper division, admitted “there are discussions going on” about a review of the Oyu Tolgoi accord, but that reports in the media about the IA should be taken in the context of Mongolia’s upcoming elections.

The following day, Ivanhoe challenged Rio Tinto’s “unauthorized remarks…about the status of the Oyu Tolgoi project,” saying it would provide further details after it communicated directly with Rio Tinto management.

Under the terms of the 2009 investment agreement (IA), the Mongolian government has the option to increase it stake in Oyu Tolgoi to 50% once the initial 30-year term on the IA expires.

But in recent weeks lawmakers in Mongolia have tried to convince the government to raise the country’s stake in the massive copper-gold project to atleast 40% and at a faster rate than outlined in the existing IA.

Choi of Frontier Securities wrote in an email to clients that during a Cabinet meeting on Sept. 22, Chief of Staff Ch. Khurelbaatar was instructed to send an official letter to Ivanhoe and Rio Tinto inviting them to negotiate regarding raising Mongolia’s stake in the project to 50% with additional payment for using reserves.

Choi also noted that the finance minister, who co-signed the IA, briefed media on Sept. 21 “that the decision is not related to recent demand by MPs to change the OT IA, but to the regular semi-annual briefing on OT to the Economic Standing Committee of Parliament.”

“The President has submitted bill on amendments on Law on Minerals,” Choi quoted the finance minister as saying in translated remarks. “Both parties must if possible not to touch the stabilization agreement. However, situation has turned like this. I think there is opportunity to say to investors-people of Mongolia don’t want to change OT IA in whole, but to discuss two issues of Mongolian stake and additional payment for using reserves and negotiate with them. We have time. Amendments cannot be done before the elections…Desire and efforts of Mongolian people to increase benefit from OT development cannot be wronged.”

In a research note to clients on Sept. 27 , Raymond Goldie, an analyst at Salman Partners in Toronto, wrote that:  “In the still unlikely event that Mongolia were to take, by confiscation1 in 2019, an extra 16% of Oyu Tolgoi, it would take our estimate of OT’s contribution to Ivanhoe’s NAV from US$23.93 to US$19.85/share and our estimate of Ivanhoe’s NAV from Cdn$28.08 to Cdn$24.32/share. Thus, although the future of Ivanhoe’s relationships with the Mongolian government has become darker, we retain our Buy recommendation on the shares of Ivanhoe Mines.”

Adam Graf of New York-based Dahlman Rose & Co. says he does “not expect any alteration from the existing contract” but says an increase in Mongolian equity ownership in Oyu Tolgoi from 34% to 40% would have roughly a negative US$1.10 per share impact on his current NAV calculation of US$17.57 per share (or roughly -6.3%) and argues that Ivanhoe’s shares “are oversold and appear to be discounting the worst case scenario.”

Whatever happens to Ivanhoe’s stock, however, one thing is clear. A chill has descended over Mongolia that has nothing to do with the weather.

“Should the Mongolian government not honor this highest profile contract, we would expect international investors to shy away completely from large commitments and long payback periods,” Graf wrote on Sept. 22.  “The mere suggestion of such a contract violation has already done damage to investor perception in our view.”