SouthGobi warns of a possible suspension of activities

Just two weeks after the Aluminum Corporation of China announced that it intended to make a proportional takeover bid for up to 60% of SouthGobi Resources’ (SGQ-T) issued and outstanding shares, and Ivanhoe Mines (IVN-T, IVN-N, IVN-Q) agreed to sell its stake in the Mongolian coal producer to Chalco, the Mineral Resources Authority of Mongolia has requested the suspension of SouthGobi’s exploration and mining activity on a number of its licences including the one that governs the Ovoot Tolgoi mine.

News of the possible suspension sent SouthGobi’s shares into a downward spiral, plunging 90¢ or 12.4% to $6.36 by mid-day in Toronto. The Toronto-listed shares of Ivanhoe Mines were also down, sliding 64¢ or 5.02% to $12.11.

In a mid-morning press release SouthGobi confirmed that it had not yet received any official notification and that it had “no reason to believe” that its licences “are not in good standing.”

“Advice to the company suggests the action has been taken under the broad national security powers of the Government of Mongolia,” SouthGobi said, noting that the Mineral Resources Authority of Mongolia says the move is in connection with Chalco’s proposed takeover bid of the company and Ivanhoe’s agreement to tender its controlling interest in SouthGobi to China’s alumina/aluminum giant.

SouthGobi has notified Ivanhoe and Chalco—requesting that the two companies discuss their agreement and the proposed transaction involving SouthGobi with the Government of Mongolia.

SouthGobi has also notified its other key stakeholders, including Rio Tinto (RTP-N, RIO-L), which is the 51% controlling shareholder of Ivanhoe, and China Investment Corp., China’s sovereign wealth fund that owns about 14% of its stock.

Ivanhoe owns 104.8 million shares, or 57.6% of SouthGobi, and estimates that it could receive up to $889 million from the sale. Selling 60% of its holdings could net $533 million in proceeds. 

Chalco has also signed a co-operative agreement with SouthGobi that includes an offtake clause.

Last year Ovoot Tolgoi produced 4.57 million tonnes of coal, up from 2.79 million tonnes in 2010, and posted record annual gross profit of US$51.7 million, up 424% from 2010.

Selling its stake in SouthGobi would help Ivanhoe develop its massive Oyu Tolgoi copper-gold project, 550 km south of Ulaanbaatar and 80 km north of the border between Mongolia and China.

Dale Choi, an analyst in Ulaanbaatar at Frontier Securities, concedes that Chinese investment in Mongolia has always been a sensitive issue given the often strained relations between the two countries, but says he does not expect Mongolia to object to the Chinese takeover of Southgobi because Ivanhoe plans to use the proceeds of the sale to fund development of Oyu Tolgoi, a project he reasons will benefit all Mongolians and particularly the ruling party.

He also believes that the suspension could be politically motivated in the context of upcoming elections in the country. “Warranted (but not legislated) caution in this matter by Mongolia is being exploited by populist, resource-nationalist politicians taking advantage of sensitivity of Mongolian public and at the same time stirring and playing on popular simplistic nationalist sentiment,” he writes in a research note.  “This development is of concern not only to China but also to foreign investments as a whole. Suspensions should be seriously debated within Government and should be lifted to regain confidence from foreign investors.