Analysis: Stakes and loans to shape China’s 2011 mining M&A menu

By Fayen Wong and Joseph Chaney

SHANGHAI/HONG KONG (BestGrowthStock) – Resource-hungry Chinese mining firms are set to be more creative in their overseas acquisition strategies and could cast their nets wider in 2011 in a bid to overcome resistance against full-takeovers.

China’s miners, many of which are government-owned, have traditionally sought buyouts and management control, but that approach is being challenged by growing resources protectionism, and a depleting number of quality takeover targets worldwide.

The new strategy, involving more financings and minority stakes coupled with offtake agreements, could mean fewer outbound mega-deals next year for major Chinese resources firms, forcing them and their advisory banks to settle for smaller deals that they may have shunned before.

“Going forward, we will see Chinese buyers use more sophisticated methods, such as convertible debt and loans for either a small stake in projects or offtake agreements or both,” said Beijing-based David Xu, partner at audit firm KPMG.

Just 38 percent of Chinese outbound acquisitions purchased less than a 20 percent stake in a target company — the trigger rate for full takeovers — in 2009, but that proportion rose to 52 percent in 2010, according to Thomson Reuters data.

Banks that had retreated from the market during the credit crisis are also regaining their interest in project finance, which means there will be fewer cash-strapped junior miners hungry for Chinese capital, posing an additional challenge to acquisitive Chinese miners.

For their part, Chinese companies are also discovering the benefits of minority ownership.

“Government scrutiny aside, Chinese firms are more willing to take minority stakes because it is often easier to let the locals run the business because of familiarity with the regulations,” said Keith Spence, president of Global Mining Capital Corp.

“All they want is the resources and they’ve realized they can get that without having to dig it out themselves.”

After spending half a decade honing their skills in the cross-border M&A game, Chinese acquirers are emerging as more savvy dealmakers, choosing to go slow on hostile corporate takeovers and explore deeper co-operation.

“In countries like Canada and Australia, Chinese buyers have learned not to charge like a bull in a China shop,” said George Fang, managing director of mining at Standard Bank. “Instead, they are now looking at more win-win co-operation.”

Partnerships can also come in the form of Chinese financial investors betting on infrastructure to help kickstart a greenfield project.

In August Indonesia’s state enterprises minister said China’s $300 billion sovereign wealth fund China Investment Corp (Read more about U.S. companies investment into China) (CIC) (CIC.UL: ) could plough $25 billion into infrastructure and energy firms, with coal miner PT Tambang Batubara Bukit Asam (PTBA.JK: ) on CIC’s radar.

SOVEREIGN RISK

Suspicions from Western governments about Chinese expansionism and increasingly pricey valuations of Australian firms are forcing Chinese miners and private equity firms to shift their focus to territories with higher risk profiles.

And despite China’s interest in resource-rich Indonesia, there is a lack of suitable takeover targets in the archipelago, given the reluctance of locals such as Bumi Resources (BUMI.JK: ) to cede control of assets.

Standing in China’s way are many Indonesian companies which resist floating more than 20 percent of issued share capital, as they themselves eye growing regional demand and aim to retain control in a country historically wary of Chinese influence.

When it comes to takeovers, that leaves Africa and Latin America as major investment destinations for Chinese mining firms in 2011.

“China is going to continue to want to do cross-border in resources and if you follow the money, China is spending a ton of money in Africa in a much more constructive way than the British did 100 years ago,” said Michael Borch, Citi’s head of industrials group, global investment banking, Asia Pacific.

China Petrochemical Corp, parent of Sinopec Corp (0386.HK: ), said on Friday it agreed to buy all of U.S.-based Occidental Petroleum Corp’s (OXY.N: ) oil and gas assets in Argentina for $2.45 billion, its first foray into the upstream market in the Latin America country.

Analysts say companies which have had their resources certified and in the late stage of exploration will fall into the M&A sweet spot, although buyers are still wary of political instability and are only willing to invest in African nations where Beijing has established strong government connections.

GOLD, COPPER FEVER

Industry observers say China’s bloated foreign exchange reserves means it will step up overseas acquisitions in the next five years, with a growing appetite for copper and gold, as prices of both commodities went through the roof in 2010.

As more rural farmers transform into urbanized consumers, some analysts predict China’s copper demand could jump to account for 48 percent of global consumption by 2013, compared to 28.5 percent in 2009 and just 8 percent at start of the decade.

For gold, dealmakers say record-breaking prices have whetted the appetite of Chinese miners and private equity firms alike, which are drawn to its allure as an inflation hedge and by Beijing’s encouragement for its miners to shop abroad.

China National Gold Group, the country’s largest state-owned gold producer, said last month it is eyeing gold mines in Congo, Brazil, Russia, Venezuela and Mongolia and expects to produce more than a third of its gold outside China within five years.

But other resources are also part of China’s strategy, especially iron ore, which China desperately needs, while bankers say they have also seen more interest in uranium after Beijing’s recent comments that it was considering doubling its nuclear capacity target to 80 gigawatt or more by 2020.

“Companies are trying to broaden their horizons,” said Peter O’Malley, managing director, head of resources and energy group, Asia-Pacific, at HSBC. “I wouldn’t be surprised to see aluminum or copper companies buy coal or gold companies.”

(Additional reporting by Michael Smith in SYDNEY and Denny Thomas in HONG KONG; Editing by Muralikumar Anantharaman)

Analysis: Stakes and loans to shape China’s 2011 mining M&A menu