Earlier this decade, the Chinese began what they called their “Go Out” strategy. State owned companies across a range of industries planned to go global by buying stakes in foreign companies. They were flush with cash, and full of optimism.
Naïve optimism, it turned out. CNOOC tried to buy UNOCAL, the American oil company, and learned about how xenophobic Congressional leaders in Washington could be. Then Beijing’s sovereign wealth fund got suckered by Wall Street sharpies. It poured $3 billion into Blackstone in return for a 10% stake in the New York-based private equity firm in 2007, just before the bottom fell out of global debt and equity markets. One private equity banker in New York says the investment is today “worth about half of what they paid, if they’re lucky.”
Today, almost alone in the world, China’s state-owned companies are still cash flush. Crucially, though, they have learned a basic — and expensive — lesson about investing abroad. As a result, the ‘Go Out’ strategy has been tweaked. It might now be better called the ‘Buy Low’ campaign, and in one of the markets that Beijing has long had in its strategic sights — Australia’s vast metals and minerals industry — it is now unfolding.
On Feb 12, China’s state-owned aluminum company Chinalco announced it would inject $19.5 billion in cash into Anglo-Australian mining giant Rio Tinto. More than $12 billion of that will give the Chinese company, which already owns 9% of Rio, a share of some of the mining firm’s most valuable mines. The remainder of the cash injection will go into bonds that can eventually be converted into an equity stake, which would double Chinalco’s overall ownership position in Rio. The $19.5 billion deal amounts to the largest foreign investment any company in China has ever made. Two days ago, another state-owned firm, China Minmetals, said it would pay $1.7 billion in cash for Oz Minerals ltd., the world’s second largest zinc miner.
The economics behind both deals is clear enough — and are so compelling from China’s standpoint that there are likely more to come. Both Rio and Oz Minerals have been crushed by the global recession’s effect on demand for what they produce. Both have seen their value plunge as a result, and now labor under enormous debt burdens. Rio’s stock price peaked at $552 a share last spring, then fell to a 52 week low of $55. The stock last traded at $112 on the New York Stock exchange. Oz Mineral’s stock price hit AU$0.55 when trading was suspended in December. Minmetal’s will pay a 50% premium on that. Clearly, for China — whose voracious appetite for metals and minerals drove commodity prices sky high until last year’s bust — the timing is now right. “These [Chinese] companies know this slump, while deep, will not last forever,” says Xu Minle, a Shanghai-based analyst at logistics company BOC International. “China is now making strategic investments overseas at a comparatively lower cost.”
For Chinalco, a huge consumer of iron ore, the deal provides potential pricing power over Rio, one of the world’s three largest ore producers. Every year, steel and aluminum producers worldwide negotiate with miners over new contracts. For the past few years the mining companies have driven up prices relentlessly. Shan Shanghua, executive secretary of China’s Iron and Steel Association, recently hinted that Chinese buyers will have some additional clout at the bargaining table.
That’s part of what bothers some of Rio’s shareholders. One institutional investor, who spoke to TIME on condition of anonymity, says it’s “up to Rio to convince us that this does not transfer key pricing power over a key commodity to a big customer. They need to make that case or I’m not inclined to vote for the deal” when it comes up for approval in May.
Metals analysts in London say rival giant BHP Billiton, which dropped a takeover bid for Rio last year as metals prices collapsed, is now poking around to see if other Rio assets may be for sale. In effect, the Chinalco deal has placed a value on some of the company’s most attractive mines, including a Chilean copper mine that BHP already owns a piece of.
Some analysts believe Chinalco paid a premium for the Rio assets, given how much prices have slumped. But BOC International’s Xu notes, “that the price is much, much lower for the assets — particularly iron ore and copper — than it would have been just six months ago. This seems like a pretty good deal for Chinalco.”
Because both Chinalco and Minmetals are state-owned companies, the deals face significant regulatory scrutiny in Australia, but are likely to go through with few major problems. Kevin Rudd, the prime minister, is a fluent Mandarin speaker who had made it clear that solid ties to Beijing are among his top priorities. And with the mining industry now flat on its back as the global recession deepens, it’s unlikely Canberra will go out of its way to insult the only people around who have some money left in their pockets — and the willingness to spend it.
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