Zijin Mining announced on 2nd January 2019 that they planned to issue 3.4 billion new shares to raise 8 billion yuan to finance its 9.36 billion yuan purchase of the Toronto-listed company Nevsun Resources. The capital raise however, caused a short term market panic that saw Zijin’s share price sharply drop by 9.9% on the first trading day after the announcement. This incident again showed why mining is such a tough business.
By Samson Li
In September 2018, China’s Zijin announced a friendly, all cash offer for Canadian listing Nevsun Resources valuing the business at $1.41 billion. The crown jewel of Nevsun is the Timok copper-gold project in Serbia, which owns a 100% interest in the Timok Upper Zone and a 60.4% project interest in the Timok Lower Zone, with Freeport-McMoRan Exploration as the joint-venture partner.
Aside from the mining and business risks in Serbia, the author believes that Timok is a Tier 1 mining asset available for sale, and these assets are not readily available very often. Lundin Mining, a highly respected mining group in the industry, attempted to take over Nevsun twice (but failed), which speaks volume on how highly regarded the Timok project is.
Indeed, a highly regarded mining executive said that he was impressed by Zijin’s aggressiveness, by buying a majority stake in the RTB Bor copper complex in Serbia before the announcement of the acquisition of Nevsun. By acquiring a 63% stake in the RTB Bor project, not only could it create working synergies with the operations at Timok, it also makes Zijin an important enterprise that will contribute to tax revenues and local employment in Serbia.
The investment community, particularly John Paulson, has been criticising the mismanagement of the gold mining industry in recent years, especially what he considered to be, reckless acquisitions during the peak of the cycle, only selling the same assets for pennies during the market trough.
The Nevsun acquisition was made during the year when the copper price fell 17.4%, which was a time when mining majors, like BHP and Rio Tinto, openly said that they were looking globally for Tier 1 copper assets. Assuming Timok can eventually be a producing mine and that metal prices remain at current levels by the time the operations commence, this transaction looks well timed and closer to a market trough than a market peak.
However, now comes the challenging part: on the 2nd January 2019, Zijin announced plans to raise $1.2 billion worth of A shares (listing in Shanghai) to fund the acquisition of Nevsun. The Chinese investment and mining community panicked, and the share price of Zijin lost 9.9% wiping approximately $1 billion off their market cap on one single day.
The panic was caused by several issues. First, in the company announcement it was stated ‘…the company will issue up to 3.4 billion new shares, raising capital up to 8 billion yuan’. Many investors simply divided 8 billion yuan by 3.4 billion new shares, which translated to 2.35 yuan per share, which is a 30% discount to the 3.34 yuan closing price from before the announcement (while in reality the placement price will be the average of a 20-day trading price).
The second issue is the culture of the Chinese investment community, which in general pays a heavy emphasis on cash flow generation. Timok, while being understandably an attractive asset, will not be in production in the short term. Therefore, some people in the Chinese mining community did not like this transaction for Zijin strictly because Timok is not a cash flow generating asset as yet, and there were some interesting debate when the deal was first announced. The even more challenging issue is that Zijin is poised to invest heavily (estimated at over $40 billion) in Timok, RTB Bor and even the Kamoa-Kakula project in the Democratic Republic of Congo (DRC). All these pre-production investments will impose a heavy burden and drag on the company’s balance sheet, and thus increasing Zijin’s financial risk. There was even a small friendly debate within the Chinese mining community recently whether, hypothetically speaking, Zijin will have sufficient funding for just one new flagship project, should they focus on developing Timok or the Kamoa-Kakula project?
The third and perhaps the most important yet unfortunate issue has been the timing of the capital raising. The investment sentiment has been poor in China, mainly due to the lacklustre performance of the domestic stock market in recent years, let alone the mining industry. Indeed, 2018 turned out to be equally challenging. Stock prices of many Chinese listed mining companies lost half of their value, and the current fragile market confidence may be difficult to support a capital raise of that proportion. The market reception would have been more positive if Zijin decided to do the raise in September/October 2018 (but could not do so before the acquisition became official), or if the U.S. equities market did not decline as much as they did in December 2018 (which was the worst performance in December since the Great Depression).
Indeed, Zijin’s Chairman Mr. Chen Jinghe, had to set up teleconference call with funds and investors to clarify the details of the raise and offer the company’s development plans for the next few years, where normally such a duty would be left to either a company’s Investor Relationships or Corporate Secretary. So that speaks volumes of the level of uncertainty hindering Zijin, which required the most important figure of the corporation to step out and try to calm down the investment community.
The market now awaits further clarity from Zijin. What the public reception will be on the capital raise or just how Zijin will come up with sufficient capital to complete the Nevsun deal will be watched closely. Based on the author’s opinion, at this point it is highly unlikely the deal will fall through. Zijin could possibly go for a combination of equities raising and debt to close the deal. A company of Zijin’s caliber should also be able to get an attractive financing package domestically if they wanted to.
The Zijing case serves as an illustration on why mining is such a tough business compared to other industries. When commodities are closer to the peak of the cycle good profits generated from mining operations are made and easier access to credit helps mining companies to conduct acquisitions that the management and shareholders may regret in the future. However, buying in a market trough is also very challenging, as a lack of support from shareholders and financial institutions may hamper the company’s future development, even though the impact may not be imminent. In 2008 when the global financial market crashed and liquidity tightened in China, several local property developers expanded their market presence against the tide, which proved to be very rewarding after the Chinese government flooded the market with stimulus. If metal prices will be accommodative in the next 5-10 years, Zijin’s current ambition and investments could pay off handsomely in the long run, but we also need to understand that business decisions seldom are risk-free.
*disclaimer: The author does not own any shares of the companies mentioned in this article
