Ivanhoe Mines (IVN-T, IVN-N, IVN-Q) says it will sell its stake in Mongolian coal producer SouthGobi Resources (SGQ-T) to Aluminum Corporation of China (Chalco) and use the proceeds to fund development of its large Oyu Tolgoi copper-gold mine in Mongolia, where it expects initial production to start in the third quarter of 2012 with commercial production following in the first half of 2013.
Chalco — the world’s second-largest alumina producer and third-largest primary aluminum producer — announced on April 2 that it intends to make a proportional takeover bid for up to 60% of SouthGobi’s issued and outstanding shares.
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’s $8.48 offer price for SouthGobi shares is a 28% premium to its $6.62 closing price on the Toronto Stock Exchange, and a 32% premium over the volume-weighted average price of $6.41 over the past 10 trading days.
The Chinese company has also signed a co-operative agreement with SouthGobi that includes an offtake clause. Under the agreement SouthGobi will have the right to offer up to 100% of its saleable coal to Chalco, and Chalco will be obligated to buy the coal at market prices for a 24-month period. Chalco will help SouthGobi procure electricity for its Mongolian operations through a direct connection to grid power, or by developing a power plant. Chalco will also support SouthGobi’s coal-haul highway project.
SouthGobi’s flagship coal mine, Ovoot Tolgoi, produced 4.57 million tonnes of coal last year, up from 2.79 million tonnes in 2010. In 2011 SouthGobi posted record annual gross profit of US$51.7 million, up 424% from 2010, and record annual revenue of US$179 million — a 124% increase over 2010.
Selling its stake in SouthGobi will help Ivanhoe develop Oyu Tolgoi, which ranks as the world’s largest undeveloped copper-gold project and is located in the South Gobi region 550 km south of Ulaanbaatar, and 80 km north of the Mongolia-China border.
Mining analyst Alec Kodatsky of CIBC says in a research note that 72.7% of first-phase construction at Oyu Tolgoi was completed at the end of February; pre-stripping the open-pit was ahead of schedule; and pre-commissioning the primary crusher, overland conveyor and coarse-ore stockpile circuits will likely start in April. Ivanhoe owns a 66% stake in the copper-gold mine project, with the rest held by the government.
Kodatsky believes Ivanhoe shares “are at a favourable entry point for investors seeking exposure to Oyu Tolgoi,” and says that the company’s “effort to daylight the value of its non-core assets should help narrow the discount implied by current share prices versus our net asset value.”
Kodatsky has a “sector outperform” rating on Ivanhoe and a 12-month price target of $26 per share.
Ivanhoe holds more non-core assets with its 59% interest in Ivanhoe Australia (IVA-T, IVA-A), a copper-gold-uranium-molybdenum-rhenium exploration and development company, and a 50% interest in Altynalmas Gold, a private company developing the Kyzyl gold project in Kazakhstan.
Kodatsky says that near-term catalysts for Oyu Tolgoi include a cross-border power supply agreement, interim project financing and possible asset sales. While ongoing delays in securing the cross-border power supply agreement present a risk to development timelines, Kodatsky says, he sees “encouraging signs that this dialogue is heading in a constructive direction, including the commencing of construction of the transmission towers on the Chinese side of the border [with the Mongolian towers already complete].”
The Toronto-based analyst also points out that the project “has significant connections to Chinese enterprise [including two smelters holding offtake rights to the produced concentrate],” and notes that Chinalco (ACH-N) is a significant shareholder of Rio Tinto (RIO-N), the majority owner of Ivanhoe.”
And while Ivanhoe has provided a first-phase construction capital expenditure update demonstrating that the budget has risen 3% to $6.2 billion, Kodatsky says this is an “admirable performance, given the levels of cost inflation observed elsewhere in the mining industry.”
The major overhang is uncertainty about the proposed $4-billion project financing facility, he says, which continues to face delays but is expected to be finalized in this year’s third quarter. “With a $2.1-billion project expenditure budget for 2012 and roughly $700 million of cash available on the balance sheet to be deployed at Oyu Tolgoi [as of the end of 2011], Ivanhoe is under near-term pressure to raise interim financing,” he writes.
Adam Graf, managing director of Dahlman Rose in New York, has a “buy” rating on Ivanhoe’s shares, with a 12-month target price of US$22.42 per share on the New York Stock Exchange.
Toronto-based mining analyst Tom Meyer of Scotia Capital has lowered his 12-month target price on Ivanhoe’s Toronto-listed shares from $18 to $15. Meyer points out in a note to clients that capital expenditure for Oyu Tolgoi is estimated at US$13.2 billion, up from an earlier estimate in 2010 of US$9.6 billion, while operating expenses are estimated at a cash cost, including by-product credits, of US$0.81 per lb. copper for the life of the reserve, compared to a previous estimate of US$0.62 per lb. copper.
“Our net-asset-value-per-share estimate declines to $14.53 from $19.01 after updating project parameters, and assuming SouthGobi is sold for $850 million,” Meyer writes. He remarks that Ivanhoe shares trade at a price to net asset value of 1.07 times, versus the peer average of producing companies at 0.62 times.
At presstime Ivanhoe traded at $14.29 per share within a 52-week range of $12.85–$27.82. In New York Ivanhoe traded at US$14.41 per share within a 52-week range of US$12.11–$28.97.
SouthGobi traded at $7.31 apiece in Toronto, within a 52-week range of $5.54–$14.75.