BEIJING, CHINA–As Chinese mining firms step up their acquisitions of resource assets overseas, foreign mining companies are continuing to look at China for opportunities. But it is a still a country where one must step with caution.
Like many developing nations, China has an incomplete and dynamic regulatory framework as well as a unique business culture that create a challenging environment for foreign firms. The nation’s mining industry is no exception.
But China’s great, untapped mineral potential remains a draw: the regional geology suggests that there are significant, undiscovered deposits of almost all major base and precious metals. This potential has attracted hundreds of foreign — mostly junior — mining companies to China. Most have been unsuccessful, but there are exceptions such as Australia’s
Leyshon Resources (LRL-L, LRL-A), Continental Minerals (KMK-V, KMKCF-O), Sino Gold (SIOGF-O, SGX-A), Silvercorp Metals (SVM-T, SVMFF-O), Jinshan Gold Mines (JIN-T, JINFF-O) and Eldorado Gold (ELD-T, EGO-X)–all of which are in, or near, production.
What differentiates the successes from the failures? In short, it is a question of learning the landscape (in all its senses) and how to use it to your advantage.
The biggest difference between China’s mining industry and that of many other parts of the world is that there is no stock exchange that welcomes high-risk mineral exploration companies. Exploration companies cannot list on mainland China’s two exchanges since one of the listing requirements is a track record of prof itability. Traditionally, junior mineral explorers do not generate revenue.
This, in turn, has meant for domestic explorers a lack of liquidity, lower access to capital, and the absence of a regulatory framework that listed companies must follow.
Let’s take a closer look at these factors:
• Liquidity: An investor in a junior in the West is able to realize profits or limit losses by buying or selling shares in the company. In contrast, an investor in a Chinese junior mining firm who wants to generate cash from the investment is limited either to a private sale of his shares or to bringing the company’s asset into production as soon as possible.
• Access to capital: A junior in the West may raise funds from the capital markets as needed to develop its property. By only raising what is needed for near-term exploration and development, the junior suffers less dilution since, when it is time for the next financing round, the results of previous work will hopefully have increased the value of the company, making it possible to raise capital at a higher valuation.
A Chinese junior doesn’t have access to the broader markets and must raise additional capital through relatively inefficient and expensive methods. This is an additional incentive for the Chinese junior to bring the property into production earlier, so cash flow can be generated and development boot-strapped.
• Regulatory framework: The unique regulatory aspects of listed junior mining companies are designed to give an investor a fair picture of the company and its properties and so allow for informed investment decisions.
Some of these requirements, as defined under regimes such as Canada’s National Instrument (NI) 43-101 and the Australasian Joint Ore Reserves Committee (JORC) code, are the submission
of independent technical reports on properties, the use of standardized press releases, and the frequent disclosure of audited financial statements.
Similar reporting standards and independent technical reports are not required in China.
As well, investors in small resource firms in China often do so on a not-so-well-informed basis. They are then eager to flip the asset to another uninformed investor for a quick profit, rather than develop it.
The combination of the three above factors means most small Chinese miners, with their limited access to capital, will be eager to start production on a property as soon as possible to recoup their initial investment or obtain funds for further property development. The property may, at best, only have a NI 43-101-compliant inferred resource.
This approach will often result in an underexplored property and make it difficult, if not impossible, to fully and efficiently exploit an entire deposit.
On the other hand, a mining company in the West will tend to spend years and millions of dollars on exploration and technical reports before embarking on mine construction. Western juniors are in no rush to start mining, since once a property has been brought into production, the market usually reckons that the upside potential of the property is well defined, and this will be reflected in a flat stock chart with little opportunity for major share-price appreciation.
Clearly, a Western company and a Chinese partner entering into a joint venture will already have divergent views on how best to exploit the asset, even if the primary goal of exploring, developing and exploiting a property for profit is shared. The Western junior will likely want to do a complete exploration program starting with mapping, soil sampling, trenching, geophysics and moving finally into a drill program, which may last for years.
While the exploration program is under way, the junior will issue press releases informing the public of the results and any progress made. If the results are good, then the stock price of the junior will likely increase and future financings should be easier.
Meanwhile, unless the Chinese party has been granted shares or options in the junior, it will receive no early benefit from exploration activities and may feel frustrated by the foreign junior’s insistence on further exploration activities which, while benefiting the junior’s owners, are viewed by the Chinese party as an additional expense and a delay of production.
Friction between foreign and Chinese partners is often compounded by the foreign junior when it assumes the Chinese party understands why the junior does not have sufficient capital on hand to complete agreed-upon development plans.
There have been more than a few foreign juniors in China that have run out of money and been unable to raise more, leaving their Chinese partners in the undesirable position of having transferred exploration or mining rights to a no-longer- viable joint venture, parked in regulatory limbo.
Also, if the Chinese partner is a government entity, there is the additional political problem of explaining the joint venture’s failure to superiors.
Juniors vs. seniors
Another challenge facing junior mining companies in China is that the Chinese government clearly prefers mid-sized or major foreign mining companies entering its market. It is only slowly learning that, while size matters, sometimes smaller is better.
Globally, it is widely acknowledged that juniors play a key role in the development of new properties. The usual role of the junior is to identify prospective properties and then explore them, often up to and including completing a bankable feasibility study. If the project’s economics are attractive, then it will likely be sold to a larger mining company for development and exploitation. Thus, the juniors act as a feeder to mid-sized and major mining firms.
Compared with the majors, juniors have an investor base and corporate culture that are much better suited to the speculative nature of the kind of exploration that is now needed in China.
Yet the Chinese government is reluctant to encourage foreign juniors. This stems from beliefs that these companies don’t have the necessary capital to develop the properties, aren’t professionally managed and don’t have access to the same technology as the majors.
The concern about access to funds is somewhat warranted, since by nature, a junior only raises enough capital to meet its immediate exploration and development needs, and so there is a very real possibility that a junior could
run out of money before a property can be fully explored and developed.
The other concerns are not as valid. Especially in today’s environment, the management of most juniors is comprised of highly experienced industry professionals, often with decades of experience with the majors. The Chinese government is realizing this, albeit slowly.
In the meantime, there remain opportunities for Western juniors in China. While it will never be easy, there are a few steps that a company can take to increase its chances of success.
The first is for the junior to fully understand its own goals and the path it plans to take to achieve them. This should be written out in a business plan, translated and communicated to the Chinese partner.
Second, the junior needs to clearly explain to its Chinese partner the nature of a junior mining company and the restrictions under which it operates. This, too, should be written out and translated into Chinese for the partners.
Third, it would be in the junior’s best interest to grant shares and/or options to its Chinese partner so that the partner can share in any price appreciation of the junior’s stock. It will likely enhance the partner’s co-operation level if it, too, can realize material benefits from the stock market. This co-operation may manifest itself in the partner transferring licences to the joint venture in a timely fashion, working with the various levels of government to get approvals quickly, and so on.
Fourth, it is absolutely essential that the junior takes the time to fully understand China’s regulatory environment — and not just mining laws, but labour, contract and tax laws as well. It is well worth the time and money to sit down with an adviser who has extensive experience in China to get a clearer picture of the regulatory landscape.
Success is never assured, but a foreign junior can increase its chances for success in China by making real efforts to communicate with, and incentivize, its partners, and by understanding both the business culture and the regulatory environment. –The author is head of the mining team at The Balloch Group, a Beijing-based financial advisory and merchant banking firm that has worked globally with companies ranging from Canadian juniors to Chinese state-owned firms. Contact Peter Fritz at: email@example.com,www.ballochgroup.com