China: Factors for Successful Chinese Investment in the Australian Mining Industry: A Case Study of Baosteel Consortium’s Acquisition of Aquila

Last Updated: 23 November 2014
Article by Xiong Jin

Since the global financial crisis in 2008, China has seen explosive growth in overseas investment. The Ministry of Commerce forecasts that the size of China's outbound direct investment will exceed that of foreign capital utilization for the first time in 2015.1 Australia is one of the earliest countries which Chinese companies have gone out for, and is the second largest target for China's overseas investment, second only to the United States. Mining is undoubtedly the industry that has attracted most investment from China into Australia. Although there has been a decline in China's investment into the Australian mining industry in recent years due to factors such as the falling market demand, carbon tax policy, the emergence of alternative countries with resources, the investment in the mining industry in Australia continues to account for the majority of the total investment value.

Over the past few years, we have seen great media coverage on failed mining investments by many Chinese investors. Over the past few years, we have observed that some Chinese investors have progressively accumulated experience and gained experiences and skills to conduct complex cross-border transactions in mature markets such as Australia. As a result, we have seen more and more successful deals. In this article, we will discuss those factors key for successful merger and acquisition (M&A) deals in Australia's resources section through a case study on the recent high-profile deal–aosteel Consortium's acquisition of an ASX (Australian Securities Exchange)-listed iron ore miner.

Transaction Overview2

Aquila Resources Limited ("Aquila") is a company listed on the ASX, whose main assets are the West Pilbara iron ore mine and Eagle Downs hard coking coal project. Except for a few coal mines which are in operation, the remaining assets of Aquila have not yet entered the exploitation stage.

On 5 May 2014, the consortium ("Baosteel Consortium") consisting of Baosteel Resources Australia Pty Ltd. ("Baosteel") and Aurizon Operations Limited ("Aurizon"), an Australian company, initiated the takeover bid offering to acquire all issued shares of Aquila at the price of AUD3.4 per share and a total price of about AUD1.4 billion.

This is a hostile takeover – Baosteel Consortium made the offer directly to Aquila's shareholders, bypassing the board. The main conditions for the offer include: the minimum percentage of shares to be acquired, i.e., 50% of the ordinary shares in Aquila, and receipt of the No Objection Letter granted by Australia's Foreign Investment Review Board (FIRB) for Baosteel and Aurizon's acquisition under the offer. The parties then obtained FIRB's No Objection Letter on 29 May.

On 12 June 2014, Mineral Resources, an Australian company, confirmed its intention to initiate a rival bid against Baosteel Consortium, and purchased on the market 12.78% of the ordinary shares in Aquila at a higher price. However, on the next day, the Baosteel Consortium made the statement that they were unwilling to raise the offer price. Then shortly after that, Mineral Resources dropped its bid. On 20 June, the board of Aquila released the Target's Statement, recommending shareholders to accept Baosteel Consortium's offer.

On 4 July 2014, the Baosteel Consortium announced to the market that all conditions for the offer had been satisfied. As of July 25 when the offer was expired, the Baosteel Consortium had obtained a total of 98.49% of the ordinary shares in Aquila, and would acquire the outstanding shares through the compulsory acquisition procedure. Until then, the Baosteel Consortium successfully completed their takeover of Aquila in less than three months.

Success Factor 1: Familiarity with Target Assets

This transaction, featuring junior mining projects and large-scale acquisition, reminds people of CITIC Pacific's Sino-Australia Magnetite Project. In 2006, CITIC Pacific obtained the right to develop the Sino-Australian Magnetite Project by acquiring the Australian company Mineralogy. Since CITIC Pacific and its Chinese EPC contractor significantly underestimated the development costs for the project, it turned out that the actual development costs was several times higher than the budget. CITIC Pacific consequently suffered substantial losses. It is believed that CITIC Pacific's lack of knowledge of the target assets and the local investment environment is the main reason for its failure.3

But Baosteel Consortium's transaction is different from the CITIC Pacific's one. Baosteel has had a good knowledge of the target assets before the takeover. Back in 2009 Baosteel has made strategic investment into Aquila by acquiring 19.78% of the issued shares in Aquila, and by doing so, it also obtained a seat on the board of Aquila. Therefore, over the past five years, Baosteel has been able to look closely at Aquila's operation and the development of the West Pilbara iron ore project. In addition, sources say Baosteel had conducted secret negotiations with Aquila on the development of the project before the takeover.

Being familiar with the target assets should also be a key condition for Baosteel Consortium to take the initiative to do a hostile takeover, and by doing so, accelerate the transaction process. Usually, when making acquisitions, the buyers who know little about the target assets must solve the problem of "asymmetric information" through due diligence. Although the due diligence on a listed company can be conducted, to a large extent, through reviewing the disclosed information, the disclosed information is subject to limitations such as the scope of and delays in making disclosures. If the buyer wants to get more information, it has to rely on the cooperation of the board of the listed company. In the event of a hostile takeover, because the buyer will not have the board's cooperation, it cannot conduct adequate due diligence. Therefore, it has to put in a long list of conditions in the offer to protect itself. All these factors, coupled with the fact that in the event of hostile takeover, the buyer will not have the protections such as the break fee cause hostile takeovers to be very difficult to carry out.

Therefore, Chinese investors are generally reluctant to do hostile takeovers. In the event that they are forced to do so, it is very difficult for them to make success. For example, Cathay Fortune Corp. (CFC) initiated a hostile takeover to acquire Discovery Metals Ltd. It carried out the due diligence relying mostly on the information disclosed by the target company. But later, CFC found that the target company made false disclosure on its copper reserves. As a result, it decided to let the offer expire by not extending the offer period, and dropped the bid on the ground that some of the conditions for the offer were not satisfied by the expiration of the offer period.

The Baosteel Consortium does not have the problem of "asymmetric information", and therefore is not hindered by this problem from doing hostile takeover. In fact, the Baosteel Consortium gave little time for the board of Aquila to consider its offer before made the offer directly to the shareholders, thus effectively avoiding the adoption of delaying tactics by the board of Aquila and closing the transaction in a short time.

Success Factor 2: Seizing the Right Time to Enter into the Transction and Following the Market Trend Closely

At the time when the Baosteel Consortium launched the takeover, the global iron ore market was sluggish, and valuations of the mining companies are low. It was particularly true for junior mining companies like Aquila. Aquila needs substantial funding to develop the greenfield projects. However, as prospects of the financial market are not optimistic, it is difficult for Aquila to find a stable source of financing. Just before the takeover, Aquila was facing significant operational risks, and its value-at-risk in the market was about AUD1.05 billion. In comparison, the offer made by the Baosteel Consortium provided a premium of about 40% of the value-at-risk.4

This is obviously an attractive offer. In this context, although the board of Aquila noted in the Target's Statement that the offer did not fully and fairly reflect the potential value of the company and its Pilbara iron ore assets, it recognised that it is a reasonable offer.5

The Baosteel Consortium's takeover of Aquila amid market fall is very much "buying straw hats in winter". But long-term strategic investors like Baosteel have good reasons to do so. It is easier to make the offer attractive when the market is down. Also, the acquisition costs are significant lower compared to Baosteel's acquisition of Aquila shares in 2009 when it offered the price of AUD6.5 per share.

Baosteel should have made the deal based on the lessons learnt from the previous failures suffered by other companies. Previously, a number of Chinese companies' mining investments in the Australian were successful if judged purely from the perspective of transaction techniques. But as they choose to enter the market at its peak, then when the market went down after their investments, they inevitably suffer losses. For example, in the aforementioned CITIC Pacific's case, at the time of the investment, the iron ore demand was high in the global market and its price was in the uptrend. CITIC Pacific made the investment based on the assumption that the iron ore price would be on the rise in the coming years, and it would in turn definitely make profits after the project reached the production stage. However, the iron ore price had turned to a downtrend since 2012, resulting in the development costs of the project higher than the market price. CITIC Pacific thus got stuck in a dilemma. Yanzhou Coal Mining Company Limited (YCM), who was widely believed to have made successful investments in the Australian mining industry, also suffered the losses from asset impairment in 2013. Analysts believe that the losses were suffered because in 2011 when YCM acquired Felix, the coal price was high, but since 2012, the coal market has worsened, which caused many problems for coal enterprises such as difficulties in sales, significant increase in financial expenses, great pressures in loan repayment, difficulties in financing, and extremely tight cash flows.

Success Factor 3: Transaction Techniques

Choosing local partners

In the past, Chinese investors usually cooperated with Chinese EPC contractors for projects involving infrastructure constructions. But in Baosteel's transaction, for the first time, it chose Aurizon, a local company, as the EPC contractor, and partnered with Aurizon as co-bidder to jointly carry out the investment. This proved to be a wise choice.

To start with, Aurizon, as an Australian local EPC contractor, has rich experience in developing similar infrastructure projects. With Aurizon as the partner, Baosteel can avoid the difficulties and risks arising from the lack of knowledge of the local market.

Further, as partners, the parties can have win-win cooperation in achieving their respective commercial goals: Baosteel desires to acquire the resources and act as a long-term strategic investor, while Aurizon wants to obtain the exclusive right to develop the infrastructures including the West Pilbara railway and port, and will seek exit after the completion of the infrastructure development. This sets the basis for their cooperation.

Further, Aurizon is more experienced in similar transactions, and Baosteel can depend, to a large extent, on Aurizon for carrying out the takeover.

Last but not least, Aurizon's involvement made it easier to obtain the necessary approvals (see below for the detailed analysis).

Approvals

In Australian, takeovers of resource companies with large-scale assets by foreign investors like this transaction are considered as sensitive transactions. Therefore, it is not uncommon for foreign investors to have difficulties in obtaining FIRB's approvals. For the previous deals such as Yancoal's acquisition of Felix, the investment of Wuhan Iron and Steel (Group) Corp. in Western Plains, and the acquisition of Lynas by China Nonferrous Metal Mining (Group) Co., Ltd., the acquirers had encountered difficulties in obtaining the FIRB's approvals. When Baosteel made on its own the acquisition of no more than 19.9% shares of Aquila in 2009, it made two submissions before obtaining the FIRB's approval.

This acquisition was granted with FIRB's approval very quickly. This may be attributed to the fact that Baosteel partnered with Aurizon, a company with good reputation in the Australian market, which made the deal more acceptable.

Also, with Aurizon as a co-bidder, Baosteel lowered its investment amount to below USD1 billion so that it avoided to go through the verification process with the National Development and Reform Commission. This not only saved the transaction time, but also excluded the necessity of setting the Chinese regulatory approvals for overseas investments as a condition of the offer, which added to the certainties of the offer.

Right strategy against "spoiler"

In previous similar deals, Chinese companies often took the tactics of raising the purchase price when there were other bidders. For example, in the acquisition of OZ Minerals by China Minmetals Corporation (CMC), to thwart the rival proposal put forward by certain investment banks, CMC raised the purchase price by 15% at the last minute before the general shareholders meeting of OZ Minerals was held. As another example, Sinosteel Corporation also adopted the same strategy of raising price in its acquisition of Midwest when encountered with rival bidders.

In this transition, when Mineral Resources acquired the shares at a higher price to force the Baosteel Consortium to raise the purchase price, the latter immediately confirmed its unwillingness to raise the price, and at the same time conveyed the following message to the market: only the Baosteel Consortium was capable of making the takeover of Aquila, and if the takeover bid fell through, Baosteel would seek exit from Aquila. As Mineral Resources was in no way able to make the takeover of Aquila, it had no choice but to drop its bid. It goes without saying that, the Baosteel Consortium's success in the takeover lines not just in its calm assessment of the market situations but also thanks to the fact that the market situation is more favorable to the Baosteel Consortium at the first place. The same strategy may not work if Baosteel had chosen to make the takeover at the peak of the market.

Conclusions

Australia attracts Chinese investors with its abundant resources, high degree of rule of law, and advanced technologies. As a mature and sophisticated market, it also has very high standards on the experience and capabilities of the investors. It is necessary for Chinese investors to draw experience and lessons from past successful and unsuccessful deals. Transaction techniques such as undertaking proper and adequate due diligence, teaming up with good local partners, investing through consortium, and structuring deals to simplify regulatory approval procedures are all important. Further, to progressively get to know the target assets through small-scale investments and to wait for the right timing to execute the transactions also proves to be critical.

Footnotes

1http://finance.sina.com.cn/china/20140916/201920309217.shtml, "Ministry of Commerce: the size of overseas investment may exceed that of foreign capital utilization in 2015? (last visit was on October 31, 2014).

2 This part was sorted out based on the relevant announcements disclosed on the website of the Australian Securities Exchange (http://www.asx.com.au/) by Aquila.

3 This event was widely reported in the media. Reports included "CITIC Pacific's iron ore mine was put into production eventually, and the EPC contract with MCC may be suspended" (http://money.163.com/12/1121/07/8GQOI659002529T0.html) (last visit was on October 31, 2014).

4 http://finance.sina.com.cn/chanjing/gsnews/20140506/001219007173.shtml, "Analysis of Baosteel's intention to acquire Aquila: to build a resource base in West Pilbara" (last visit was on October 31, 2014)

5 For details, please refer to the Statement of the Bidder disclosed on the website of the Australian Securities Exchange (http://www.asx.com.au/) by Aquila.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions