To fully understand the crash of the shares of Turquoise Hill (NYSE:TRQ), which swooned from $22.80 to $6.99 as of Nov. 29 one needs to know about Mongolia and one needs to know about Robert Friedland, the man that made it all happen. Turquoise Hill (TRQ) NYSE is 51% owned by mining giant Rio Tinto (RTP) NYSE. A long story ensues. Buckle up…
Most of the world knows about the Mongolian conqueror Genghis Khan and the vast empire he founded, which became history's largest contiguous empire after his demise. However, those who have visited Mongolia know that Genghis Khan embodies the country's national and ethnic identity - in spades. Monuments, likenesses, signage, office buildings and hotels proclaim the name, the pride of the citizenry. It's said that over 60% of the populace carry the 'clan' name of Borjigid, the designation of the clan of Genghis Khan. Nowhere on earth that I know of has such a deep national and personal identification with a personified symbol as Mongolia does with its great conqueror. Once a year the country holds its national celebration, a week of events called the Naadam Festival which celebrates the old traditions of archery, long distance horse racing, wrestling, music, and all around fun and mayhem. I attended the festival a few years back and it was a fantastic once-in-a-lifetime memorable experience for me.
Let's note here that along the way the great subjugator was said to have killed tens of millions, to the point where atmospheric carbon levels plummeted. Ecologists even believe the period may be the first ever case of successful manmade global cooling as a result of countless villages and towns being obliterated and gradually returned to forest, shrub, and steppe. Also keep in mind that the Chinese built their 4,000 mile Great Wall to keep the Mongolians out. So, don't mess with the Mongolians… Hang on to that thought.
Enter Robert Friedland: mining mogul, billionaire, promoter (and speaker) extraordinaire, Mongolia philanthropist and all around good guy in my estimation.
This is the quick version - the entire enchilada would take a book: Friedland acquires mining rights to a large chunk of Gobi Desert that had previously belonged to BHP Billiton, which is the world's largest mining company with a market cap of $199 billion. To say that Mr. Friedland has the Midas touch when it comes to mining is to badly understate matters. It's like he hits on every lotto ticket… So the little green spot on the tiny barren knoll that local geologist Muckbat first discovered; he's showed me the spot, turns out to be what is now estimated as the world's largest gold / copper discovery called Oyu Tolgoi, English translation; Turquoise Hill - perhaps worth $1 trillion when the system is fully expanded. SEC docs say there are over $350 billion in hard proven reserves. A few years earlier in 1992 Friedland had found the world's largest nickel discovery and sold it to Vale, previously Inco, for $4.3 billion.
At the time of his Gobi move most people thought Friedland had gone crackers, but pretty early on some drilling and 'diagnostic' holes showed positive results and subsequent drilling yielded more 'good shows' of copper and gold. Friedland then began to promote the story as only he can. Few believed him at first, and some even accused him of 'salting' the results. Numerous articles in the world press were deriding him as a charlatan and the bad press kept going for years until Rio Tinto (the world's second largest mining company, market cap $88 billion) took a 3% financial interest and that changed the market's mind-set. Then the shares began to trade higher in earnest. Eventually Rio's percentage grew to over 51%, resulting in Friedland's ouster. Ivanhoe Mines is now Turquoise Hill Resources Ltd. But I'm getting way ahead of myself.
A necessary bit of backdrop here: In 1992 Mongolia had just wiggled free from 70 years of Soviet control. Once emancipated the country of only 2.75 million was beyond poor with a GDP of nil. About 20% of the population lives on less than US$1.25 per day. Much of the look of the capital city of Ulaanbaatar is stark, bleak, Soviet-era architecture, and there is even an old WWII vintage Russian T-34 tank near the 'entrance' to the city. So a certain Soviet / communist / socialist / vibe and mindset still lingers about, and Mongolians don't exactly like or trust the Russians.
Anyway, as I said it turns out the greenish spot on a hill in the vast Gobi was an outcropping of the largest copper / gold deposit ever, but the extent of the find was a long time coming with hundreds of millions needed to determine its size, grade, and so forth - also think about the engineering and planning, power needs, water, etc. out 100 miles away from the closest flush plumbing. To pull it all together was an endeavor of monumental proportions: to spread the word, generate interest, secure the funds to do all of the above.
Once again, Friedland does his thing: he invites some of the world's leading mining analysts, geologists, investment bankers and investors to come see for themselves and watch the progress. All were given what amounted to a several day on-site seminar where we were instructed in a detailed and comprehensive manner by Friedland, by Ivanhoe's management and employees, and by their contracted support companies, all of whom delineated the still-expanding outlines what was to be the world's largest copper gold deposit. I and my son Victor were part of one of these early 'show and tell' extravaganzas orchestrated by Friedland, which also included visits to Ivanhoe's incredible coal discovery treks to fascinating geological and cultural locations, visits to the northern industrial regions of China and numerous factories and foundries there, plus being wined and dined in some spectacular venues along with 'high and higher' echelons of Chinese and Mongolian officialdom - even meeting the Mongolian prime minister at a big gala in Ulaanbaatar. This was after attending the Naadam festival and visiting the site of an orphanage that Friedland founded. All of this was done in top-notch first class manner including travel between Mongolia and northern China in Friedland's 737. To call this a Wow! trip is to put it mildly.
I began my first of many ON THE MARKET reports on Ivanhoe Mines at about this time, titling it: Beyond Superlatives. A couple of years later I traveled to Mongolia and China again to report on the Gobi site's progress after attending the JP Morgan China Conference in Beijing where Friedland was the keynoter speaker.
So in begins to flow the tens of millions in investment on the way to being over $8 billion and the development of the mine site is proceeding apace. Along the way, Friedland / Ivanhoe even lend $50 million to the Mongolian government to assist in retiring the Soviet era debt. But, Uh-oh!: the Mongolian government wants to re-jigger the original mine development deal. Consternation and a big hang up follows, and the shares of Ivanhoe Mines crater… It takes a couple of years of politicking to finally get a 'new' deal ironed out in 2009 for not only Ivanhoe, but the other entities now in the Mongolian resource hunt. During this multi-year period much of the global interest in Mongolian exploration goes on hold as the world's big miners watch the Ivanhoe saga unfold. Net, net, the Mongolian government gets a sweeter deal.
Now Rio Tinto interest starts getting tangible, with hundreds of millions added to Ivanhoe's coffers to fund the build-out of the Oyu Tolgoi mine. Construction continues, some years go by. What few people know is that a world-class mine site takes many years to build before there is any production. Such sites involve mind boggling technological and scientific wonders such as "block caving" procedures that reach nearly a mile deep into the deposit. (Do not fail to check out the video here to get a handle on how the process works and the equipment needed to get ore out of the mine.)
Once brought to the surface the ore goes to an on-site concentrator / crusher - price tag another billion plus - to process. The video of Oyu Tolgoi / Turquoise Hill here is astonishing and shows what $8 billion buys. As of the end of September 2012 the mine had a workforce of approximately 15,150 of which about 12,000 were Mongolians, making it the largest construction site in the world.
Anno 2012. Yikes, a double Uh-oh! After another Mongolian election last June the new government wants to re-jigger the deal again to get more out of the resource extraction bonanza - and they may get it. Who knows how this chapter of the Oyu Tolgoi / Rio Tinto story will play out, but one thing for sure is that Mongolian people are now beginning to prosper and there are many more billions on the way. With a population of only 2.75 million the wealth per-capita will soon match the Kuwaitis and the Qataris. And with further incredible mineral and oil discoveries in the making, the Mongolian people could well become, at least per-capita, the richest people on earth.
The new legislation in the Mongolian parliament aims to raise royalty taxes on all mining, including that at Oyu Tolgoi. This new proposed deal after the $6 billion has already been put in by investors breaches the previous 2009 agreement. The government is now looking to raise its take up to up 20%, compared to the 5% of the Oyu Tolgoi Investment Agreement it signed in 2009.
To show how far the Mongolian Government has veered away from the original Investment Agreement of 2009 consider that the Government as recently as October 2011 reaffirmed the Investment Agreement of 2009 and stated that it was signed in full compliance with all laws and regulations of Mongolia. Another provision of the agreement was that it contracted for a stabilized royalty rate of 5% over the life of the agreement and specified that new laws made after its signing will not apply to Oyu Tolgoi and that any change in the royalty rate would require the agreement of all parties.
That said, what's the outlook going forward for the shares of Turquoise Hill Resources Ltd? To begin - value cries out for the shares. Let's first go with the fact that is primarily a gold mine for the first 7 years or so and the ore from the open pit portion is extremely gold rich. (1.5 grams of gold and 1.3% copper) The SEC proven reserve docs say that there is 57 million ounces of gold in there. Gold is about $1750 an ounce. And keep in mind that Rio Tinto (RTP) did a $1.8 billion rights offering at $7.17 per share. In addition to the gold there is 41 billion pounds of copper. Copper is $3.48 a pound. The mine is slated to begin production in the next few weeks and reach full production in March 2013. 's consolidated cash position was $1.7 billion as of September 30, 2012 and approximately $1.5 billion by November 14, 2012. Total capital invested in the construction of the first phase of the Oyu Tolgoi mine to the end of Q3 2012 was approximately $5.6 billion. The electricity is 'on' and it's coming from the China grid after a long and complex negotiation. Also, important is that the Mongolians want to distance themselves from massive China, just to the south - considering their history. Add it up and the share price and current market-cap of $7.4 billion is below cost plus cash.
My thoughts re the Mongolian governments 'possible' renege of the agreement and the play-out; what's now needed to fix the impasse is a resolution of a portion of the agreement. The agreement states that anything part can be renegotiated subject to both parties agreeing to a renegotiation. What happened was that a very thoughtless Mongolian mining minster wrote a letter asking to renegotiate a point of the 2009 agreement. Rio then rejected this renegotiation and there has been no more press re the issue. In my opinion, at the end of the day - soon - there will likely be a Rio loan to the Mongolian government to tide them over until 2013 when they begin to receive royalties. Keep in mind that the Government is incredibly stressed as far as finances are concerned and they look to the mine as their one and only sugar daddy.
The Government already owes Rio $1.8 billion, with an interest rate of Libor plus 6.75%, that needs to be paid out of future cash flows. I do not see Rio caving on this as a concession would become an annual event. Bear in mind that Rio deals with numerous governments and jurisdictions' globally and if a precedent were set in Mongolia they would be subject to a continuum of petitions to renegotiate. A good example of a mine 'suffering' under a government in flux is Grasberg, the world class copper mine in Indonesia that has been subject to numerous changes / upheavals in governments and coups over its 40-year life. Consider that once a mine is up and running and generating large cash-flow it is very problematic for a government to want to upset it; such is the case with Grasberg. And while there could be some change it would be minor and take a lot of time and in the meantime the clock ticks while Mongolia goes still deeper into financial distress. They are already broke so its unlikely that 'they' would want to upset what will be significant cash-flow.
The Wall Street Journal had a feature article in Thursday's edition (11/29/2012) re the financial mess the Mongolian Government is in and it's a beaut. Inflation is running at near 15%, Government spending went up 42% in the first eight months of the year, growth is expected to slow to 12.7% this year and inflation is running at 15%. In addition the Mongolian central bank has spent $800 million in currency markets to prevent their currency from losing value against the dollar. Link to the WSJ article - Mongolia Binges on Bond Bonanza here.
When the mine goes into production in 2013 the Mongolian government will receive royalties and taxes; for example they will receive a 4% ad valorem gross royalty off the mines production - huge numbers. While it's possible that the impasse could go on it's stipulated that conflicts be settled in an international arbitration in London. I'd also expect that the government will promise a 'cross my heart and hope to die' solemn oath not to muck it up again.
Another thought; the shares have cratered and have come off 70% ish from their highs. Now ponder the billions of lost market-cap… Wouldn't it, shortly following the correction of this mess, be an ideal time for Rio to buy out the minor shareholders? In a strange way this whole caboodle could a boon for Rio as they could acquire the stock ultra-cheap and look forward to the 60 to 100 years of production, owning all that isn't owned by the Mongolian government.
Since the commencement of ore mining in late Q2 2012, a total of 5.2 million tonnes had been stockpiled by the end of Q3 2012. Also, 56,000 tonnes have been sent through the primary crusher to the coarse ore storage building during the Q3 2012 period.
Another part of the story are several coal projects in southern Mongolia, 25 miles from the Chinese border, owned by South Gobi Resources. Their flagship resource is over 30 meters wide and runs 120 kilometers in length, and is as close to perfect coal as there is, and it's scooped up and sent to China in a seemingly endless stream of trucks. The coal resource also now largely belongs to Rio Tinto and is hung-up in a separate mess relating to an attempted takeover by a Chinese state-owned enterprise. Mongolia became China's largest coking coal supplier in 2011.
For a 'can't put the book down' read re Genghis Khan / Mongolia / Asia and more; Genghis Khan and the Making of the Modern World by Jack Weatherford. It's on my top 10 great reads list - it was part of the information 'package' that the investment group was given.
Disclosure: I am long TRQ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.