The Financing of Emerging Market Transnational Corporations in the Global Mining Industry
The mid-1990s witnessed the dramatic emergence of transnational corporations (TNCs) from the emerging markets. Though much of investment by these corporations is concentrated in other developing countries (South-South) but increasingly they are also investing heavily in the developed economies (South-North). A number of important factors including regional integration, trade and financial liberalization, the rise of big business as well as limited market size and resource base at home have encouraged emerging market TNCs to invest abroad.
Interestingly, substantial investments by emerging market TNCs have taken place in the natural resources projects pertaining to oil, gas, minerals and metals. State-owned oil companies from China and India are rapidly acquiring oil, gas and mining fields in the Sub-Sahara Africa, Central Asia and Latin America. For instance, almost half of China’s outward FDI went to acquire natural resources projects in Latin America in 2004. Similarly, India’s state-owned firm, Oil and Natural Gas Corporation, invested heavily in oil and gas fields in the Russian Federation and Angola. To secure access to strategic assets and critical technologies, some Chinese and Indian companies have also acquired junior mining companies in the developed countries including the US, Australia and Canada.
It is in this context, the financing of emerging market TNCs in the global mining industry become very important. Like oil and gas, the global mining industry is also witnessing a boom thanks to sharp rise in the commodity prices and a significant increase in market capitalization driven by mergers and acquisitions.
Since 2005, the rise in the commodity prices (particularly of copper, coal iron ore and nickel) has been phenomenal across the world. To a large extent, the weakening of financial markets and the resultant global economic slowdown has pushed many investors to commodity markets in order to diversify their investments. Besides, strong demand for minerals and metals in many emerging markets has fueled the rise in the commodity prices.
All these developments have induced banks, financial institutions, private and state-owned mining corporations and sovereign wealth funds belonging to the emerging markets to take notice of the relatively high revenue and profits of the mining industry and to seek out a greater share of the global mining pie. With the result, the emerging markets are spreading out from their geographical homes to own and operate mining assets globally.
According to the PricewaterhouseCoopers’ annual review (2008) of global trends in the mining industry - "Mine, As good as it gets?", the market capitalization of the industry grew by 54 per cent as measured by the HSBC Global Mining Index.
A major fundamental change in the composition of the global mining industry is the relative reduction in the market capitalizations of the traditional mining powers (Canada, United States and Australia) and the growth of the emerging markets’ companies from the BRIC and South American countries. The emerging market companies have shown especially high growth, with these companies comprised 36 per cent of market capitalization of the Top 40 global mining corporations in 2007. In 2003, the market capitalization for these emerging markets’ companies was mere 14 per cent. Out of top 40 global mining giants, 19 belonged to emerging markets in 2007. Not an insignificant development. This is despite the fact that many big Chinese and Indian companies have very limited publicly-floated share holdings. Therefore, the true value of their total market capitalizations could be much higher.
By and large, the global mining giants enjoy tremendous flexibility in raising cash for acquisitions and new investments. For instance, the majority of acquisition deals completed in 2007 have had significant cash components, including Rio Tinto’s purchase of Alcan and Freeport’s acquisition of Phelps Dodge. Rio Tinto’s cash acquisition was largely funded by debt where as Freeport’s acquisition of Phelps Dodge utilized both funding from issuing shares and taking on debt.
There is no denying that the top corporations have become increasingly more leveraged over the years but thanks to favorable commodity price environment they are in a better position to repay existing debt. In fact, some global giants have been able to repay debt more quickly. Therefore for global mining giants, the current credit crunch may not significantly impact the management of existing debt as well future prospects of large scale acquisitions.
On the other hand, the emerging market companies do not enjoy such flexibilities in raising cash to cover the increased levels of investment and acquisition activities (both domestically and abroad). Rather they are increasingly dependent on external financing from a diverse range of financial institutions to fund their investments. Since a number of Chinese and Indian companies are owned by the state agencies and therefore are heavily dependent on their state-controlled banks and financial institutions. As mentioned above, many Chinese, Indian and Russian mining companies have very limited publicly-floated share holdings which make it difficult in issuing share-based bids in the overseas capital markets. As a result, these companies are relying on their respective home capital markets for share issues.
However, of late, there has been vigorous activity in IPO markets by mining companies belonging to the emerging markets. In particular, Chinese companies are seeking to tap global capital markets to fund expansion. The issuance of shares worth US$9 billion by China Shenhua Energy, the country’s largest coal producer, in 2007 is a case in point. The Chinese authorities are encouraging their mining corporations to list in Chinese stock exchanges with the objective of strengthening the stock exchanges and to suck out excessive liquidity in local capital markets.
In the case of India, mining companies are tapping capital markets for raise financial resources to fund expansion plans. Interestingly, the state-owned Chinese and Indian companies are only issuing minor stakes to public as their respective governments wish to retain the majority control. The Indonesian coal mining companies are also raising funds from capital markets to fund capacity additions to meet growing demand from China and India. Interestingly, the majority of Asian listed companies belong to the coal and the iron ore sectors.
Whereas the Russian companies are primarily seeking capital markets to strengthen their domestic merger and acquisition activities.
Like oil and gas, mining sector also has a strong mix of private and public sector investment in the emerging markets. Given the rise of sovereign wealth funds in many emerging economies coupled with the advent of “resource nationalism,” the dynamics of mining sector has undergone tremendous change in recent years. With the result, there is a growing competition in securing mining projects. Since emerging markets are themselves major consumers of minerals and metals, there is a growing interest in these countries to lock up resources abroad to feed country’s appetite for commodities. Some countries like Russia have expressed their desire to retain strategic mining assets in local hands while promoting consolidation in the mining sector through creating “national champions.” Therefore, it is likely that the domestic “national champions” would get an advantage in acquiring mining assets.
More and more countries are pursuing investment policies which look beyond merely the pure financial returns. They are aiming at securing resources to fuel domestic economic growth and infrastructure. Several Latin American countries (such as Bolivia, Ecuador, Argentina, Ecuador, and Venezuela) are renegotiating contracts with TNCs to bring economic equilibrium between the foreign company and the host country. In Bolivia, for instance, the government successfully renegotiated contracts with ten foreign energy companies (mostly from the region) in October 2006. Under the new contracts, majority ownership of gas fields has been transferred to the state and government’s energy tax revenues are expected to increase by four times. The renegotiation of contracts was the outcome of the nationalization policy announced by President, Mr. Evo Morales, on May 1, 2006, under which foreign companies were asked to sign new contracts giving the government majority control or leave the country.
In March 2006, Ecuador passed a new law that gives the government 60 per cent tax on oil profit of foreign companies if the oil prices exceed certain benchmarks. Russia is considering new rules to protect its strategic resources, particularly oil and gas. Russia has refused to provide non-discriminating access to foreign companies to the country’s pipelines, primarily the gas transportation network controlled by state-owned gas company, Gazprom.
Simultaneously, even private companies in the emerging markets are being given special tax benefits, cheaper credit, export credit guarantees and policy support by their home governments to pursue international investments in natural resources projects, similar to the benefits that state-owned oil companies receive.
However, the recent acquisitions by emerging market transnationals of junior mining companies in the US, Australia and Canada have raised concerns related to non-commercial and non-transparent practices. Can these developments lead to a major backlash against emerging market transnational corporations? Time will tell.
Critics have pointed out some deals by Chinese corporations in Africa where they used the political and financial backing of their home country to secure mining assets. In particular, the case of China providing loans worth US$5 billion to the Democratic Republic of Congo for infrastructure projects in an exchange for majority stakes in two Congolese copper cobalt deposits for Chinese firms is often cited. There is no denying that the Chinese authorities are using their financial prowess to access natural resources from Guinea to Kazakhstan to fuel its economic growth. It is also a well-known fact that loans from the Chinese Development Bank (CDB) helped finance Chinalco’s purchase of 9 per cent stake in the Rio Tinto Group. But many observers point out that this is not a new phenomenon as many Western corporations in the past used the same tactics (including development assistance, infrastructure financing and export credit guarantees) to secure access to natural resources and markets in the developing world.
Also, it would be grossly incorrect to view all deals by emerging market transnationals made on non-commercial and non-transparent terms. For instance, Chinalco’s purchase of bauxite mines in Australia, and Norilsk’s purchase of Canada’s LionOre were made on competitive market terms.
Nevertheless, nowadays there is a greater scrutiny of acquisitions and new investments carried out by emerging market transnationals, particularly those financed by sovereign wealth funds and state-owned financial institutions.
Given the fact that mining sites in the world are few and the financial resources of the emerging market transnationals are relatively limited, there is a new trend towards building a strategic partnership between emerging market TNCs and their international counterparts. The partnership between India’s largest state-owned mining firm, National Mineral Development Corporation (NMDC) and Rio Tinto is a shining example of this. In 2008, they launched a 50:50 joint venture which will bid for both domestic and global mining projects. Already Rio Tinto has a significant presence in the India’s domestic mining operations. This is the second joint venture signed by the NMDC, in addition to another one with Spice Energy Group under which mining assets in Armenia, Congo and Eritrea are being acquired. What is interesting to note is that both joint ventures won’t compete with each other and would bid for different mining assets in different countries.
All these developments reflect the rapidly changing dynamics in the global mining industry due to increased presence of emerging market transnational corporations.
