Chalco and Ivanhoe extend SouthGobi deal deadline

VANCOUVER — The Aluminum Corporation of China (Chalco) and Ivanhoe Mines (IVN-T, IVN-N) have agreed to wait a month before Chalco make its official offer to buy Ivanhoe’s stake in SouthGobi Resources (SGQ-T) as doubts remain as to whether Mongolia will allow the deal to go through.

Chalco, which had initially agreed to make the takeover offer by July 5, will now make a bid for at least 56% and as much as 60% of SouthGobi’s shares by August 3.

The revised timeline comes only days after SouthGobi announced it was ramping down production at its Ovoot Tolgoi coal operation in Mongolia because of an uncooperative government and dwindling coal contracts. That news sent its share price down as much as $1.59 to close at $3.81 on June 28.

Meanwhile, the terms of the Chalco deal announced in early April are for the Chinese aluminum giant to buy Ivanhoe’s 104.8 million shares of SouthGobi for $8.48 per share, a 28% premium to the $6.62 closing price of the stock the day before the deal was announced. In updating the timeline, Chalco stated that otherwise the terms of the deal remain unchanged, which helped bring SouthGobi’s share price up to $4.75 by July 4.

But the question of whether Mongolia will accept the deal remains. The country only just wrapped up its parliamentary elections where questions about mining benefits and resource nationalism played a prominent role. With neither front-running party winning an outright majority, there is a chance one of the parties will form a coalition with the Mongolian People’s Revolutionary Party, which campaigned on a platform of resource nationalism and opposes foreign investment in mining.

And on May 17 the Mongolian government passed a law that would allow it to assess foreign investments, though the exact scope of the law is still unclear. According to University of British Columbia researcher Julian Dierkes, the law includes a listing of strategic sectors to which it applies – and that certainly includes mining; a minimum ownership threshold that triggers a review, apparently 49%; a minimum transaction value of roughly $75 million; and overall far lower criteria when foreign state-owned entities are involved, as in the case of Chalco. Dierkes notes that in many provisions the law resembles the Canada Investment Act, which recently allowed Canada to stop the takeover of Potash Corp (POT-T, POT-N).

In their July 3 co-statement Ivanhoe and Chalco reiterated that they will cooperate with the Government of Mongolia to ensure any requirements under the country’s new strategic foreign investment legislation are satisfied.

Meanwhile SouthGobi is still struggling with its operations after the government threatened to suspend its license, though the company has received no official notification as to any suspension. The company reports that the uncertainty about the suspensions has meant that many government departments have not issued approvals and permits to SouthGobi, while customers have been hesitant to sign contracts with the company.

On the permitting side, SouthGobi sited the delay in approval of a revised environmental impact assessment for dry-coal-handling facility from the Ministry of Environment, which if not issued may block the company from being able to operate it.

On the coal exports side, SouthGobi reports that customers were reluctant to sign ‘meaningful’ export contracts because of the lack of clarity on whether SouthGobi will be able to deliver the coal because of the suspension. The company also noted contracts were down because of a lack of border crossing capacity — brought on by government delays, repair issues, and extended holidays — and because of the deteriorating market conditions.

The combined difficulties have led the company to curtail activity at its Ovoot Tolgoi mine, with the company expecting to mine only 200,000 tonnes in the quarter and then halt operations entirely at the end of the quarter. The company expects new coal contracts of between 200,000 and 300,000 tonnes for the second quarter, but has not put out a guidance for third quarter sales because of the uncertainty with its operations and the regional coking coal market in general.

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.