Oyu Tolgoi back on track with Ivanhoe-Rio deal (December 20, 2010)

VANCOUVER — The Oyu Tolgoi partners have signed a deal that gives Ivanhoe Mines (IVN-T) access to as much as US$6.5 billion to keep construction on track while giving Rio Tinto (RTP-N, RIO-L) an increased stake in its partner and control over the mine from here on. The deal ends a potentially nasty arbitration proceeding and ensures full financing to complete development of one of the largest coppergold mines in the world,

The agreement gives Ivanhoeaccess to US$4.4 billion for Oyu Tolgoi through a schedule of equity and rights investments by Rio Tinto, plus another US$1.8 billion through an interim loan. The loan will only occur if Ivanhoe runs out of cash before the partners can ink a deal for a long-term project-finance package, negotiations for which are already underway.

The joint Ivanhoe-Rio technical committee recently estimated that to carry Oyu Tolgoi from the beginning of 2011 to the start of production will cost another US$4.6 billion. The partners have already spent US$1.4 billion at the site. The assurance that this capital will be available gave Ivanhoe president and CEO Robert Friedland the confidence to say he expects production to start in less than two years, six months ahead of schedule.

Oyu Tolgoi is a sizable project. Once operational the mine is expected to constitute roughly 30% of Mongolia’s gross domestic product. The project boasts resources containing 81 billion lbs. copper and 46 million oz. gold in measured, indicated and inferred categories. There are already 5,500 people working at Oyu Tolgoi. In 2011 on-site jobs will peak at 14,000 as 3,700 Mongolians are trained for jobs in the mineral sector, many of them at the mine.

The mine will start at the nearsurface Southern Oyu deposits, where an open-pit operation will send 100,000 tonnes of ore to a mill every day. Once the open pit is underway the partners plan to almost double the mill’s capacity, in order to accommodate ore from an 85,000-tonne-per-day underground block-caving operation at the Hugo North deposit.

Rio Tinto does not actually own a stake in Oyu Tolgoi. Rather, the Mongolian government owns 34% of the project and Ivanhoe holds the rest; Rio joined the scene three years ago by becoming Ivanhoe’s largest shareholder. Currently, the major owns 34.8% of Ivanhoe.

That stake is now set to increase. The new deal includes financing measures that will boost Rio’s stake in Ivanhoe to 46.8%. The deal also allows Rio to top that off to 49% through additional rights subscriptions and open market purchases.

Rio will also now take over as project manager, assuming responsibility for building and operating the Oyu Tolgoi mining complex. Ivanhoe will continue to manage the project’s exploration arm, which has a budget of roughly $30 million a year.

Rio’s increased role in the project is coming at a price. To start, the major will exercise nearly US$800 million worth of remaining Ivanhoe warrants in three stages over the next 14 months. Rio is also buying another 20 million Ivanhoe shares directly. Half of those shares will come from Friedland and the other half will come from Citibank, with both deals using Ivanhoe’s 20-day average closing share price. Friedland may use the roughly US$250 million in proceeds to buy any further Ivanhoe rights from the current offering that become available on the secondary market.

That rights offering now has two solid backers in Friedland and Rio, and another component of the new Oyu Tolgoi deal is a commitment from Rio to fully participate in the US$1-billion to US$1.2-billion offering. The major will exercise all of the rights to which it is entitled, thereby maintaining a minimum 42.3% ownership stake in Ivanhoe. With Friedland also committed to participate fully in the offering, Ivanhoe is assured that almost 60% of the rights will be exercised.

Those moves will provide Ivanhoe with some US$2 billion to advance Oyu Tolgoi. For the rest of the needed capital, Ivanhoe and Rio are working together to complete an international project finance package worth up to US$3.6 billion. A core lending group, comprising the European Bank for Reconstruction and Development, International Finance Corp., Export Development Canada, BNP Paribas, and Standard Chartered, is considering the request. The partners are aiming to have a signed deal by mid-2011.

In case they cannot complete the project finance deal in time, Rio is prepared to provide Ivanhoe with a US$1.8-billion interim finance facility. The interim facility will only become available once all the proceeds from the rights offering and the exercise of warrants have been used up at Oyu Tolgoi and if the project finance package is not yet ready.

And the deal not only assures financing for the mine but also marks the suspension, for at least six months, of the arbitration battle that was brewing between Ivanhoe and Rio. In July, Rio charged that a shareholder rights plan approved by the company’s minority shareholders breached Rio’s contractual rights; in October Ivanhoe responded with a statement of defense and a counterclaim alleging that Rio had breached certain covenants of a 2006 private placement with Ivanhoe.

“The suspension of the current arbitration procedure for six months, agreed to by both companies, is further confirmation of our immediate focus on the common objective of building Oyu Tolgoi and provides potential opportunities for the companies to pursue a permanent settlement of issues that have arisen,” said Friedland.

Ivanhoe investors were not pleased with the latest deal, sending the company’s share price down $4.54 or 15% in two days to $25.28. Analysts say the negative reaction was likely due to disappointment that a potential takeover will now certainly not come until at least 2012. Ivanhoe has a 52-week trading range of $12.36 to $30.28 and 531 million shares outstanding.