October 2014

Exchange rate

China insider and mining investment mastermind Keith Spence on how that country went from an investee to investor

By Chris Balcom

Special Report: China

China’s big moves in the mining industry have attracted considerable international attention in recent years. Few understand the country’s development better than Keith Spence, who has been working in China for more than a decade. With a background in geology and investment banking, Spence first came to China as the president of an exploration company working in Xinjiang, and later became an early mover in China’s outbound investment in the mining sector. Today, Spence serves as president and partner of Global Mining Capital Corporation, involved in private equity and partnering with Chinese investors looking to make international acquisitions. Spence is a CIM Distinguished Lecturer and former CIM board member, and is the recipient of several awards, including the Queen Elizabeth II Diamond Jubilee Medal and the Robert Elver Mineral Economics Award.

CIM: Drawing on your first-hand experience, how would you explain China’s rise as a major investor in foreign mining projects?

Spence: From 1999 to about 2004, there was a huge influx of investment in China because it had just changed the laws to allow foreigners to invest in mining. What China needed at that time was money. It sounds like a joke now, but it was really true. They needed money, they needed management expertise and they needed technical help, particularly in exploration.

Then, from about 2004 to 2005, China started to change from an importer of capital to an exporter. The seminal event was when China Minmetals made a bid for Noranda. Minmetals was unsuccessful in its bid, but that was the time when we started looking at China as having serious money.

Since then we have seen a change in the kind of projects the Chinese have been seeking. The geographies they’re interested in have changed considerably over time, the types of metals have changed over time, and the actors have changed over time.

CIM: Let’s start with the actors. Is it still primarily state-owned enterprises that are investing abroad?

Spence: Initially, it was mainly state-owned enterprises because they were the ones that had the resources and the technical depth to go abroad. They were also the ones who got permission because in order to go overseas to make acquisitions, you have to get permission from the state.

Now there’s more diversification in the kinds of investors. You’re seeing companies in other industries that want to make investments in mining, and you’re also seeing smaller mining companies and private mining companies. So there’s been more of a mix in the last few years.

CIM: What about the geographic change?

Spence: In the early years, there was more emphasis on Africa, which was a natural fit because China had very strong relationships with a lot of Third World countries. Most of the early investments were in Africa because of diplomatic relations. The African investments, while in mining, were tied to infrastructure developments. There were also a lot of early investments in Latin America.

As the boom continued, you started seeing China spread out to Australia, Canada, Central Asia and Southeast Asia. Since the downturn in the market, the Chinese risk appetite has changed and the focus has been on less politically risky places. The countries at the top of the list now are Canada and Australia.

CIM: What kind of projects and minerals are of interest to Chinese investors?

Spence: There is a strong focus on very late-stage, near-development projects. That is the sweet spot for the Chinese right now. There isn’t a lot of interest in early-stage exploration.

In terms of minerals, most of the Chinese forays abroad have been in what I call the “big four”: copper, iron ore, metallurgical coal and to some extent, gold. Now the focus is on gold and to some extent, copper.

CIM: How has the ownership structure that Chinese investors seek changed since their first forays abroad?

Spence: In the early days there couldn’t be any deal that was structured without majority control. There are still some who insist on majority control but that demand isn’t as strong as before. Now they’re starting to consider strategic investments in the 20 to 30 per cent level and also joint ventures. All of these transactions usually involve some form of mineral off-take agreements. This structure has elements of the Japanese model of the 1970s, where the Japanese took a minority stake in the foreign company but also got access to the mineral output. This has a lot of advantages. You allow the foreign company to run the company and handle all the technical and managerial challenges, but you still have what you really want, which is access to the raw material.

CIM: What kind of challenges have the Chinese faced in their pursuit of foreign mining assets?

Spence: The labour standards are a lot less rigorous in China than in some other countries, so there have been labour problems in some of the investments in Africa and in Latin America. The other challenge is management of the soft issues, which they didn’t pay a lot of attention to. One case in point: one of these companies has a project in Peru, which they haven’t been able to develop because of local opposition.

Then in the more developed countries, there’s a sort of backlash, a form of nationalism, like we had in the case of the Chinese national oil company CNOOC’s purchase of Nexen, where people were saying, “Yes, you can invest in our country if the companies are small and insignificant, but when you’re going to take national treasures or national trophies, that’s a problem.”

Another issue that the Chinese have faced in their investments abroad is that their due diligence probably wasn’t what we would do in North America. Just on purely economic criteria, they’ve made acquisitions and then have realized that there are a lot of issues they weren’t aware of.

CIM: Is securing supply the reason why Chinese firms have been so active abroad?

Spence: I would say there are three principal reasons. One is what everybody talks about – securing a source of raw material. Second, China also looks to some of these acquisitions to beef up their technical and managerial skills. By making these acquisitions they’ll learn how to operate overseas and learn some of the capital market skills as well.

But probably the most important reason for these investments is to diversify China’s huge foreign reserves. By last count, China had more than $3 trillion in foreign reserves, with most of it in U.S. dollar instruments. It’s another way to manage some of that money by putting it into hard assets, such as in mineral resources, and as a hedge against the U.S. dollar. This is just good portfolio management.

CIM: What kinds of lessons are the Chinese learning going forward?

Spence: Number one is that they should use foreign advisors in all their acquisitions. That includes technical and financial advisors, but also for corporate social responsibility, environment and political risk management. All of these advisors are integral to making a foreign acquisition successful.

CIM: What does the future hold for Chinese investment?

Spence: I think the Chinese are now more focused on their international investments and they have liberalized the rules so that not every investment has to be approved by government, only the very large ones. The future augurs well.

Mineral prices are at all-time lows. I often tell my Chinese partners this is a time for a buying spree, and the irony is that the Chinese were actually more aggressive in foreign investments during the time when the prices were high. Now they’re a little more cautious because they know more and they’ve had to deal with some challenges. Expect more investments and mergers and acquisitions from China, but from a more sophisticated and astute Chinese investor.

Next: Inside the Chinese Green Mining standard
The Fankou mine has undergone major changes in recent years

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