Xingyun Liu, Lifan Wu and Jim Hatch wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. Richard Ivey School of Business Foundation prohibits any form of reproduction, storage or transmission without its written permission. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Richard Ivey School of Business Foundation, The University of Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail [email protected] Copyright © 2010, Richard Ivey School of Business Foundation Version: (A) 2010-09-28
As the financial crisis became more severe in early 2008, the prices of base metals, such as zinc and lead, declined greatly. As a result, many mining companies suffered significant operating losses and experienced extreme difficulty obtaining financing from the capital markets. Consequently, some companies had to either sell some of their assets or find a strategic buyer. In late November 2008, Zhang Shuijian, the chief executive officer (CEO) of Shenzhen Zhongjin Lingnan Nonfemet Co. Ltd. (SZLN), and his management team had identified an opportunity to acquire Perilya Limited (PEM), a base metal mining company listed on the Australian Securities Exchange (ASX). Before making an offer, the team needed to determine the strategic benefits of this acquisition, the risks that might be incurred as a result of the purchase and the maximum price SZLN would be willing to pay. ABOUT ZINC AND LEAD1
Zinc is the fourth most common metal in use, trailing only iron, aluminum and copper. About threequarters of zinc used is consumed as metal, mainly as a
coating to protect iron, steel and aluminum from corrosion. The resulting product is known as galvanized metal. Zinc is also frequently employed as an alloying metal to make bronze and brass, as a zinc-based die casting alloy and as rolled zinc. The remaining one-quarter of zinc is consumed as zinc compounds, mainly by the rubber, chemical, paint and agricultural industries. In 2008, global refined zinc production increased by 5.1 per cent to 11.9 million tons, and consumption by 3.8 per cent to 11.8 million tons. Metal production rose as a result of increased output in China and India. A decline in zinc consumption in Europe and the United States during the year was offset by increased consumption in countries with emerging markets, particularly China, but also Brazil and India. Identified zinc resources of the world were approximately 1.9 billion tons. Lead is a very corrosion-resistant, dense and ductile metal, which has been in use for at least 5,000 years. Concern with lead poisoning has reduced the demand for lead in non-battery products. Use of lead worldwide was estimated to have increased by about 5 per cent in 2008, driven primarily by strong 1
U.S. Geological Survey, Mineral Commodities Survey, 2009, at http://minerals.usgs.gov/minerals/, accessed March 2010.
economic growth in the information technology, telecommunications and transportation sectors in China. Global lead mine production in 2008 was expected to be 3.8 million tons. Identified lead resources of the world totaled more than 1.5 billion tons. In recent years, significant lead resources were found to occur in areas with deposits of zinc, silver, and copper. As a result, lead ores were produced as a byproduct of mining these other metals. In fact, zinc producers typically netted lead revenues when calculating their zinc production cost. SHENZHEN ZHONGJIN LINGNAN NONFEMET CO. LTD.
China Nonferrous Metal Industry Shenzhen Co., the predecessor of Shenzhen
Zhongjin Lingnan Nonfemet Co. Ltd. (SZLN), was founded in 1992 and went through several restructurings, including a merger with Guangdong Shaoguan Lingnan Lead Zinc Group Ltd. Co. (Lingnan) in 1999. The major assets of Lingnan were the Fankou Lead Zinc Mine and the Shaoguan Smelter. At the time of the merger, Lingnan was China’s largest lead zinc ore mining company and China’s third largest lead zinc smelter. In January 1997, the company listed its stock on the Shenzhen Stock Exchange and, after the amalgamation, changed its name to Shenzhen Zhongjin Lingnan Nonfemet Co. Ltd. (SZLN). SZLN’s largest shareholder (at 38.22 per cent) was Guangdong Rising Assets Management Co. Ltd., a state-owned enterprise. As of 1999, lead zinc products contributed approximately 80 per cent to profits, construction material and decoration 10 per cent and trading approximately 6 per cent. Due to an economic downturn and continuously depressed demand for lead and zinc, the prices of lead and zinc fell to historical lows, resulting, in 2001, in a decline in SZLN’s net income of more than 75 per cent compared with 2000. In response, the company formed a new management team with Zhang Shuijian as the new CEO. This team instituted stringent cost controls and restructured the business to make lead and zinc products the company’s main focus. As a result of this restructuring, net income in 2002 increased by more than 30 per cent over the previous year, despite the low metal prices. By the end of 2006, the prices of lead and zinc metal were at their highest levels in 20 years (see Exhibits 1 and 2 for historical lead and zinc prices). Approximately 55 per cent of domestic zinc was used in hot-dip galvanizing.
Because additional galvanizing units were expected to be put into operation, the demand for zinc was expected to grow continuously. In 2006, domestic consumption and exports of lead-acid batteries, the main lead-consuming industry, had increased by 20 per cent and 35 per cent, respectively over 2005 levels. On the supply side, capacity growth was constrained by a lack of high-quality mines and limited smelter capacity. SZLN forecasted that this growth trend in the demand for lead and zinc products would continue and, thus, increased its annual capacity to 180,000 tons of lead zinc ore and 400,000 tons of metal products. This expansion was financed by issuing 60 million new shares from which SZLN received proceeds of RMB700 million. Output of ore in 2007 was approximately 99,900 tons of zinc and 45,500 tons of lead. Metal output was 181,500 tons of zinc metal products and 92,200 tons of lead electrodes. Thus, the firm was required to purchase ore from both domestic and international companies to feed its manufacturing operations. The prices of lead and zinc in 2007 fluctuated like a roller coaster. In a review of the competitive situation in 2008, SZLN made the following key observations:
• • •
According to the data, the total capacity of the top 10 domestic lead zinc companies was less than 50 per cent of domestic total capacity, which indicated a fragmented industry. In 2007, upstream companies expanded downstream, and some downstream companies extended to upstream business, illustrating a trend to vertical integration. Industry competition intensified as a result of capital market developments. Because the stock market had performed abnormally well in 2007, many companies had taken the opportunity to issue additional shares to raise money for possible merger and acquisition opportunities. SZLN also raised money so it could expand, in hopes of surviving the imminent industry consolidation. Clearly, the government intended to consolidate the industry. As a result SZLN would likely either acquire other companies or would be acquired
SZLN’s share of the segment’s total gross profit reflected the company’s changes in emphasis over time for various product lines (see Exhibit 3). The latest financial statements for SZLN are shown in Exhibits 4 and 5. RECENT ACQUISITION ACTIVITIES
In June 2008, SZLN acquired a 55 per cent equity stake in Wuxuan Panlong Lead Zinc Co. Ltd. (Panlong Mine) at a price of RMB341 million. According to data provided by the Mineral Resources and Reserves Evaluation Center of China’s
Ministry of Natural Resources, Panlong Mine contained 19.7 million tons (Mt) of ore, 3.31 per cent grade of zinc and 1.05 per cent grade of lead. Given these estimates, the total of contained metals was 0.86 Mt.2 As of September 30, 2007, the evaluated net assets of Panlong Mine were RMB620 million.3 Another takeover attempt in the overseas market had not been completed. In late December 2007, Indonesia Bumi had announced a hostile takeover offer for Australia Herald Resources Limited (Herald) at AU$2.25 cash per share. The main asset of Herald was an 80 per cent share of the Dairi project, which was located in Indonesia. As of June 30, 2007, the net assets of the project were estimated to have a value of AU$138 million. According to the announcement, the Dairi project contained 17.3 Mt of lead and zinc ore, with 13.1 per cent grade of zinc and 7.6 per cent grade of lead, ranking as the world’s largest preproduction-stage lead zinc mine. In response, on January 30, 2008, SZLN and Indonesia PT Antam Tbk (Antam) set up a Special Purpose Vehicle (SPV) in Singapore — Tango Co. — which announced a tender for all outstanding shares of Herald (there were 202 million shares outstanding) at a price of AU$2.50 cash per share. The offer was conditional on Tango acquiring more than 50.1 per cent of the shares of Herald. Tango raised the tender offer price twice in June; however, on July 15, Herald announced it would accept Bumi’s unconditional tender offer, of AU$2.85 per share, and SZLN gave up its takeover attempt. In mid-November 2008, SZLN received information that PEM was seeking a strategic buyer, leading to a prompt response from Zhang and the management team. Due to the financial turmoil, lead and zinc prices had decreased dramatically, and PEM’s stock price had crashed from AU$2.64 per share at the beginning of 2008 to AU$0.15 per share in mid-November. In addition, the Australian dollar had depreciated by onethird relative to the Chinese renminbi compared with six months earlier.
The contained metals were computed as follows: contained metals = 19.7 Mt × 3.31% + 19.7 Mt × 1.05% = 0.86 Mt. The evaluated net assets method values the equity of a firm on the basis of the fair market value of its assets less its liabilities. This method is in contrast to the discounted cash flow method, which values the equity at the present value of future free cash
flows to equity.
Perilya Limited (PEM) was an Australian base metals mining and exploration company, listed on the Australian Securities Exchange. It operated the Iconic zinc, lead and silver mine in Broken Hill, New South Wales. PEM’s operations also included the Flinders Project in South Australia and the Mount Oxide Project in Queensland. The financial statements and major shareholders of PEM are shown in Exhibits 6, 7 and 8. Established in 1987, PEM had grown rapidly since its purchase of the Fortnum Gold Mine in 1994. In anticipation of the closure of the Fortnum Gold Mine in 2001, PEM embarked on an evaluation and acquisition program. Broken Hill, one of the largest and most renowned zinc, lead and silver mines in the world, was acquired in May 2002. As of June 30, 2008, the combined Broken Hill ore reserve was 10.02Mt at an average grade of 6.1 per cent zinc, 4.5 per cent lead and 46.7 grams per tonne (g/t) of silver. Substantial mineral resources could possibly be converted to ore reserves at a later date, which could extend the life of the Broken Hill operation.4 PEM’s Broken Hill operation included the Southern Operations, the North Mine and Potosi Exploration Decline, with a 2.8 Mt concentrator. Zinc and lead concentrate produced was sent by rail to Port Pirie in South Australia, from which the zinc concentrate was shipped to Korea Zinc in South Korea (based on an agreement that was to expire in December 2012), and the lead concentrates were then sold to NyStar (based on an agreement that was to expire in December 2009) and processed at Nystar’s smelter in Port Pirie.
Management of SZLN noted that if an acquisition by SZLN took place, the ore could be economically shipped to SZLN’s underutilized smelters after these contracts expired. PEM’s operations also included the Flinders Project in South Australia and the Mount Oxide Project in Queensland. A total of 316,400 tonnes of direct shippable zinc silicate ore had been mined and stockpiled in Flinders, and approximately one-third of it had been sold by June 2008. PEM owned 100 per cent of the Mount Oxide copper project. On September 10, 2008, PEM reached an agreement with Chalice Gold Mines Limited (CHN) for Chalice to acquire PEM’s 100 per cent interest in the Mount Oxide project in return for 200 million Chalice ordinary shares.5 However, because the capital market was severely depressed and the copper price dropped, Chalice asked for a cancellation of the deal. PEM accepted Chalice’s request on October 24, 2008, at which time CHN’s stock price was AU$0.07 per share. On February 5, 2008, the board of PEM announced both the appointment of Patrick O’Connor, the former non-executive chairman, as the executive chairman, and the board’s commencement of a process of reviewing strategic options for maximizing shareholder value. The objective would be to refine the company’s growth strategy and pursue merger and acquisition opportunities. On February 21, 2008, PEM disclosed that discussions had taken place regarding a potential merger between PEM and CBH Resources Limited (CBH). The merger proposal endorsed by boards of both sides was publicized on March 26. During this time, a number of key management personnel at PEM resigned. Due to the continuously falling base metal prices and increasing operating costs (net cash costs at Broken Hill increased from US$0.75 to US$1.03 per pound of zinc during fiscal year 2008), financial conditions of
Operational mineral resources as discussed in this case include the proven ore reserve, in addition to indicated and inferred resources. If a company is fortunate, the actual reserve may be much higher than the reported reserve. A lower possibility exists that the actual reserve will be less than reported. The statistics on mineral resources were reported in accordance with the Australian Code for Reporting of Exploration Results, Mineral Resources and Ore Reserves. 5 CHN’s shares were trading at AU$0.12 per share as of this date, making the transaction worth AU$24 million.
PEM continued to deteriorate. On August 21, PEM released a Broken Hill operation resizing plan that included the following: • • • • • • •
A reduction in output to annual production of approximately 55,000 tonnes of contained zinc6 and 50,000 tonnes of contained lead Higher zinc grades of 6.5 per cent and lead grades of 6.0 per cent on the back of increased remnant pillar production (compared with current grades of 5.8 per cent zinc and 3.5 per cent lead) Exposure to spot prices, with hedging restricted to quote period hedging7 and the use of option contracts Reduction in staffing levels from 760 to 320 persons at a total cost of AU$20 million Lower capital and development expenditures for fiscal year 2009 forecast at AU$25 million reducing to AU$15 million in fiscal year 2010 Lower exploration expenditures within the Broken Hill region Further cost reductions at the corporate head office (another member of key management personnel resigned in September)
According to PEM’s release, the estimated cash costs of production as a result of the revised production plan would decrease to US$0.60 and US$0.65 per pound of zinc. Patrick O’Connor was also quoted as saying: The Company is confident that the Broken Hill Operation can be sustained to maintain a level of continuity of production and one that is financially viable at current metal prices for at least the next two to three years without significant compromise to the longer-term life of the mine. UNSOLICITED TAKEOVER OFFER FROM CBH RESOURCES LIMITED
CBH Resources Limited (CBH) was an Australian-listed resource company with an operating base metal mine at Cobar and a new base metal (i.e., zinc, lead and silver) development at Panorama and Broken Hill (see Exhibits 9 and 10 for CBH’s financial statements). CBH’s Broken Hill mine was located in the center of PEM’s Broken Hill mining area (see Exhibit 11). On March 26, 2008 PEM and CBH announced a merger plan, in which CBH shareholders would receive one PEM ordinary share for every three CBH shares they held and one PEM share purchase option for every 20 CBH shares they held. Immediately following completion of the proposed merger, PEM shareholders would own
approximately 41 per cent of the combined group, and CBH shareholders would own the balance of approximately 59 per cent. The combined companies would be the world’s ninth largest zinc producer. The proposed merger was expected to generate important benefits for shareholders in both companies. The merger would unify Broken Hill ownership and significantly enhance operating efficiencies, such as increasing through-put at PEM’s concentrator8 of up to about 2.8 Mt per annum (from the current levels of about 1.8 Mt per annum), adding material life to Broken Hill mining through efficient access to combined resources and remnant ore. The combined group would have opportunities to reduce corporate overhead,
Annual production is measured by the quantity of metal produced, which in turn is equal to the tons of ore multiplied by the average grade of the ore. 7 Quote period hedging is used to hedge against the price fluctuation between the time the company submits the quote and the time the buyers accept the quote. 8 A concentrator separates useful ore from waste ore.
manage a quality portfolio of base metal assets at varying stages of development, create a significant global zinc and lead producer and increase equity market scale and ongoing liquidity. However, on June 24, 2008, the board of CBH advised that it had “been informed by PEM that the merger is unlikely to be completed within the original timeframe of 25 August 2008.” Subsequently CBH submitted to PEM a revised merger proposal of 3.5 CBH shares for 1 PEM share, which was also rejected despite a strong logic for merging the two companies. CBH claimed that “the Perilya board has rejected CBH’s offer on the basis that it is considered to be ‘inadequate’ even though it is superior to the current merger terms that they have recommended.” CBH found this position “astonishing and illogical.” PEM issued a media release on the same date, which listed the rationale for
rejecting the CBH takeover proposal, including the following: • • • • • •
CBH had recently announced major changes to its operations while PEM “has had limited opportunity to properly evaluate the changes”9 Erosion of the anticipated short-term merger benefits as a result of the decline in commodity prices and anticipated delays to CBH’s Rasp project approvals10 An indicated lack of support from some CBH note holders Delays to CBH’s independent experts report Recently reported exploration results from PEM’s Mount Oxide copper project that enhanced the value of PEM’s assets “CBH . . . is relatively unhedged.”
On the first day after PEM issued its annual report for fiscal year 2008 (ended on June 30), CBH announced a tender offer of 4.2 CBH shares for 1 PEM share, which represented a premium of approximately 13.7 per cent more than the recent PEM share price. If 100 per cent of the equity was acquired, PEM shareholders would own approximately 48.5 per cent of the combined company and CBH shareholders would own approximately 51.5 per cent. The board of PEM advised shareholders to “take no action,” because “CBH would expose Perilya shareholders to additional risks, including CBH’s high cash cost assets and approximately $200 million in debt with associated debt-servicing costs in the order of $15 million per annum.” CBH lodged a bidder statement on November 12, and PEM’s board needed to release its target statement in response before December 12, to advise its shareholders to accept or reject the CBH offer, or support the submission of a new proposal. The significant events relating to this merger negotiation are summarized in Exhibit 12. OPPORTUNITY FOR SZLN WITH PEM
As lead and zinc prices continued declining, PEM encountered greater operational and financial pressures. Although PEM had reduced its production and staffing levels, maintaining its operational cash flow and necessary basic capital expenditures continued to be a difficult task. If the ores mined were of lower grade CBH responded, “there are no other material changes at any of its operations . . . . Indeed, it is surprising that Perilya is yet to respond to the recent decline in metal prices in respect of its own operations at Broken Hill.” 10 CBH had undertaken an
environmental assessment and submitted a project application under the Environmental Assessment Act. Once completed, the company would have approval for commencement of operations at its newly developed Rasp mine. 9
than had been estimated, PEM would probably be short of cash and, thus, might fail to pay the interest or principal on its outstanding debt. The CBH takeover threat further aggravated the pressure on PEM’s management. Patrick O’Connor, who was actively seeking a strategic investor, connected in November 2008 with SZLN at the China Mining 2008 convention in Beijing. From SZLN’s perspective, the ore mined by SZLN was not enough for SZLN to fully utilize its smelting capacity. Also, although commodity prices had declined greatly since the financial crisis, the management of SZLN was confident that mineral resources would be scarce in the long run. According to the analyst reports of several major investment banks, zinc and lead prices would recover in the next several years. The forecasted zinc prices were US$1,250, 1,650 and 2,200 per tonne in 2009, 2010 and 2011, respectively.11 If the acquisition of PEM were successful, some additional synergistic effects would result, although they would be difficult to quantify. For example, because PEM was a world-known lead zinc mining company, SZLN would gain the platform it needed to achieve international expansion (such as acquiring international resources or making foreign direct investments). SZLN and PEM each had specific advanced mining technologies, which provided a sharing opportunity. PEM also had operational and managerial efficiencies that SZLN could learn from. Based on the assumptions of SZLN management and those of the case writers, a forecast of U.S. dollar cash flows for the next three years was generated (see Exhibit 13). All revenues were in U.S. dollars, whereas some of the operating costs were in U.S. dollars and some in Australian dollars.
For purposes of the forecast, the Australian costs were converted into U.S. dollars at the assumed spot rate. To simplify the forecast and the valuation, lead prices and production were not modeled independently. Instead, consistent with industry practice, net revenues from lead operations were used to offset the operating costs. Capital expenditures included payments for mine properties and for property, plant and equipment. Although not relevant for the equity valuation, the company estimated it would need at least AU$15 million in the next year to conduct further exploration of its properties. The life of the remaining ore reserves was estimated to be approximately eight years (starting from 2009), given the future metal price assumptions. As seen in Exhibit 13, some debt was assumed to be repaid in 2009 and 2010, but no further debt repayments were assumed from 2011 to 2015. The remaining debt of US$9.05 million was to be repaid at the end of 2016. Interest payments were assumed to be unchanged between 2011 and 2016. REGULATORY ENVIRONMENT
Many regulatory uncertainties surrounded the deal even if both management teams could reach agreement. SZLN would need to receive approval from Chinese regulators, its largest Chinese shareholder, Australian regulators and the shareholders of PEM. National Development and Reform Commission (NDRC)
China’s various industries were highly regulated by a number of state and provincial agencies. For example, the National Development and Reform Commission (NDRC) was a macroeconomic management agency under the Chinese State Council and had powerful and broad administrative and planning control 11
Source: Internal data of SZLN; 1 tonne = 2204.6 pounds.
over the Chinese economy. The NDRC’s functions were to study and formulate policies for economic and social development, to maintain the balance of economic development and to guide restructuring of China’s economic system. Of direct interest to SZLN, the NDRC was responsible for the formulation of comprehensive industrial policies. In 2007, the NDRC produced a report on
“Access Requirements of the Lead and Zinc Industry,” which focused on the need to consolidate the companies operating in this highly fragmented space. SZLN was stimulated by this report grow the company. The firm’s strategy set in early 2008 was to “focus on the lead zinc industry, prioritize the development of mines, emphasize management of smelters, and build an internationally-competitive lead zinc group company.” In addition, the NDRC had issued “Interim Measures for the Administration of Examination and Approval of Overseas Investment Projects” in 2004. This document noted that “overseas investment projects in resource development . . . in which the Chinese party invests an amount of US$30 million or more . . . shall be subject to examination and approval of the NDRC.” Overseas investment projects of US$30 million or less were to be subject to the examination and approval of the provincial development and reform commissions. NDRC explained that the purposes of “The Measures” were to improve the orderliness and effectiveness of Chinese administration of the overseas investment, to enhance the “go global” strategy, to promote Chinese enterprises expanding overseas and to diversify investment channels. The go global strategy of the government included creating a favorable environment for direct foreign investment and fostering international trade. Given the recent international financial crisis, this area appeared to offer many opportunities. China State-Owned Assets Supervision and Administration Commission (SASAC)
Another major regulatory agency was the State-Owned Assets Supervision and Administration Commission (SASAC). This agency was mandated to perform investor’s responsibilities with respect to state-owned enterprises. SASAC shouldered the responsibility of supervising the preservation and increments to the value of the state-owned assets by the supervised enterprises. It guided and pushed forward the reform and restructuring of state-owned enterprises, advanced the establishment of modern enterprise systems, improved corporate governance and propelled the strategic adjustment of the layout and structure of the state economy. SASAC was the sole shareholder of Guangdong Rising Assets Management Co. Ltd, which was SZLN’s largest shareholder. In summary, the Chinese regulatory authorities were concerned with such aspects as the following: • • • •
The safety and return on the investment of SASAC The efficient use of foreign exchange reserves The political relationship with the investee country Enhancing Chinese competitiveness and consistency with the country’s go global strategy
Australia Foreign Investment Review Board (FIRB)
In recent years, some large-scale overseas mergers and acquisitions initiated by Chinese companies had been thwarted. For example, China National Offshore Oil Corporation (CNOOC) had cancelled its proposed takeover of Unocal because of resistance from the U.S. Congress, and Australian Rio Tinto had
rejected the acquisition of Chinalco. Thus, receiving approval of the foreign regulators was important for the proposed acquisition. Australia was a world-leading exploration and mining country. The Foreign Investment Review Board (FIRB) examined proposals by foreign interests to undertake direct investment in Australia and made recommendations to the government on whether those proposals were suitable for approval under the government’s policy (no FIRB examination was needed if less than 15 per cent of the equity was to be acquired). The Australian government’s guidelines for the examination of foreign investments included the following key elements:12 1. The foreign investment must be consistent with Australia’s national interest. 2. Although investments by foreign government entities are permitted, the investor’s operations must be independent from the relevant foreign government and require special consideration. This criterion reflects the fact that investors with links to foreign governments may not operate solely in accordance with normal commercial considerations and may instead pursue broader political or strategic objectives that could be contrary to Australia’s national interest. 3. An investor is subject to and must adhere to the law and observe common standards of business behavior. 4. An investment may not hinder competition or lead to undue concentration or control in the industry or sectors concerned. 5. An investment must not negatively affect Australian government revenue or other policies. 6. An investment must not affect Australia’s national security. 7. An investment must not negatively affect the operations and directions of an Australian business or its contribution to the Australian economy and broader community. Key interests here would include impacts on imports, exports, local processing of materials, research and development and industrial relations. Cultural Uncertainties
Besides the usual risks associated with acquisitions were numerous managerial and cultural issues related to cross-border acquisitions by Chinese companies. Although Chinese companies had completed numerous acquisitions, none had been especially successful. For example, the acquisitions of Alcatel and Thomson by TCL, the IBM PC business by Lenovo and the 50 per cent equity of Fortis Investment by Ping An Insurance were incurring huge losses or showing an inability to adapt. These unsuccessful acquisitions could not be ignored by SZLN. On the other hand, it is useful to note that the English language capabilities of the SZLN management team were quite good. PAYING FOR THE ACQUISITION Where Would the Money Come From?
Because of SZLN’s alignment with Chinese government strategy, its relatively strong financial structure, its relationship with Chinese banks and the cash flow prospects from the investment, SZLN anticipated it 12 Government of Australia, “Release of a Set of Principles to Enhance the Transparency of Australia’s Foreign Investment Screening Regime,” press release by the Hon. Wayne Swan, Treasurer of the Government of Australia, February 17, 2008.
could borrow sufficient U.S. dollar funds from Chinese banks to make the acquisition in cash if required. Because SZLN had raised approximately US$90 million equity funds in late 2006 and had accumulated profits in 2006 and
2007, its liabilities–assets ratio had decreased from approximately 70 per cent to 50 per cent over the 2006-2007 period. This financial slack provided the company with a degree of flexibility to take on this opportunity. Nevertheless, the future cash needs of PEM would need to be considered before signing the deal. Another potential source of funds would be the issuing, again, of new shares on the stock exchange. However, this option did not appear to be feasible because the stock issuance of Chinese public companies was closely regulated and took a relatively long time (approximately six months) to process. A third potential option was to offer to exchange newly issued SZLN shares to the holders of PEM shares. However, in addition to the time required gain approval, SZLN was authorized to issue only class A shares, which only mainlanders and selected foreign institutional investors were allowed to trade. Alternative Deal Structures
While considering the form of acquisition, SZLN anticipated at least three possibilities: offering a cash tender in the market, purchasing newly issued PEM treasury shares directly from the company to become the largest shareholder, and financing the purchase with convertible bonds and then converting the bonds into common shares at some future time. Offering to purchase PEM shares for cash in the secondary market was expected to be very difficult and carried a highly uncertain outcome (unless a substantial premium was paid) because the current stock price was perceived by PEM shareholders to be extremely low. The direct purchase of PEM treasury shares had the advantage of providing a new injection of equity capital into PEM; however, key issues would be the price and proportion of ownership held by the acquirer. The convertible bond alternative would reduce the risk to the acquirer because, in the case of liquidation, a bond ranks higher than equity. However, this form of financial instrument had low liquidity, and the conversion prices would be difficult to negotiate. Even more difficult was deciding on the right conversion timing so that SZLN could gain control. THE DECISION
Zhang Shuijian and his team needed to design an acquisition proposal that could increase the long-term value of SZLN, meet the requirements of both Chinese and Australian regulators, and satisfy the board and shareholders of
PEM. On November 28, 2008, the Australian five-year Treasury bond interest rate was 3.97 per cent, and the 10-year Treasury bond interest rate was 4.58 per cent. The most recent stock price of PEM was AU$0.14 per share, and 196,882,640 shares were outstanding. The Australian dollar exchange rate was AU$1.5249 = US$1, and the U.S. dollar exchange rate was RMB6.8349 = US$1. Selected share prices and exchange rates are shown in Exhibit 14. Lifan Wu is a Professor at College of Business and Economics, California State University, Los Angeles. Xingyun Liu is a Lecturer at Lingnan College, Sun Yat-Sen University.
Exhibit 1 LONDON METAL EXCHANGE ZINC INVENTORY AND SPOT PRICE, 1989–2008
14,000 12,000 10,000 8,000 6,000 4,000 2,000 0
5000 4500 4000 3500 3000 2500 2000 1500 1000 500 0
19 89 –
Source: Guosen Securities Base Metals Industry database
0 19 1 90 -0 1 19 91 -0 19 1 92 -0 1 19 93 -0 1 19 94 -0 19 1 95 -0 1 19 96 -0 19 1 97 -0 1 19 98 -0 19 1 99 -0 1 20 00 -0 1 20 01 -0 20 1 02 -0 1 20 03 -0 20 1 04 -0 1 20 05 -0 20 1 06 -0 1 20 07 -0 1 20 08 -0 1 Zn LME Inventory Mt Zn LME spot price US$/t
Exhibit 2 LONDON METAL EXCHANGE LEAD INVENTORY AND SPOT PRICE, 1989–2008
4,000 3,500 3,000 2,500 2,000
4500 4000 3500 3000 2500 2000
1,500 1,000 500 0
01 01 01 01 01 01 01 01 01 01 01 01 01 01 01 01 01 01 20 07 20 06 20 03 20 02 19 99 19 98 19 94 19 95 19 90 19 91 19 89 19 93 19 92 19 97 19 96 20 01 20 00 20 05 20 04 20 08 01 01
1500 1000 500 0
Pb LME Inventory Mt
Pb LME spot price US$/t
Source: Guosen Securities Base Metals Industry database
Exhibit 3 SZLN GROSS MARGINS BY SEGMENT AND PRODUCT LINES AS A PERCENTAGE OF TOTAL GROSS MARGIN, 1999–2006
1999 Gross Margin Rate Lead & Zinc Trading Constructional Material & Decoration Transportation Real Estate High-tech. Products % of total gross margin Lead & Zinc Trading Constructional Material & Decoration Transportation Real Estate High-tech. Products Total 21.4% 7.7% 20.3% 64.3% 53.6% –
2000 24.0% 6.8% 17.1% 63.7% 28.8% –
2001 19.9% 3.8% 17.7% 66.3% 10.5% 14.3%
2002 17.7% 5.6% 15.2% 69.2% -25.6% 28.5%
2003 16.2% -1.1% 13.0% 58.6% 15.4% 20.7%
2004 28.5% 3.8% 10.5% 55.8% 6.0% 14.0%
2005 28.9% 1.2% 12.5% 50.4% 78.2% 13.5%
2006 37.3% 7.0% 12.3% 38.3% 20.8% 11.5%
79% 12% 7% 2% 0% 0% 100%
80% 10% 6% 2% 3% 0% 100%
77% 12% 7% 2% 1% 0% 100%
83% 14% 1% 3% -2% 2% 100%
79% 10% 0% 2% 6% 3% 100%
88% 7% 0% 1% 1% 2% 100%
90% 6% 0% 1% 0% 2% 100%
95% 3% 0% 0% 0% 1% 100%
Note: Totals do not add to 100% due to rounding. Source: Compiled by authors with information from annual reports of SZLN.
Exhibit 4 SZLN CONSOLIDATED BALANCE SHEETS, 2004–2008 (IN MILLIONS OF RMB)
Year Cash Accounts receivable Other receivables Inventory Other current assets Current Assets Long-term investments PP&E Intangibles Other long-term assets Total Assets Short-term debt Accounts payable Advances Salary payable Tax payable Other current liabilities Current Liabilities Long-term debt Other long-term liabilities Total Liabilities Common Stock Retained earnings
Minority interest Total Equity Total Liabilities & Equity Note: PP&E = property, plant, and equipment
2004 599 297 77 1,204 103 2,280 388 2,169 108 2 4,947 2,404 277 177 19 61 142 3,079 412 132 3,623 916 298 110 1,324 4,947
2005 532 267 33 1,267 88 2,186 371 2,093 98 4 4,753 2,164 260 109 35 23 156 2,748 460 14 3,222 918 521 92 1,531 4,753
2006 1,418 334 50 2,476 204 4,482 384 2,245 87 1 7,198 1,951 267 94 61 171 127 2,671 1,180 22 3,873 1,705 1,525 95 3,325 7,198
2007 1,326 327 145 2,467 206 4,470 574 2,516 127 247 7,934 2,091 259 152 151 300 349 3,302 180 689 4,171 2,025 1,557 182 3,763 7,934
2008 859 240 74 1,915 452 3,539 276 3,217 721 166 7,920 990 278 131 149 (12) 731 2,267 1,000 677 3,944 2,085 1,483 407 3,976 7,920
Source: Compiled by authors with information from annual reports of SZLN.
Exhibit 5 SZLN CONSOLIDATED INCOME STATEMENTS AND KEY FINANCIAL INDICATORS, 2004–2008 (IN MILLIONS OF RMB)
Year Revenue COGS Sales Tax and Others Gross Profit Selling Expenses G&A Expenses Other Operating Income Financial Expenses Investment Income Inventory Write-Offs Others Pretax Income Tax Minority Interest Net Income EPS (in RMB) OCF per Share (in RMB) Total Liab./Total Assets ROE
2004 3,548 (2,664) (33) 852 (60) (442) 9 (129) (28) (0) (3) 199 (57) (6) 137 0.32 1.05 73.2% 11.7%
2005 4,237 (3,105) (32) 1,100 (60) (524) 11 (125) (37) (0) (34) 331 (47) (6) 277 0.64 1.07 67.8% 21.0%
2006 6,240 (4,058) (41) 2,141 (56) (548) 16 (144) 41 (0) (81) 1,370 (232) (4) 1,135 1.71 0.16 53.8% 55.6%
2007 8,257 (5,893) (75) 2,289 (84) (525) 1 (118) 126 (249) (24) 1,416 (202) (10) 1,205 1.65 1.49 52.6% 41.3%
2008 7,442 (5,844) (90) 1,508 (96) (531) 14 (257) 103 (220) (2) 518 (113) (5) 400 0.39 1.58 49.8% 10.5%
Note: COGS = Cost of Goods Sold; G&A = General and Administrative; EPS = Earnings per Share; OCF = Operating Cash Flow; ROE = Return on Equity Source: Compile by authors with information from annual reports of SZLN.
Exhibit 6 PEM CONSOLIDATED BALANCE SHEETS, 2004–2008 (IN MILLIONS OF AU$)
Note Cash & Short-Term Investment Accounts Receivable Inventory Other Current Assets Current Assets Fixed Assets Other Long-Term Assets Total Assets Short-Term Debt Accounts Payable Tax Payable Other Current Liabilities Current Liabilities Long-Term Debt Other Long-Term Liabilities Total Liabilities Stock & Capital Surplus Retained Earnings Shareholders’ Equity Total Liabilities & Equity
2004 33 8 11 6 58 118 17 193 26 20 0 12 58 9 28 95 78 21 99 193
2005 21 9 13 2 45 132 11 188 5 25 0 13 43 8 21 72 99 16 115 188
2006 130 22 22 6 180 125 37 342 4 34 28 59 125 3 83 211 64 68 131 342
2007 152 30 15 24 221 168 60 449 10 46 27 112 195 5 99 300 26 123 149 449
2008 67 2 31 142 242 46 19 308 20 21 0 86 127 6 27 160 169 21 148 308
Note: 1. Other current assets mainly include derivative financial instruments, such as metal futures, metal options and currency options. 2. Fixed assets include exploration, development and evaluation expenditure, mine properties in use, PP&E. Because of the resizing in 2008, fixed assets balance decreased after the AUD 173 million write-off. 3. Other current liabilities mainly include derivative financial instruments, other payables and deferred option premiums. Comparing to the end of FY2007, the balance of derivatives at the end of 2008 decreased by AUD 91m, other payables increased by AUD31m, and deferred option premiums increased by AUD30m. 4. Other long-term liabilities include derivative financial instruments, provisions, and prepaid income. “On the back of the resizing of the Broken Hill Operation, the company reviewed the balance of the deferred silver revenue relating to the up-front proceeds received from Coeur d’Alene Mines Co. in October 2005. Under the agreement with Coeur D’Alene, there were approximately a further 12.5 million ounces of silver outstanding at 30 June 2008. Accordingly, the company has booked a pre-tax credit of $36.034 million resulting from the re-estimate of silver production under the current resized operating plan. In the event that the company re-establishes increased production beyond its current operating plan, it will continue to deliver silver to Coeur d’Alene in accordance with its obligations.” Note: PP&E = property, plant, and equipment; FY = fiscal year. Source: Compiled by authors with information from annual reports of PEM.
Exhibit 7 PEM CONSOLIDATED INCOME STATEMENTS AND OPERATING STATISTICS, 2004–2008 (IN MILLIONS OF AU$)
Note Revenue Raw materials, power and consumables used Employee benefits expense Depreciation & Amortization External services and consultants Freight and Handling Impairment Losses Finance Costs Other expenses (Loss)Profit b/f income tax Income tax and other Net Profit/(Loss) EPS (in AUD) Net Operating Cash Flow Net Investing Cash Flow including: CapEx Net Financing Cash Flow Production of Zinc (tonnes) Production of Lead (tonnes) 1
2004 158 (51) (37) (18) (27) (20) (9) (1) 24 18 5 13 0.08 9 (4) (30) 0 140,400 54,500
2005 191 (50) (45) (20) (28) (22) (1) (4) (27) (7) (2) (5) (0.03) 30 (48) (42) (1) 132,000 61,100
2006 345 (55) (51) (36) (37) (26) (20) (3) (19) 98 31 67 0.35 166 (47) (47) (6) 144,100 74,800
2007 387 (71) (70) (36) (43) (21) (6) (8) (18) 115 33 82 0.42 132 (78) (77) (32) 92,100 60,500
2008 273 (31) (81) (48) (50) (31) (188) (13) 1 (168) (28) (140) (0.72) (10) (60) (100) (11) 91,300 52,400
Note: 1. “Raw materials, power and consumables used” includes the “changes in inventories of finished goods and work in progress.” 2. “Others” refers to “Profit/(loss) from discontinued operations.” 3. “Capex” includes payments for mine properties; payments for property, plant, and equipment; and
payments for exploration and evaluation. Note: EPS = earnings per share; CapEx = capital expenditures; PP&E = property, plant, and equipment. Source: Compiled by authors with information from annual reports of PEM.
Exhibit 8 TOP 10 SHAREHOLDERS OF PEM
2007-6-30 Shareholder Name HSBC Custody Nominees (Australia) Limited Citicorp Nominees Pty Limited ANZ Nominees Limited J P Morgan Nominees Australia Limited National Nominees Limited CS Fourth Nominees Pty Ltd HSBC Custody Nominees (Australia) Limited A/C 2 Cogent Nominees Pty Limited HSBC Custody Nominees (Australia) Limited GSI ECSA CPU Share Plans Pty Limited Source: PEM 2007 and 2008 annual reports.
% 18.54 10.35 9.13 9.07 8.18 4.58 2.28 2.17 1.41 1.24 66.95
2008-6-30 Shareholder Name ANZ Nominees Limited (Cash Income A/C) HSBC Custody Nominees (Australia) Limited Citicorp Nominees Pty Limited JP Morgan Nominees Australia Limited National Nominees Limited CPU Share Plans Pty Limited (Perilya Employee Share Acquisition Plan) Argo investments Limited HSBC Custody Nominees (Australia) Limited Mr Andrew Tsang Neweconomy com au Nominees Pty Ltd
% 19.09 9.91 7.59 6.43 3.38 2.77 1.03 0.88 0.87 0.82 52.77
Exhibit 9 CBH RESOURCES LIMITED CONSOLIDATED BALANCE SHEET, SIMPLIFIED, 2006–2008 (IN MILLIONS OF AU$) 2006 Cash & short-term investment Accounts receivable Inventory Other current assets Current Assets Fixed assets Other long-term assets Total Assets Short-term debt Accounts payable Other current liabilities Current Liabilities Long-term debt Other long-term liabilities Total Liabilities Stock & capital surplus Retained earnings Shareholders’ Equity Total Liabilities & Equity 18 11 6 36 66 30 131 3 16 6 25 23 29 78 73 19 54 131 2007 238 27 9 0 275 170 56 501 2 31 10 44 215 56 315 167 20 186
501 2008 125 8 14 9 156 283 67 507 3 45 7 54 201 95 350 165 9 156 507
Source: Compiled by authors with information from annual reports of CBH.
Exhibit 10 CBH RESOURCES LIMITED SELECTED DATA FROM CONSOLIDATED INCOME STATEMENTS AND CASH FLOW STATEMENTS, 2006–2008 (IN MILLIONS OF AU$) 2006 Revenue Profit/(Loss) b/f tax Net Profit/(loss) EPS (in AUD) Net Operating Cash Flow Net Investing Cash Flow including: CapEx Net Financing Cash Flow 85 (22) (15) (0.02) (14) (25) (24) 24 2007 260 56 39 0.05 61 (67) (62) 226 2008 159 (41) (29) (0.03) 11 (153) (154) 29
Note: b/f = before; EPS = Earnings per share; CapEx = Capital expenditures Source: Compiled by authors with information from annual reports of CBH.
Exhibit 11 BROKEN HILL’S LEASE BOUNDARIES FOR CBH RESOURCES LIMITED AND PERILYA LIMITED
Source: Merger of Perilya and CBH Investor presentation, announced by PEM on March 26, 2008 at the Australian Securities Exchange.
Exhibit 12 TIMETABLE OF SIGNIFICANT RELATED EVENTS IN 2008
Date 2008-1-30 2008-2-5 2008-3-7 2008-3-26 2008-3-31 2008-6-2 2008-6-14 2008-6-17 2008-6-24 2008-7-16 2008-8-21 2008-10-1 2008-10-2 2008-10-10 2008-10-24 2008-11-12 2008-11-13 2008-11-25
Event SZLN announced cash tender offer for Herald PEM announced commencing review of strategy, Patrick appointed executive chairman SZLN submitted official tender offer to Herald through Tango PEM announced merger plan with CBH CEO of PEM resigned Tango increased bidding price for Herald SZLN successfully acquired Panlong Mine Tango increased bidding price for Herald again CBH announced new merger proposal, PEM rejected SZLN retreated from acquiring Herald, accepted competitor’s tender offer PEM announced operational resizing plan PEM issued annual report for FY2008 CBH announced the tender offer, PEM advised shareholders to take no action PEM’s board advised shareholders take no action on CBH’s tender offer PEM announced the cancellation of Mt. Oxide sale, appointed Paul executive director CBH released official bidder’s statement China Mining 2008 Convention held in Beijing on Nov 11~13, PEM’s board rejected CBH’s offer One director (appointed in Sep. 2007) and corporate secretary of PEM resigned
Source: Compiled by authors based on announcements and annual reports of PEM and SZLN.
Exhibit 13 CASH FLOW FORECASTS OF PEM, 2009 TO 2011
Note Production Forecasted Zinc Spot Price (USD/tonne) Forecasted Zinc Spot Price (USD/pound) Operating cash costs (USD/pound Zinc) Net Operating CF (million USD) CapEx (million USD) Dept Repayment (million USD) Finance Cost (million USD) Net Cash Flow Exchange rate
1 2 3 4 5
2009 55,000 1,250 0.57 0.65 (10.06) (4.45) (5.88) (1.07) (21.46) 1.5249
2010 55,000 1,650 0.75 0.65 11.94 (3.11) (2.12) (0.76) 5.94 1.5249
2011 55,000 2,200 1.00 0.65 42.19 (5.90) 0.00 (0.68) 35.61 1.5249
Note: 1. Operating cash costs are net of taxes. Lead revenues are netted off in calculating zinc production cost. 2. CapEx includes payments for mine properties and payments for PP&E, but excludes payments for exploration and evaluation. The company must ensure about 15 million AUD additional cash next year for the exploration expenditure. Capex forecasts in million AUD for year 2009, 2010 and 2011 are 6.78, 4.74 and 8.99 respectively. 3. Debt repayment forecasts in million AUD for year 2009 and 2010 are 8.96 and 3.24 respectively. 4. Interest payment forecasts in million AUD for year 2009, 2010 and 2011 are 1.63, 1.16 and 1.04 respectively. 5. Assume the current assets equal to the current liabilities (excluding short-term debt) in the long run, thus there is no change of working capital, and “Net cash flow” equals Equity free cash flow. Note: CF = cash flow; CapEx = capital expenditures; PP&E = property, plant, and equipment. Source: Based on interviews with SZLN management and the authors’ own estimates.
Exhibit 14 CLOSING PRICES OF SELECTED STOCKS AND FOREIGN EXCHANGE RATES, 2006 TO 2008 CBH PEM (note 1 & (note 1) 4) (AUD) (AUD) 0.14 0.04 0.23 0.05 0.30 0.07 0.53 0.10 0.54 0.14 0.74 0.19 0.79 0.29 1.07 0.36 1.05 0.36 1.65 0.40 0.41 1.64 2.64 0.55 2.96 0.60 3.89 0.56 3.99 0.53 3.85 0.54 4.76 0.62 4.37 0.54 4.18 0.56 4.21 0.59 3.62 0.50 4.42 0.60 5.19 0.61 5.48 0.74 4.69 0.78 4.35 0.71 2.87 0.46 3.08 0.45 2.65 0.35 2.39 0.34 2.87 0.45 2.82 0.44 2.46 0.40 1.88 0.28 2.03 0.28 SZLN (note 1) (RMB) 7.40 6.46 10.43 10.57 13.93 14.02 27.43 29.58 30.86 39.94 35.08 44.44 37.24 60.00 64.00 48.60 40.90 29.30 31.35 30.89 26.65 24.79 21.16 16.99 17.70 13.97 11.67 12.38 11.94 13.07 14.17 13.24 10.95 8.70 8.85 AUD USD Shenzhen ASX200 (note 2) (note 1 & Composite Index (note 2) (note 1) 3) (AUD) (RMB) (RMB/AUD) (RMB/USD) 3,743 6,659 4.4821 6.8349 4,018 5,839 4.5525 6.8258 4,601 7,559 5.4519 6.8183 5,136 8,004 5.9074 6.8345 4,977 9,470 6.4551 6.8388 5,215 9,371 6.5964
6.8591 5,655 12,048 6.6217 6.9472 5,595 13,505 6.5256 7.0002 5,356 13,302 6.4131 7.0190 5,572 15,824 6.7232 7.1058 5,650 15,858 6.3954 7.1853 6,340 17,701 6.4036 7.3046 6,533 15,638 6,754 19,531 6,568 18,865 6,247 17,872 6,144 15,200 6,275 12,546 6.4607 7.6155 6,314 12,944 6,166 10,866 5,995 8,549 5,833 8,040 5,773 7,633 5,670 6,647 6.1599 7.8087 5,482 5,667 5,384 4,622 5,154 4,327 5,115 4,179 4,986 3,947 5,074 4,302 5.9196 7.9956 5,002 4,292 5,259 3,848 5,130 3,516 4,921 3,352 4,930 3,242
Nov-08 Oct-08 Sep-08 Aug-08 Jul-08 Jun-08 May-08 Apr-08 Mar-08 Feb-08 Jan-08 Dec-07 Nov-07 Oct-07 Sep-07 Aug-07 Jul-07 Jun-07 May-07 Apr-07 Mar-07 Feb-07 Jan-07 Dec-06 Nov-06 Oct-06 Sep-06 Aug-06 Jul-06 Jun-06 May-06 Apr-06 Mar-06 Feb-06 Jan-06
Note: 1. Prices of stock index are the closing prices of the last trading date of the month, adjusted for stock splits and dividends. Source: Yahoo! Finance. 2. Exchange Rates are the month-end official exchange rate of Bank of China. Source: Bank of China website. 3. ASX200 is the Standard and Poor’s Australian Securities Exchange 200 Index, which covers approximately 75 per cent of Australian equity market capitalization. Source: S&P website. 4. At the end of November 2008, PEM’s beta was estimated to be 2.17 (with ASX200 as market portfolio and 5-year weekly data).
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