Check the details before boarding this bandwagon Resourcehouse hopes to cash in on rising coal prices, but small shareholders take all the risks
MONEY MATTERS Shirley Yam May 21, 2011
You have heard about the rising price of coal and China's ever-growing hunger for the fuel. Now comes Australia's billionaire businessman Clive Palmer, with his Resourcehouse initial public offering.
Tempted to jump on the bandwagon? Think twice.
Beneath the glossy wrapping around Resourcehouse lie some plain facts: Those behind the deal aren't taking much risk here: not Palmer, its founder, not its Chinese suppliers; not the mainland buyer; and not the bankers. Only the minority shareholders.
Yes, investment is about taking risk. But you may be taking a risk for nothing because one of the company's core assets - a coal mine in Queensland - is designed more like a production centre for China rather than a profit centre for shareholders.
Some basics first. Strictly speaking, Resourcehouse has no business yet. The only thing it has is the contractual rights to a coal mine in Queensland and an iron ore mine in West Australia granted by Palmer.
According to the Resourcehouse draft prospectus, posted on the Hong Kong Exchange website, the coal mine will not start any commercial production until December 2014.
Resourcehouse is looking to raise US$3.4 billion to help fund the US$8.01 billion development of the coal mine.
The draft prospectus describes Palmer as a top-notch negotiator and an old China hand.
In 2006, Palmer made headlines by selling the right to mine six billion tonnes of magnetite at Pilbara in Western Australia to the mainland-backed Citic Pacific (SEHK: 0267). But the project ran into all kinds of problems - labour disputes, 70 per cent cost overruns, extensive delays and significant foreign exchange losses.
In 2007, Chinese steel giant the Shouguan Group agreed to provide full financing for and guarantee purchasing from his US$2.1 billion Pilbara iron ore project. Shouguan pulled out two years later.
Meanwhile, Palmer's listed arm, Australasian Resources, has not really been able to come up with any real mining business a decade after its listing. The stock has lost 77.32 per cent while the country's metal and mining index has gained 47.59 per cent during the commodity boom in the past five years.
The fact that Resourcehouse has burned through three different executive directors in the past 24 months - each staying less than six months - offers little comfort.
Metallurgical Corporation of China (MCC) and China Railway Group (SEHK: 0390) have each agreed to buy US$200 million worth of Resourcehouse shares as cornerstone investors.
That would be some comfort if their commitment was not limited to a lock-up period of between six and 12 months; and if they were not contractors in the coal project.
MCC is its engineering, procurement and construction manager, while China Railway will build a rail line that links the mine to the port.
MCC gets US$700 million if production commences on time. That includes an upfront payment of US$150 million once the project kicks off, as revealed by the draft prospectus. That payment equals 75 per cent of MCC's investment in Resourcehouse.
By the way, MCC is also the project manager for Citic Pacific's iron ore mining in Pilbara. Last year, MCC asked for a US$835 million top- up, claiming a rise in labour and equipment costs.
That is 74 per cent above the original contract cost. The start of production is more than a year behind schedule.
Resourcehouse says it has a purchase agreement signed with China's major power supplier, China Power International (SEHK: 2380) Holding. This is interesting, but in two negative ways.
First, the credibility of management. The deal, which Resourcehouse claimed included a US$3 billion sales agreement, was first announced by Resourcehouse in a high-profile press event in February 2010 when it was about to make its first attempt at an initial public offering. China Power immediately denied the US$3 billion figure. The accord was not signed until November and the committed quantity of the coal purchase was only two-thirds of what Resourcehouse originally claimed.
Second, doubts about profitability. China Power has committed to buy 50 per cent of the project's coal production for 20 years, but the price will be at a 7 per cent discount to a complex cost-adjusted market price.
The draft prospectus notes there is 15-year financing provided by the China Eximbank. The state-owned bank is to lend 70 per cent of the total project investment, or US$5.66 billion.
According to the loan agreement contained in the draft prospectus, the loan will be provided only if the three contractor agreements and the purchase agreement mentioned above are signed and in full effect. At the same time, China Power will honour the purchase agreement only if the three mainland contractors are hired.
Translation: the loan is there to ensure the mine and its supporting infrastructure is designed and built by mainland companies and the coal is used by the mainland at a discounted price.
Under this framework, everybody is happy. Mainland contractors get the work; China Power gets the coal and China Eximbank gets a steady cash flow to pay off the debt and any interest. The profitability of the project, or Resourcehouse for that matter, is not their concern.
But what about Palmer? Won't he, as a majority shareholder, care about profit? It would be good if the project made some profit, but he will be enjoying the royalties anyway. He gets paid 30 Australian cents, plus any inflation adjustment, for every tonne of coal produced. That is estimated to be A$25 million for the first three years of production, according to the draft.
As for the minority shareholders, may God be with them.
ARH Price at posting:
33.0¢ Sentiment: LT Sell Disclosure: Not Held
