SouthGobi starts pre-marketing for $400 million HK IPO

Last November the Canadian-listed coal company with mines in Mongolia attracted CIC as an investor, now Hong Kong investors will get their chance to buy a share.

Bankers and market watchers are predicting that natural resources and commodities will be busy sectors in 2010 in terms of new listings and, deeming from the activity on the first trading day of the year, these predictions seem to bear out. Alongside Russian aluminium giant United Company Rusal, yesterday also saw the start of investor education for the Hong Kong listing of SouthGobi Energy Resources, which may raise about $400 million, according to sources.

Technically SouthGobi isn’t an initial public offering since the company is already listed in Toronto, but it is the first time the stock will be offered to Hong Kong retail investors and many institutional investors in this region are also unlikely to have it in their portfolios. That doesn’t mean that SouthGobi — a Canadian coal producer with all its operations in Mongolia — is an unknown company, however. In fact, it got quite a lot of press in November when China Investment Corp (CIC) invested $500 million into the company in the form of 30-year convertible debentures. That nod of approval is expected to help attract other investors to the stock during the upcoming offering.

Indeed, people close to the deal say the company and the two bookrunners are in talks with at least a few investors who are interested in supporting the deal as cornerstones. These discussions are expected to be firmed up this week ahead of the launch of the formal roadshow and bookbuilding next Monday.

One of the things that attracts investors to the company is the fact that its flagship project, the Ovoot Tolgoi mine, is located only 40 kilometres from the Chinese border. This is important since one of the key issues with mining in Mongolia is transportation, both within and out of the country. In fact, industry insiders have turned away from seemingly lucrative opportunities in this resource-rich country because of the lack of a functioning transportation infrastructure.

SouthGobi is currently transporting its coal to China by truck, but part of the proceeds of the share offering will go towards the construction of a railway line to the border, which should improve the efficiency and lower the costs further.

Other positives, according to sources, include the company’s lower costs compared with its competitors in China and the high quality of its coal.

According to a preliminary listing document posted on the Hong Kong stock exchange website, SouthGobi produces both thermal coal, which is used primarily in power plants, and coking coal, which is often used as fuel when smelting iron ore in blast furnaces. Aside from the Ovoot Tolgoi mine, it has two other development projects — the Soumber deposit and the Ovoot Tolgoi underground deposit. The company also holds 18 mineral exploration licences in Mongolia.

The company started mining at the Ovoot Tolgoi mine in April 2008 and began selling coal in September the same year. All the coal it produces is sold to customers in China. So far, the company has sold about 1.1 million tonnes of coal from this mine, but according the listing document, independent technical expert Norwest believes it is possible for its production from this one mine to increase to about 8 million tonnes per year from 2012 onwards.

SouthGobi says an expansion of this mine is one of its priorities and estimates that the capital expenditure related to such a ramp-up will be about $140 million until the end of 2012.

However, the offering isn’t without risk. For one, the company has a limited track record, it hasn’t generated any profits and so far, cash flows are still negative. In 2008 it posted a net loss of $69.6 million and in the first nine months of 2009, the loss was $41.7 million. For the full year 2009, the company is expecting a loss from continuing operations of no more than $53 million and a net loss of $135.8 million. The latter includes a non-cash financing cost of up to $71.4 million caused by the change in fair value of embedded derivatives on the convertible debentures bought by CIC.

While these losses should eventually turn into profits, they make it more difficult for potential buyers to judge the business and the growth. On the positive side, investors will get a low-cost company with a strong growth potential and a much more transparent management than they would buying into a pure Mongolian miner — should that even be possible. The listing candidate is currently 78.7% owned by Ivanhoe Mines, a Candian company that has been publically listed since 1996 and currently trades in Toronto as well as on the New York Stock Exchange and Nasdaq. Ivanhoe too has a mining project in Mongolia, in partnership with Rio Tinto, although this mine produces gold and copper. It also has mining operations in China, Australia and Kazakhstan

SouthGobi is seeking to sell 16.8% of its enlarged share capital as part of the Hong Kong listing. As usual, 10% of the deal will be earmarked for Hong Kong retail investors, but on top of that, there will also be a 15% Canadian tranche for investors who would rather have their shares listed in Toronto. All the shares will be new.

The fact that the company is already listed means investors already have a live price to guide them in terms of valuation. However, SouthGobi isn’t a particularly liquid stock and also it is not that well covered by the analyst community. Consequently, investors are likely to look to the Chinese coal companies that are listed in Hong Kong for a benchmark — companies like Shenhua Coal, China Coal Energy and Yangzhou Coal.

The Hong Kong public offering will run from January 15 to 20 and the final pricing is expected to be determined on January 22 — the same day as Rusal will set its price. The trading debut is scheduled for January 29.

Citi and Macquarie are acting as joint global coordinators and bookrunners.


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