All-natural assets

When China’s Hopu Investment Management, together with Singaporean sovereign wealth fund Temasek, pumped $300 million into Hong Kong Lung Ming Investment Holdings (now called Iron Mining International) in May 2008, the private equity world sat up and took notice.

Though headquartered in Hong Kong, the company’s principal asset is the iron ore mine it owns in Mongolia; home to some of the world’s largest untapped reserves of natural resources and neighbour to China, the world’s most natural resource-hungry nation. 

Underlining its conviction in the Mongolian natural resources story, Hopu, alongside Hong Kong-listed industrial investment company Silver Grant International Limited, and Chinese state-owned metals trading company China Minmetals Corporation, recently put $110 million into Chinese company Winsway Coking Coal Holdings Limited. The investment, in April this year, bought the three investors a 20 percent stake in the coal processer and transporter, which focuses on the transportation of natural resources from Mongolia to China.

Though Hopu stands out as an early mover in Mongolia, it is far from being the only private equity firm eyeing potential investments in the land-locked Central Asian country. With a wealth of natural resources including iron ore, coal, copper and gold, and a ready market right next door, the investment thesis is pretty clear.

“There are strong parallels between Mongolia and Western Australia,” says Alisher Djumanov, CEO of Eurasia Capital Group, a Singapore-headquartered investment group focused on Russia, China, Central Asia and Mongolia. “The territory is similar, the population is almost the same and so on – but Mongolia is 30 to 35 years behind Western Australia.”

If mining has transformed the fortunes of Western Australia, then investors say it will do the same for Mongolia – especially as the gates to foreign investment are opening at a time when natural resource prices are already very high. In fact, Mongolia’s development may be to the detriment of Australia, which must export its natural resources by sea to its largest trading partner, China. Mongolia on the other hand, can simply truck or rail freight its exports over land.

“It is comparatively cheap to truck or to rail across the border as compared to shipping from Brazil, South Africa or Australia,” says Chris Rynning, CEO of Origo Partners, a China-focused private equity firm which made its first investment in a Mongolian coal company in November 2009.
Rynning called trade between Mongolia and China a “cost saving exercise for China”, with Mongolia able to offer high quality products at a far more competitive price than those shipped from other continents. And for Mongolia, China represents the end market for the largest share of its exports.

With such a compelling investment story, it might seem strange that Mongolia has been left untouched by the investment community for so long. Even strategic investors like Canadian Ivanhoe Mines and British Rio Tinto, which in March finalised an agreement with the Mongolian government to invest in and develop the Oyu Tolgoi gold and copper mines, have not long been on the scene.

One key catalyst for investment has been the arrival of Sükhbaataryn Batbold as Prime Minister last year. Before then, political unrest was a marked feature of the country, whose 2008 election results met with allegations of fraud, leading to violence and a state of emergency being declared.

Batbold has wasted no time in starting Mongolia on a forward trajectory and the government has already acted to usher in investor-friendly changes to the country’s mining laws and remove some of the tax uncertainties around investment.

There is still a long way to go though, and the regulatory environment and the country’s poor infrastructure remain key stumbling blocks for would-be investors. Roadways are basic and rail networks are under-developed, making exporting Mongolia’s riches that much harder and less cost-effective than they could be. On the business infrastructure side, many firms have found it necessary to outsource their legal and accounting departments to countries like Hong Kong.

Lack of corporate governance and an arbitrary regulatory regime are also highlighted by investors as major hurdles. Uncertainty is part and parcel of dealing with both private individuals and entrepreneurs, but also in dealing with the government – which has made a difficult and demanding negotiating partner when it comes to the signing over the rights to exploit the country’s natural resources.
“What investors want is predictability,” points out Rynning, and there are many who feel that Mongolia is a long way from being predictable enough.

Still, this means that for those prepared to accept the risks inherent in the market, the path is pretty much clear. Eurasia Capital, which has a base in Ulaanbaatar, is one such firm. The firm first planned a listed Mongolia investment vehicle in 2008, but shelved it due to the economic downturn. Now it intends to list a Mongolia-focused vehicle on the London Stock Exchange later this year to target private equity, pre-IPO and listed opportunities, in a style of hybrid private equity investing. Djumanov anticipates strong interest from emerging market and frontier funds and investors for this product.

Origo, on the other hand, is still mulling its options. The China-focused firm opened an office in Ulaanbaatar less than six months ago and has three or four on-the-ground objectives, including further investments in natural resource companies. The firm is also, says Rynning, considering launching a dedicated Mongolian natural resource fund at some point. “It’s early stages,” he says, “but the opportunity is there.”

Rynning is strongly convinced that Mongolia’s government – which desperately needs private capital to back up its development plans – will welcome private equity investment going forward. On the one hand, he says, the long-term outlook of the asset class suits the government’s own plans for development, and on the other hand, the geopolitical neutrality of foreign PE firms fits with a country that is “not ready to be run by foreign wealth funds”.

“Mongolia needs capital. It doesn’t want it from Russia or China or from a strategic investor – it wants it from a neutral party with a long time horizon and the only investor I know like that is private equity. International investors can play a neutral geopolitical role yet develop high quality, low cost access [to Mongolian resources] for Chinese consumption,” he states.

For private equity firms themselves, the opportunities are of course – though attractive – restricted to the mining and mining infrastructure sectors. With a population of just over 3 million, the consumer-related plays seen in the rest of Asia are not going to take off in Mongolia.

However, it seems inevitable that where Hopu has led, other private equity investors will follow. Those already doing so describe Mongolia as being at an “inflection point” – the next couple of years will doubtless see this once overlooked country become a key feature on Asia’s investment map.

Case study: Iron Mining International

Investment into Iron Mining International can be seen as typical of the way investment in Mongolia as a whole is unfolding, says Alisher Djumanov, CEO of Eurasia Capital Management.

The Hong Kong-based company, owner of one of Mongolia’s largest iron ore mines, first came onto the private equity radar when it received $300 million in a joint investment in three-year convertible bonds from Chinese private equity firm Hopu Investment Management and Singapore’s Temasek.

Also joining Hopu and Temasek in the round were Swiss bank Credit Suisse and Los Angeles-based private equity and venture capital investor Clarity Partners. Both had reportedly also invested in the company the year before: Clarity with a $20 million injection in June 2007 and Credit Suisse as part of an investor group which bought convertible bonds in October 2007.

Following the Hopu deal, China Investment Corporation, the $300 billion strong Chinese sovereign wealth fund, put a further $700 million into Iron Mining.

“Investment in Mongolia will be from multiple sources – funds that are not private equity per se, but listed equities funds, special situation funds, hedge funds,” Djumanov emphasised. Amongst these multiple sources, there is an established pattern: first come the hedge funds and the prop desks; then come the strategics and the sovereign wealth funds. Last into the game is private equity, which has been somewhat of a laggard in Mongolia. Nonetheless, there are signs the asset class is catching up.

“Sovereign wealth funds and strategics have already started to move, which is a good sign,” says Chris Rynning, CEO of Origo Partners. “Private equity will follow.”