Mongolia: the new China play

Chinese private equity firm Hopu Investment Management may have raised eyebrows when it made its maiden investment in May 2008. The firm backed the Hong Kong-based owner/operator of a Mongolian iron ore mine, Hong Kong Lung Ming Investment Holdings (now called Iron Mining International).

However, by the time it made its second Mongolia-themed investment in April this year, this time into Chinese coal processor and transporter Winsway Coking Coal, which focuses on bringing coal from Mongolia, it is doubtful there would have been any surprise registered at all.

In the two years between Hopu’s investments, Mongolia has gone from being a bit of a puzzle (is it part of Central Asia? Does it fit within a “Russia and beyond” remit, or is it best looked at from Asia?) to a compelling investment case in its own right. But although interest in Mongolia, which is rich in largely untapped resources including coal, gold, copper and iron ore, is coming from investors and mining companies around the world, the success of their investments there may depend to a large extent on the appetite of one Asian country: its resource-hungry neighbour China.

With a population of just over three million, the consumer-related plays seen in the rest of Asia as the region develops are not going to become significant in Mongolia.

Jenny Blinch

Since the two countries signed a “Treaty on Friendship and Cooperation” in 1994, China has become Mongolia’s largest trading partner and biggest importer of natural resources. China is, of course, a significant trading partner to other natural resource-rich regions and countries, such as Australia, Brazil and South Africa. However, the advantage Mongolia has lies in sharing a land border with China.

“It is comparatively cheap to truck or to rail across the border as compared to shipping from Brazil, South Africa or Australia,” commented Chris Rynning, CEO of China-focused Origo Partners, in a recent interview with sister magazine PEI Asia. He 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 with China’s seemingly bottomless appetite for coal, amongst other resources, it is clear this is a business relationship that works for both sides and will do for some time.

But while China and Mongolia are convenient trading partners, the Mongolian government seems wary – given the countries’ shared history of invasions and counter-invasions – of letting its relationship with China, or northern neighbour Russia for that matter, become too dependent. And therein lies the potential opportunity for foreign private investors, especially private equity investors, says Rynning.

“Mongolia needs capital. It prefers not to get it from Russia or China or from a strategic investor – it prefers it from a neutral party with a long time horizon and the only investor I know like that is private equity,” he stated.

For private equity firms themselves, the opportunities are of course – though attractive – restricted. With a population of just over three million, the consumer-related plays seen in the rest of Asia as the region develops are not going to become significant in Mongolia.

Likewise, 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.

However, the China angle alone makes a compelling enough investment thesis for Mongolia. The opportunity to develop high quality, low cost access to Mongolian resources for Chinese consumption, is in fact another way to play on the China story – something that Hopu is only too aware of.

And although Mongolia, which fits firmly into frontier market territory, has yet to receive attention from Asia’s private equity mainstream, investments from the likes of Singaporean and Chinese sovereign wealth funds Temasek and China Investment Corporation are paving the way and onlookers expect more private equity activity to follow. It seems this land-locked country is set to become an increasingly prominent feature on Asia’s investment map.