Mongolia: Inexplicable Politics And 3 Investable Companies
Against this backdrop, there has been uncertainty in global markets and buzz about China's economy slowing.
The newly elected government is now settling in and appointments to cabinet-level ministries have been made. In an earlier draft of this article, I noted that this was bringing stability to the political environment vis-a-vis its relation to the investment climate. Unfortunately, this is not true, again.
By my count, for the fifth time in about the last 15 months, members of the government have actively been lobbying to renegotiate the Oyu Tolgoi agreement (formerly with Ivanhoe Mines; now renamed Turquoise Hill Resources (TRQ)). When Oyu Tolgoi's copper-gold mine ramps up to full production in about 2020, it will add 50% to current GDP levels of Mongolia. The government's stake in the mine is 34%; those who would renegotiate want to raise the government stake to 50%.
Once again, Rio Tinto (RIO), majority owner of Turquoise Hill Resources, refuses to renegotiate. However, both in private e-mails from friends in Mongolia and in comments from people participating on my blog about Mongolia, those who live in Mongolia indicate they have become exasperated by the constant repetition of this story by a minority of government officials. Some examples of their frustration:
"Mongolians are so far under the mistaken impression that the Mongolian economy is a resource economy and that they have something extremely attractive to barter with. This may be true in the future, but the fact of the matter is that Mongolia currently has an FDI economy. The country has a gigantic trade deficit, has relatively little coal and iron exports, and most major projects are being built with foreign financing and foreign expertise. Most economic growth up to this point has been financed by foreign FDI. The country produces almost nothing but unrefined raw resources with no value added. The Mongolian growth story is the story of foreigners investing here in anticipation of great things to come. If the government would pull their heads out of the sand they would realize that they are in a position to completely derail everything. Where would the Mongolian economy go if OT were stopped? It would fall backwards 20% in a year. These gains will not be cemented until the mines are built and producing and the Mongolians don't need foreigners to run them anymore. Then they can think about renegotiation." (Reader comment on blog; works in Mongolia's capital markets)
"I think there is little risk of OT being stopped; the government certainly can't be that stupid, but these news of renegotiation attempts will cost Mongolia a lot in future FDI. Rio Tinto has all the leverage and this is terrible timing for Mongolia to demand renegotiation. Halting operations would be disastrous for the Mongolian economy. I expect the government to continue to demand renegotiation, Rio Tinto to continue refusing to engage, and OT to continue to operate despite the disagreement. RT is doing Mongolia a huge favor by refusing." (Reader comment on blog: entrepreneur in Mongolia)
Beyond this, questions remain about the government's intent to add more mines to its list of strategic mines, something included in the new government's 4-year plan. When a mine is declared strategic by the government of Mongolia, the government is entitled to 34% or 51% ownership depending on various aspects of the situation.
Lastly, there are ongoing questions that anti-corruption government activities have been misused for the purpose of corruption. Since April, there have been many political arrests of people in the former government majority party, the MPP, and the smaller challenging MPRP. However, the new ruling party, the DP, has to my knowledge had no one arrested on charges of corruption. As the office of President, which controls the justice department, is a member of the DP, and elections for President are next year (always one year after parliamentary elections), it looks to outside observers like corruption charges have been used to clear a path for the DP to gain its majority.
While it was thought the process of arresting DP opposition politicians ended with the election, corruption charges were recently used to transfer two more of Mongolia's 76 parliament seats from the MPP to the DP. Oliver Belfitt-Nash of Monet Capital, a prominent local brokerage, wrote in his free e-mail news service (e-mail belfittnash.o@monet.mn to subscribe) on October 18, 2012:
NEWSFLASH: Protests outside Parliament over 2 expelled MPs
Opposition party protestors gathered outside the government house today after two opposition MPs were booted from their seats on Tuesday. The court deemed their recent victories void and replaced them with members of the ruling Democratic Party. Today fewer than 100 people are barring the entrances to the government house, preventing anyone from leaving and threatening hunger strikes.
Some believe this was a desperate attempt to consolidate power by the new ruling party, but others (including the court) say the seats were illegitimately obtained and should be revoked. The two expelled members of parliament were convicted of distributing cash to their potential voters in Ovorhangai province, which warrants immediate and automatic expulsion from parliament according to the Election Law of Mongolia.
N. Tumurkhuu and S. Chinzorig were replaced by Dashzeveg Zorigt and Gavaa Batkuu, founder of APU beverage company, an MSE-listed entity.
The opposition MPP party has been protesting the results of the election since they lost back in June, and this could be another attempt to jab at the winners from the losing position. Some say the aim is to separate the [ruling] coalition and divide public opinion in order to bring about a re-election. However, others protest that if the ruling party can revoke opposition seats after the election, what is the point in electing at all?
Either way, this recent update exemplifies the continued desperate attempts by Mongolian politicians to dislodge and outshine the other political parties by any means possible. While we do not believe this will cause any long term strife that can threaten investors, it is upsetting to see that internal bickering still has a prominent voice in parliament despite facing the largest deficit in history and a severe export slowdown.
We expect the ruling Democratic Party to emerge as upholding Mongolian law and re-focus on the issues that matter, but we doubt this will be the last challenge they face from their opposition.
Despite the above problems, Mongolia is reliant on foreign direct investment (FDI), has an over-extended budget, an infrastructure that badly needs development for the sake of the general population, and a population that has become too urbanized without sufficient urban infrastructure. For all these things, the government is now dependent on the success of Mongolia capitalizing on its natural resources. To fail now because of the egos of politicians and businessmen would be to drag the country back to the economy of the 1990s, an economic collapse brought on by the end of Soviet support under communism with no economic aid to bridge the gap.
In the end, Mongolia's economy will succeed despite the foolhardiness of politicians who are more interested in international media attention than moving their country forward (indeed, every suggestion to renegotiate the Oyu Tolgoi agreement has come from a minority of the parliament's politicians who do not have the power to pass the legislation, but do have the power, by way of the international media exposure, to hurt Mongolia's FDI and the stock valuation of all Mongolia-related companies).
Thus, I would counsel against investing in Turquoise Hill Resources which seems destined to be a political football at least twice per year. If the markets would ignore the gyrations of a minority of politicians, it could be a good investment, but media coverage to-date suggests coverage will always say "the government" is seeking action against Turquoise Hill instead of saying that a minority group in the government is making noise again.
Due to the unknown enforcement of the new foreign investment law and the unknown details of a possible future expansion of strategic mining assets, caution is advised in foreign-owned speculative mining investments in Mongolia.
For companies publicly traded outside of Mongolia, that leaves three options that can be recommended: a value play, a growth play, and a unique situation.
Mongolian Mining Corporation
A subsidiary of Mongolia's largest conglomerate, MCS Holdings, Mongolian Mining Corporation (MOGLF.PK) is safely Mongolian owned and not subject to any issues stemming from the foreign investment law. The company has some of the best coking coal in the country. Their mine is strategically located near the Chinese border, and near both Oyu Tolgoi (the largest copper-gold deposit in Mongolia) and Tavan Tolgoi (the largest coal deposit in Mongolia), an area where there is now signs of progress that a railway link to China will get done in the next few years. Reports from friends indicate construction on the Gashuun Sukhait railway (from MMC's primary mine to China) has begun which will ultimately be a huge boost to Mongolia Mining Corporation's profitability.
Mongolian Mining Corporation managed to raise significant debt financing at favorable rates shortly before election-related issues caused all companies related to Mongolia to struggle in the markets. The financing should be more than sufficient to carry both operations and expansion (of coal washing facilities) for multiple years. The company, as well as its parent company, is conservatively managed. This is not a corporation that has grown to be the largest in Mongolia by taking on too much risk, but one that is run strategically, and thoughtfully. The company will not overstate potential results to investors, but does focus on completing everything it says it will do on time.
This company is a value play at current prices and I extensively profiled the company in March 2012. In addition to the other problems suffered by Mongolian companies generically, which have been discussed in this article, the company's valuation has also been hurt by the problems generically of coal companies worldwide. Coal is out of favor as an investment, but it's not going away as part of the fabric of society. The combination of Mongolia's government stabilizing and coal cycling back to investment relevance should reveal great value in Mongolian Mining Corporation's share price at current levels.
Mongolian Growth Group
Mongolia Growth Group (MNGGF.PK) has become predominantly a real estate play on the capital city of Ulaanbaatar. It has been some time since I wrote meaningfully about the company's real estate operations. The company's stock price has found stable support and the price to book ratio of the company is slowly improving while share price has been stagnant.
The company's particular strategy emphasizes real estate in Ulaanbaatar's center where there is limited available property. The thesis is that as the economy booms from mining down the road, the economic center will experience increasing valuations. There are a lot of particularities to Ulaanbaatar that make this strategy make sense which I will review again in another article after the Mongolia Investment Summitin Hong Kong (October 29 - 31) where I am among the presenters.
Interviews I conducted across the real estate sector and other subsequent interviews have indicated that real estate valuations in central Ulaanbaatar held steady in 2009 when the impact of 2008's financial crisis was felt across the world. Thus, in troubled times, the right real estate has been a resilient sector in Mongolia. At the same time, real estate is a leveraged play on Mongolia's growth. With two other Mongolian real estate companies planning IPOs in Canada and Hong Kong respectively in the coming year, it is still a sector that is developing and off to the side, away from the politicized mining developments.
Obviously, for real estate investments to be a wild success, the mining sector must succeed. On the other hand, investing in the right mining company that will show the success of Mongolia's mining sector with an improving share price can be tricky, even without the government shenanigans. Trying to capture the mining sector success via real estate will likely not match the returns of the best performing mining stock in a given year, but it also will not be one of the many underperforming mining companies. In this way, real estate is a safer way to play the growth story if and when Mongolia's growth story arrives.
That said, one should thoroughly understand the risks of this investment and its valuation prior to investing. Like Mongolian Mining Corporation, Mongolia Growth Group uses its website to provide as much transparent material as possible. This should be studied prior to investment.
Blue Wolf Mongolia Holdings
While the first company was a value play and the second a growth play, this one is an intriguing speculation. Blue Wolf Mongolia Holdings (MNGLU) is a blank check company which originally raised $80.5 million in the summer of 2011. The company has to invest its capital in a single project by April 20, 2013. It has been presumed by local rumors that the company would purchase a mine. However, there is no restriction on how the company selects its investment.
It may be speculation to buy the company, but one can assume the stock price will pop when an investment decision is made. Furthermore, the instability in the financial markets wrought by Mongolian politicians over the past few months has left many assets in the country trading at low valuations. Either the company will make its move to purchase an asset sometime in the coming 3 quarters or if not, the company is a pile of cash waiting to make a purchase, and the share price is relatively stable while it has no underlying asset. Worst case scenario might be that the company decides there is no investment opportunity good enough and returns cash to investors.
Conclusion
While Mongolia's government finds its way, there are investment opportunities being created. There is a famous saying that the best time to invest is when there is blood in the streets. For cautious thoughtful investors willing to build positions patiently, there are such opportunities in Mongolia.
One should keep in mind that Mongolia itself is impacted by the global economic situation, specifically neighboring China's economic situation, and particularly natural resource demand both in China and globally.
seekingalpha.com
Jon Springer
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