US fund threatens Rio with legal action over Oyu Tolgoi

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Pentwater Capital, the second-largest shareholder in Rio-controlled Turquoise Hill (TSX, NYSE: TRQ), said on Monday it was ready to file an “oppression” order against the mining giant.

The move is a statutory right available to “burdened” shareholders, empowering them to bring an action against the corporation in which they own shares. They can do so when the conduct of the company has had an effect that is oppressive, unfairly prejudicial or disregards the interests of a shareholder.

The Naples, Florida-based fund said it would spare Rio Tinto the legal action if it allows its subsidiary to take on more debt to fund the $6.8 billion underground expansion.

“We do not undertake this lightly, but enough is enough,” Pentwater chief executive Matthew Halbower said in the open letter.

“This mine is a jewel. It will be the third-largest gold and copper mine in the world. It will produce tens of billions of dollars of free cash flow for decades. Its owners should be treated as business partners, not as puppets or pawns,” Halbower said.

The dispute over funding the expansion’s sudden cost increase started to heat up in early November when Turquoise Hill, which is Oyu Tolgoi’s operator, launched arbitration proceedings against Rio to get clarity on funding.

Rio Tinto has said it will not allow the Canadian miner to take on more than $500 million in additional debt, telling the company to fill up a funding gap of up to $3 billion by reprofiling loans and raising equity.

Pentwater Capital said it strongly opposes Rio’s attempts to force Turquoise Hill to conduct an equity raise, despite the fact that the current equity price “severely undervalues the company.”

The fund noted there are “much cheaper and more advantageous financing options” available to the Canadian company, such as streaming and bond financing.

This is not the first time Pentwater has taken issue with the way Oyu Tolgoi’s expansion is being handled. In April, it demanded a shakeup at operation over what it claimed was “a massive devaluation” of the asset.

Pentwater’s threat comes on the heels of a similar warning issued by Odey Asset Management, a London-based hedge fund. The firm accused Rio last week of holding the “people of Mongolia…accountable for Turquoise Hill’s failings” after it called the country’s government’s $7 billion-equity stake in the copper-gold mine “worthless.”

Mongolian muddles
Mounting investor activism is just one of the may headaches Rio Tinto has had while building what would rank as one of the world’s three largest copper mines when operating at full tilt – now expected to be by 2025 at the earliest.

In January 2018, Mongolia’s government served Oyu Tolgoi with a bill for $155 million in back taxes — the mine’s second tax dispute since 2014. The company said at the time the charge related to an audit on taxes imposed and paid by the mine operator between 2013 and 2015.

Shortly after, the mine had to declare force majeure after protests by Chinese coal haulers disrupted deliveries near the border.

The situation prompted Rio’s former chief executive Jean-Sebastien Jacques to visit Prime Minister Ukhnaagiin Khurelsuk to discuss how to build “win-win” partnerships. The trip was followed by the company’s announcement that it was opening a new office in the country, focused on exploration and building local relationships.

The issue resurfaced later, when a group of Mongolian legislators recommended a review of the 2009 deal that launched construction of the mine. It also advised revoking a 2015 agreement allowing for an underground expansion.

In December that year, Mongolia’s parliament unanimously approved a resolution that reconfirms the validity of all the Oyu Tolgoi mine-related agreement, bringing the 18-month review to a close.

Behind schedule and over budget
Mongolia has also complained about overruns in the past. Much of Oyu Tolgoi’s copper lies deep underground. When Rio finally kicked off the delayed project, profits from surface extraction were meant to pay for digging up more of the copper below.

With time, it became clear the underground mine alone would cost as much as a third more than the original $5.3 billion budget.

Rio Tinto cut estimated reserves at the project in July and confirmed it would face delays and higher costs after ground instability forced it to redesign the mine plan.

The underground expansion of Oyu Tolgoi is Rio’s most important growth project. Once completed, it is expected to lift the mine’s production from 125,000–150,000 tonnes in 2019 to 560,000 tonnes at peak output, targeted for 2025.

The giant deposit, discovered in 2001, is one-third owned by Mongolia’s government and two-thirds by Turquoise Hill. Rio has a 51% stake in the Canadian miner.