China Inc. Tires Of Arm-Twisting – Tries A New Trick That Challenges The Rules Of The Manganese Game

By John Helmer, Moscow

One man’s poison is another man’s meat – so long as he chews carefully and doesn’t swallow.

What’s been bad for Japan’s steel industry has accordingly been not so bad — you might say good — for the China market, and those who supply it with what it must have — iron-ore, coking coal, ferrous scrap, nickel, and manganese. These are the primary ingredients of steelmaking. Russian exports them, so does Australia.

The earthquake and tsunami of March 11, followed by the partial meltdown of the Fukushima Daiichi nuclear power complex, have cut about 15 gigawatts of electricity from Japan’s current consumption capacity. That directly threatens to reduce Japanese steel production and exports for up to 12 months. Less Japanese steel production means less imports of the wherewithal to make it, but only for the time it takes for Japan to recover from the shock. Then rebuilding accelerates demand for steel. There are big and related impacts on other minerals and metals, the magnitudes of which vary with the size of Japan’s share in global consumption:

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Even before Japan’s disaster in March, China’s appetite for steelmaking materials, as well as for imported steel, had been growing so fast as to diminish the impact for the Asia market as a whole of the disruption in Japan. China’s internal steel production reached 103 million tonnes in January and February, up 25% on a year ago. In February, a single day’s output of Chinese steel came to 1.74 million tonnes. That’s a record for China. Noone in the history of the world has ever produced so much steel.

In the very short run, for about three to six more months, Japan will be producing and exporting less steel, and the market for steel will tighten in the rest of Asia. Rising steel prices also translate into rising prices for steelmaking ingredients. Flooding and cyclones in Australia in January added to the tightness in shipments of coking coal to China; the Australian contract price has jumped 55% for orders this quarter and according to Rio Tinto, one of the dominant suppliers worldwide, the price of coking coal for steel is currently at an all-time record high. Nippon Steel and Anglo American (South African) have followed with 50% price hikes.

Even if the coalminers do not get all the price increase they are asking for, Chinese demand puts a comfortable floor under forecasts of the coking coal price for as far into the future as JP Morgan was able to tabulate on March 29, 2011:

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Iron-ore miners are more demanding than coking coal miners. Last month, Vale, the Brazilian iron-ore miner, demanded a 90% increase in the price the Chinese should pay for iron-ore. Then before the Chinese had time to say no, the Brazilian price demand went up to a 100% price hike.

Steel scrap to feed electric-arc furnaces and produce steel for building construction is growing shorter in supply, even as Chinese mills are cutting back on the growth rate of their deliveries to their domestic construction market. Import volumes of scrap required this year by China are expected to triple from last year, while supplies are being curtailed by Russia, a traditional supplier, by protectionist measures to prevent exports, which have been lobbied by Russian steelmills.

For steel alloys like nickel, which is required for stainless steel, and manganese – a metal related chemically to iron, but much rarer, essential for hardening, permeability and corrosion reistsnace in steel — the uncertainty in demand and supply forecasts circulating in the last quarter of 2010 has been reduced by the Japanese difficulty. The expectation of massive Japanese rebuilding, drawing all the imported steel and steelmaking materials Japan can get, adds to confidence in demand growth after mid-year.

Watch the tsunami strike in each of these charts:

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If you are a Chinese steelmaker watching the rising line in charts like these click open each day on your computer screen, you might think to yourself that your arms are being twisted more and more painfully by foreign devils. Whenever the wind blows hard or the rain falls torrentially in northern Australia, you might say (in Chinese) – whenever Russians turn off their methane sensors and Siberian coal mines blow up, or Japanese utility executives conceal unsafe procedures at their reactors — China must pay the damage.

Who will rid me of these meddlesome price-riggers? you might ask if you are a Chinese steelmaker or Beijing official supervising the sector. The recent record of answers by the regional and central state authorities in China demonstrate how hard they are trying. But most front-door deals are barred, like Chinalco’s attempt to increase its stake in Rio Tinto from 11% to 18% in 2009, have been rejected. Subsequent disclosure of US diplomatic cables reveals that BHP Billiton encouraged the Australian government to take a political and racial stance towards Chinese investment. “Rio Tinto has no business credibility as a company,” Chinalco announced in July of 2009, in the middle of a Chinese indictment of business espionage and bribery by the Anglo-Australian company. BHP’s attack on the Chinese reflected its frustration at Chinalco’s success at blocking BHP’s attempted at taking control of Rio Tinto in 2008.

So you can’t blame the Chinese steelmaker for answering his question by backdoor methods, so discreet (Chinese word; secretive is another word for it) that the Australians and the global market don’t realise what is going on. Almost.

The manganese tale, which has been building around OM Holdings (OMH), one of the few manganese miners listed on a recognised public stock exchange, has already revealed a great many oddities. Although its shares are listed on the Australian Stock Exchange (ASX), OMH is incorporated and registered in Bermuda; controls investment vehicles in the British Virgin Islands, Mauritius, Hong Kong and Singapore; is headquartered for management purposes in Singapore; sells virtually all of its manganese (its only line of business) to China, where it controls a ferromanganese refinery, the Guizhou Jiahe Weiye smelter (Qinzhou); and trades between its Australian mine and its Chinese buyers but not directly, using trading companies identified in Tianjin, Qinzhou, Shanghai, and Malaysia.

Two individuals, husband Low Ngee Tong and wife Heng Siow Kwee, appear to be the controlling shareholders of the company. He is identified on the OMH website as group Executive Chairman; she is reported to be Joint Company Secretary of the group and human relations director of an OMH subsidiary in Singapore, OM Materials. Heng has previously served as a director on the OMH board. Low is reported in company disclosures to control 36.4 million shares (7%). Since his wife is no longer a director, there is no current disclosure of how many shares she and entities associated with her may control. In January 2009, the company reported to the ASX that Heng and an entity of hers called Dino Company Ltd owned 9.99%.

Other Singapore Chinese were reported in May of 2009 to be holding significant, though small blocs of shares, either for themselves or as nominee holders for unidentified interests. Neither they, nor Mr and Mrs Low agreed to discuss shareholder identity and shareholder policy in 2009. They repeated that position this week.

Asked what she estimates to be the free float of OMH shares on the Australian exchange, Heng did not say. Market watchers estimate the free float of OMH shares is currently about 8%.

The only talkative shareholder has been another global manganese magnate, the Ukrainian Gennady Bogolyubov. Based in London, with mining interests in Australia (Consolidated Minerals) and Ghana (Nsuta), he has also moved in and out of Russian steelmaker, Evraz. Through Stratford Sun, Bogolyubov controls a bloc of 11.7%, shares. Adding this to the free float makes almost 20%. The remainder, roughly 80% of OMH’s current share issue, is in the hands of Low, Heng and others they refuse to identify.

In mid-2009, Mr and Mrs Low (Heng), and their chief executive, a Hungarian named Peter Toth, suspecting a hostile takeover attempt by Bogolyubov, took action which Bogolyubov interpreted as a hostile dilution scheme.

Bogolyubov filed in the West Australian Supreme Court for full disclosure of how company share options, deal making, executive compensation, and shareholder votes were being decided on shows of hands without accountability to the market, or to Stratford Sun. The lawsuit demanded production of “documents…referring to or recording the relationship between the Respondent’s [OMH] director Mr Low Ngee Tong and his spouse Ms Heng Siow Kwee with respect to their respective shareholdings and option holdings…”

The court case was suspended on promises of improved cooperation between the Lows and Bogolyubov. In the interval, there was market speculation of talks to effect a merger of the two manganese groups; an IPO by the combined company; and also a buy-out by the Lows of Bogolyubov. No deal eventuated, and this week neither side said it wants to discuss what has been happening between them.

However, sources in Melbourne now confirm that Stratford Sun has formally applied for an investigation by the Australian Securities and Investments Commission (ASIC) of alleged violations of Australian market rules relating to OMH’s beneficial owners and of the interests they have required the company to serve. Limited though the available evidence is so far, there are grounds for believing that powerful mainland Chinese interests stand behind the control shareholding of OMH. While that may be unsurprising, the way those interests are directing OMH’s policy towards other shareholders may not be lawful, according to the Australian market rules.

Chaired by Melbourne lawyer Tony D’Aloisio, the ASIC says it does not comment on operations.

Since the ASIC investigation, OMH has issued a number of announcements suggesting that the control shareholders intend to increase their stake at the expense of the minorities. On March 30, for example, one of the Singapore board directors, Tan Peng Ching, converted 1 million unlisted options into the same number of listed shares. Other company releases indicate that 31 million options have been issued, and will be converted to listed shares for the benefit of an as yet unknown group of beneficiaries. The company reveals that it may issue up to 150 million options, equivalent to 30% of the current share issue. These are believed to be tied to the control shareholders, led by Low and Heng. Current company documents show that 16 million of the options are held by CEO Toth.

Asked to say what OMH believes to be the current free float, and what he expects this will be after the HKSE listing, Toth said: “That’s not something we want to discuss in the media. We address these questions with our shareholders when they come up. Discussion of these issues does not belong in the media”.

A dramatic change of shareholding is signalled in the small print of OMH’s announcement of its Annual General meeting, scheduled for Singapore on April 20. With less than a month’s notice, OMH revealed last week that it plans to list its shares on the Hong Kong Stock Exchange, and issue 345 million new shares for sale. For a company with only 504 million shares currently listed on the ASX, this move represents a dilution by more than two-thirds of the current shareholders. The target appears to be the 20% of minority shareholders — Bogolyubov’s 11.7% stake and the 8% free float.

Up for a vote, OMH’s March 28 notice says, is the proposal “that, for the purposes of Listing Rule 7.1 and for all other purposes, and in conjunction with the proposed dual listing of the Company on the Main Board of The Stock Exchange of Hong Kong Limited (“HKSE”), the Directors be authorised to issue up to a total of 345,000,000 Shares at an issue price yet to be determined but that will not be less than 80% of the volume weighted average market price of Shares trading on the ASX over the last 5 days on which sales in the Shares were recorded before the date on which the offer price is fixed for the purpose of the Global Offering and in accordance with the terms and conditions as set out in the Explanatory Statement.”

CSI and Morgan Stanley are the coordinators of the share sale, but no prospectus has been issued yet. OMH reported in the “explanatory statement” dated March 28, that a listing application and draft prospectus were lodged with the HKSE a month earlier, on February 28. HKSE’s spokesman confirms that no approval has been granted yet; no stock code or ticker assigned to OMH for trading on the exchange; and no prospectus released.

Asked why her company had not mentioned the plan to list in Hong Kong when it made an investor presentation at the Euroz securities conference on March 8, Heng said there had been an announcement earlier on. She referred to a release to the ASX, dated November 23 and posted a week later; this says only that OMH “is assessing a proposed secondary listing”. The brief notice claims “the secondary listing will further broaden the Company’s shareholder base internationally” but omits to mention the size of the share sale.

Asked to clarify why investors were not told of the 345-million share sale, Toth said: “a listing on a public stock exchange [like ours] is not a matter for public discussion.”

According to the latest OMH statement to its shareholders, the company hopes to raise between A$406 million and A$498 million in the Hong Kong share sale. The money may be spent, according to this document, on reducing debt, paying for new exploration or “capture of strategically suitable projects”; the latter identified in the document include projects in South Africa and Malaysia. Investments OMH has already made in iron and manganese exploration and mining in Norway and Sweden aren’t included in the list.

Announcements of the sale of such a large number of shares usually impact badly on share price, but noone in the market has apparently noticed what is about to happen.

Chart of 3-year share price trajectory for OMH

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At its June 2008 share peak, OMH, was worth A$1.4 billion. With the plummeting price of manganese chasing the falling demand from Chinese steelmakers, OMH’s market capitalisation dropped to $321 million in November of 2008. That collapse forced OMH to cancel a secondary listing it had arranged of 90 million shares – 19% of the issue – on the HKSE which had been planned for August of 2008 at a share price of A$2.50 — close to OMH’s earlier peak of A$2.87.

OMH is currently trading at A$1.39, and is currently valued at A$698 million. The new HKSE share placement is four times the one OMH thought appropriate three years ago, when its business was going much better than it is now. The decline visible in the share price trajectory so far this year follows from the release of OMH’s financial results for 2010, despite a lift in profit. Revenues are reported to have come in at A$307.5 million, up 10% on 2009. Cost of sales was $190.1 million, up 14%. Bottom-line profit was $48.8 million, a gain of 81%.

Debt jumped from a negligible level in 2009 to more than $43 million as of December 31, 2010, while net cash generated from operations shrank from $24.7 million in 2009 to $20.7 million in 2010. Investing mistakes appear to have triggered losses, and unsold inventories jumped almost fivefold. That last item suggests what the market suspects – the manganese price gain expected from Chinese buyers is languishing on plentiful supply.

The financial report confirms that almost all of OMH’s sales went to China (96.2%). Just one customer, unnamed, accounted for 11% of this revenue.

If OMH is a natural, discreet vehicle for mainland Chinese control of at least part of China’s flow of manganese into the steel smelters, the way it is being managed is bound to run into problems with ASX rules on corporate governance, shareholding accountability, and conflict of interest. But now that OMH is planning to move a large part of its shareholder float out of Australia and into Hong Kong, diluting those left behind, the move is certain to oblige the Hong Kong regulator, in addition to ASIC, to probe who is pulling the strings. “I have absolutely no intention of discussing these questions,” Toth says for OMH.

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