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Legal challenge threatens to undermine Rio's Turquoise Hill acquisition

By Market Index
Mon 12 Sep 22, 12:25pm (AEST)
Chess move
Source: Unsplash

Key Points

  • Pentwater has opposed the 'final' CAD$43 per share offer by Rio to acquire Toronto-listed mineral explorer/developer Turquoise Hill for US$3.3bn ($4.8bn) on the grounds it "significantly undervalues" the asset
  • Assuming the deal proceeds, Rio will own 66% of the Oyu Tolgoi copper mine, with the Mongolian government owning the remaining 34%
  • Pentwater is taking the longer-term view that growing demand can push the copper price beyond US$4 per pound over the next decade

Six days after entering into a definitive arrangement to acquire full ownership of Toronto-listed mineral explorer/developer Turquoise Hill, a major shareholder is currently planning to stop Rio Tinto (ASX: RIO) from consolidating its ownership of Mongolian copper mine Oyu Tolgoi.

For the uninitiated, Turquoise Hill owns 66% of the Oyu Tolgoi copper mine, and Rio owns around 51% of Turquoise Hill.

The Oyu Tolgoi copper mine - which is part-owned by the Mongolian government - is integral to Rio’s plans to be a dominant player in the copper sector, hence its interest in taking the company out.

While Rio has now presented three separate offers to minority shareholders, the most recent seems to have won the board’s favour.

Assuming the deal proceeds, Rio will own 66% of Oyu Tolgoi, with the Mongolian government owning the remaining 34%.

Spanner in the works

After taking its shareholding in Turquoise Hill to 11.67%, US-based hedge fund Pentwater Capital Management, has opposed the 'final' CAD$43 per share offer by Rio for US$3.3bn ($4.8bn) on the grounds it "significantly undervalues" the asset.

Pentwater argues that the proposed price is a fraction of the free cash flow its expects Turquoise Hill to generate over the next 10 years.

In short, Pentwater expects demand for more electric vehicles to send copper soaring over coming decades.

Despite the copper price having fallen more than 25% this year to about $US3.60 per pound, Pentwater is taking the longer-term view that growing demand can push the price beyond US$4 per pound over the next decade.

This is why Pentwater expects Turquoise Hill to generate over CAD$14.2bn of free cash flow through 2030.

Long-term copper short falls

Fuelling Pentwater’s optimism [around copper] are revelations within new S&P Global research which projects an exponential growth in demand for copper over the next 13 years, with long-term shortfalls surfacing in just two years.

S&P research claims that unless new supply of copper - the metal of electrification - comes online in sufficient volume and timeliness, “the goal of net-zero emissions by 2050 will be short-circuited and remain out of reach.”

Given that renewable power and electric vehicle applications must be in place by 2035 to meet net-zero targets in 2050, S&P expects copper demand to jump from 25m tonnes in 2021 to 50m tonnes in 2035.

Potential legal action

Pentwater also advised investors that the proposed premium doesn’t pass muster for Oyu Tolgoi, in the South Gobi region of Mongolia, a mine that’s expected to be the world’s third largest copper and gold mine, with a mine life exceeding 90 years.

Turquoise Hill directors are urging minority shareholders to vote in favour of Rio’s best and final offer, which requires the approval by 66.67% of shareholder votes to proceed.

Meantime, Pentwater is currently weighing up its legal options to stop it: Including the possible exercise of dissent rights or other legal action.

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Rio Tinto share price snapshot.

 

What brokers think

Rio’s share price is down -11% over 12 months.

Consensus on Rio is Moderate Buy.

Based on Morningstar’s fair value of $99.29 the stock appears to be undervalued.

Goldman Sachs has a Buy on Rio (target price of $121.50) and believes the agreement in principle for Turquoise Hill is below valuation, implying 0.7xNAV.

Based on the seven brokers covering Rio (as reported on by FN Arena) the stock is currently trading with 9.4% upside to the target price of $104.21.

Macquarie retains a Neutral rating but downgrades its 2022-24 alumina price forecasts by -9-12% and its aluminium price forecasts by -12-24%.

This drives cuts in 2022-25 earnings forecasts for Rio of -2-12% and a target price cut to $93 from $97.

Credit Suisse expects lower near-term prices for copper and iron ore and this has driven the broker to lower its earnings forecasts -14%, -16% and -7% through to 2024. 

The broker’s outperform rating is retained and the target price decreases to $101.00 from $115.00. 

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