RCS - Odey Asset Mgmnt - Rio Tinto/Turquoise Hill Accountability

Rio TintoAnnouncement

25/11/2020 08:05

RNS Number : 3948G
  
Odey Asset Management LLP
  
25 November 2020
  
 

Dear Jakob,
As you know, Odey Asset Management LLP ("Odey"), as shareholder of Rio Tinto plc ("Rio Tinto"), wrote to the board of non-executive directors ("Board") of Rio Tinto on 5 April 2019 (the "Letter") in order to set out its views of the duties of Rio Tinto's Board with regards to both Turquoise Hill Resources ("Turquoise Hill"), a listed entity of which Rio Tinto is the 50.8 per cent shareholder, and the polymetallic Oyu Tolgoi mine in Mongolia, in which Turquoise Hill holds a 66 per cent equity interest.
Odey wrote the letter pertaining to the Board's responsibilities according to the Companies Act 2006 (the "Act") and the UK Corporate Governance Code ("Governance Code") and in keeping with our responsibilities as signatories of the UK Stewardship Code ("Stewardship Code").
Odey is, through funds that it manages, a shareholder in Rio Tinto and holds a short position in Turquoise Hill.
Odey continues to have serious concerns as to the way that Rio Tinto's management have chosen to carry out their duties with regards to Turquoise Hill and Oyu Tolgoi. 
As you know, Odey has sought to engage with Rio Tinto's management on many occasions about Turquoise Hill and Oyu Tolgoi. Indeed, Odey has sought to ask questions on both Rio Tinto's and Turquoise Hill's public earnings calls but Odey has not been given the opportunity on these calls to propose any such questions, limiting the opportunity for greater public scrutiny of the Oyu Tolgoi investment case. 
In the interest of many of Rio Tinto's stakeholders, including Rio Tinto's shareholders, Turquoise Hill's current and prospective shareholders and the Government of Mongolia, we feel it is appropriate and fair that these questions be addressed immediately, in a public manner in the interest of transparency, accountability and integrity.
In particular, Odey believes that Rio Tinto's lack of action in triggering the clauses set out in the Financing Support Agreement is causing material damage to Rio Tinto's shareholders, Turquoise Hill's prospective shareholders, and the Government of Mongolia allowing the creation of, in Odey's opinion, a false market to form in the trading of Turquoise Hill's shares, given our opinion that the market inaccurately represents the reality of the situation which we discuss below. Indeed, the recently announced arbitration proceedings between Turquoise Hill and Rio Tinto, in Odey's opinion, simply serve to exasperate this problem, which comes at substantial cost to Rio Tinto's shareholders.
As chief financial officer of Rio Tinto, as well as a director of the Rio Tinto, Odey believes that you now have a fiduciary duty to rectify the situation immediately. 
Whilst Odey understands that there has historically been of a potential conflict of interest within Rio Tinto around the Oyu Tolgoi project due to the project being a legacy of the current chief executive, his resignation now gives you a new opportunity to act.
Our concern relates, in the most part, around two simple issues: the fairness of the financing package surrounding Oyu Tolgoi, and the sustainability of the agreements with Government of Mongolia.
 
Financing package
Odey does not believe that the $4.4 billion project finance package associated with Oyu Tolgoi is accurately described as "project" finance. 
Whilst it is referred to as "project" finance by the lending parties, the reality is that Rio Tinto has given corporate guarantees to the lenders for most of the duration of these loans. True project finance, as you know, is ring-fenced, non-recourse lending to an asset. 
Despite the original intention of the lending package to become non-recourse once the project was "completed", it is Odey's understanding that the quantitative completion tests are, in reality, close to impossible to meet, and others are in some cases vague, allowing 'get-out' clauses for the lenders. Hence, it could be argued that the lending parties never actually intended for the loans to become non-recourse and therefore there is minimal risk allocation away from Rio Tinto to the lending parties.
Moreover, it is Odey's opinion that the lenders have better security than a Rio Tinto bondholder: not only do they have a Rio Tinto corporate guarantee, but they also have first-lien security over the Oyu Tolgoi asset. Despite this, the lenders are indirectly charging Rio Tinto substantially more[1] than a Rio Tinto bondholder of matching duration.
Odey also notes that the lenders in the syndicate have little-to-no presence in Mongolia and are not exposed to "political" risk given the Rio Tinto guarantees and nature of the political risk carve-out. Odey therefore struggles to see how an argument can be made that further stakeholders are being brought into the project through the lending facility to justify the great incremental expense of the loans compared to other sources of financing.
Odey also notes that Rio Tinto consolidates all Oyu Tolgoi debt onto its own balance sheet, exposes itself to 100% of the risk of it, and yet only has an effective 33.53% equity stake in the Oyu Tolgoi project.
It is therefore Odey's opinion that the current project finance at Oyu Tolgoi achieves none of the benefits what "project" finance is intended to be, yet it suffers all the costs.
However, there is some good news which allows for this situation to be rectified. 
On 15 December 2015, Rio Tinto put in place a Financing Support Agreement[2] ("FS Agreement"). Despite Turquoise Hill management's reluctance to talk about this agreement on their most recent earnings call when asked about it (16/11/2020), it is clear to Odey that section 3 of the FS Agreement has been triggered by the delay, cost overrun, and impairment of the Oyu Tolgoi asset. 
However, as far as Odey is aware, Turquoise Hill has failed to file a "TRQ OT Notice", as stipulated in the agreement, and Rio Tinto has failed to file a "Demand Notice" as stipulated in section 7 of the FS Agreement.
Whilst both Rio Tinto and Turquoise Hill might suggest that they would like to complete the Oyu Tolgoi Definitive Feasibility Study Estimate (due in Q4 2020), before making such filings, this is certainly not required in the agreements. The lack of filing these notices has come at substantial cost to Rio Tinto's shareholders. 
Odey believes that such a Demand Notice, as Schedule E demonstrates, gives Rio Tinto the right to demand that Turquoise Hill cure the effective event of default within 30 days through the means of a rights issue, if another funding mechanism is not provided by Turquoise Hill which is acceptable to Rio Tinto. Whilst Odey can appreciate that section 9 (ii) allows for Turquoise Hill to temporarily avoid putting into effect the funding mechanism chosen by Rio Tinto, if Turquoise Hill's chief executive officer provides a letter within 10 days stating that "TRQ will have sufficient resources to fund and meet its Debt Service Obligations during the 180 days following the date of the Demand Notice", the act of filing, its nature and the size of such a Demand Notice by Rio Tinto would need to be disclosed to the market by Turquoise Hill due to its continuous disclosure obligations, and hence the market would be clearly informed as to Rio Tinto's intentions towards the refinancing of Oyu Tolgoi.
Given the reality of the nature of the current, and any future "project" finance being wholly inappropriate for Rio Tinto shareholders, Odey is of the opinion that Rio Tinto should remove the project finance package at Oyu Tolgoi altogether. Odey believes Turquoise Hill's failure to deliver the Oyu Tolgoi project on time and on budget should be met with accountability. Furthermore, Odey is of the opinion that Rio Tinto should not continue to subsidise Turquoise Hill in the manner that it is currently.
Therefore, Odey proposes that Rio Tinto should confirm if it intends to seek to refinance the $4.4 billion of loans through a rights issue, which is well within Rio Tinto's rights as the effective lender to Turquoise Hill, and is normally the case for any lender where material covenants have been breached by the borrower.
Further, Odey believes that Rio Tinto should confirm if it intends for Turquoise Hill to meet the existing capital expenditure funding shortfall through equity, and whether Rio Tinto will continue to lend out its balance sheet in a way which is of great value destruction and risk increase to Rio Tinto shareholders. Odey believes that Rio Tinto should also announce if it will conservatively plan for the funding shortfall, as any high quality operator would, and therefore will seek to raise the top-end range figure of the estimated funding shortfall estimate, rather than Turquoise Hill's proposed "base case". It is Odey's opinion that this would require a further $4.5 billion of equity financing, but this is subject to confirmation of the definitive feasibility study estimate. Indeed, Odey's opinion is that it is reasonable for Rio Tinto to include a provision for the construction of the Oyu Tolgoi Power Plant. If the Mongolian people are not to be held accountable for Turquoise Hill's failings, then it seems to be the most likely outcome of the revised Power Source Framework Agreement that the Government of Mongolia will conclude that it is in their interest for Turquoise Hill to build the power plant. We believe this to be the case if our expected changes to the Investment Agreement materialise (further discussed below). 
Rio Tinto is well within its rights to do this, and it is Odey's opinion that it is in the best interests of Rio Tinto to do this.
Furthermore, Odey believes that Rio Tinto should confirm publicly whether the possible proposals of Turquoise Hill to use a Medium Term Note program, and/or royalties, would be acceptable to Rio Tinto, or, to the Government of Mongolia, or not. 
We note the following:
1.     Any such structure would likely require Rio Tinto guarantees, potentially further exposing Rio Tinto to an asymmetric risk profile in the project of suffering 100% of the risk downside, with only 33.53% of the equity upside;
 
2.     Any such structure would most likely be treated as debt by credit rating agencies and hence would be consolidated through to Rio Tinto's balance sheet giving inefficiency to the running of the group's balance sheet;
 
3.     Any such structure would likely be more expensive than Rio Tinto's own financing and/or give away Rio Tinto's exposure to the commodities within the Oyu Togloi mine (in the example of the sale of a gold royalty);
 
4.     Such a structure would likely further impact the people of Mongolia in a detrimental way. It is natural that Turquoise Hill would look for the interest payments on debt/royalty expense to be offsettable against corporate taxes, further diminishing the value of the project available to the Government of Mongolia. This would not be the case with an equity issuance. Indeed, Odey does not believe the people of Mongolia, nor those of any other jurisdiction in which the interest payments might be offsettable, should be held accountable for Turquoise Hill's failings.
 
5.     The risk allocation apportioned within the Oyu Tolgoi Underground Mine Development and Financing Plan[3] ("the Dubai Agreement") is, in Odey's view, irrational. Clause 5.5 (vi) of the Dubai Agreement states that "the Project Finance Guarantee Charge will only be applied to the extent the amount of funds held by Rio Tinto as described in paragraph (ii) is less than the amount guaranteed by Rio Tinto under its Completion Support Undertaking. As a result, the effective rate of the guarantee fee over the tenor of the UG Project Finance is estimated to reduce to less than 1%." The irrationality arises as Rio Tinto has made commitments to financial expenditure beyond its drawn down debt (long term, committed purchase contracts are signed and represent liabilities to Rio Tinto). The Guarantee Charge should have matched the contracted cash outflows associated with the project, not just the drawn cash flows from the facility, since it is the contracted cash outflows (including payables, accrued liabilities, purchase obligations, power commitments, operating and finance leases) that Rio Tinto has implicitly guaranteed, as well as the drawn cash flows. Such a charge that truly reflects the risk that Rio Tinto is taking on would be excessively burdensome for Turquoise Hill to accept compared to equity.
 
In Odey's opinion, the outcome of this conservative scenario is that, if Rio Tinto acts in the interests of its stakeholders, Turquoise Hill would be required to seek a minimum rights issue of $8.9 billion.
Odey appreciates that this may sound like a large number but the structure of such a refinancing is not uncommon. Indeed, Katanga Mining Limited ("Katanga") executed a similar refinancing in December 2019 of C$7.7 billion in order to repay Glencore plc ("Glencore") loans outstanding.
Despite the Financing Support Agreement outlining a method for Rio Tinto to underwrite such a rights issue, Odey does not believe that Rio Tinto has an obligation to do so given the outstanding circumstances, and that such an underwriting would be inappropriate. Again, such a scenario would be like the Katanga rights issue of December 2019, which Glencore did not underwrite but provided a standby commitment instead.  
Whilst it seems to Odey that Turquoise Hill has subtly indicated to the market that Rio Tinto may intend to take a course of action in line with Odey's view (given Turquoise Hill's 5 November 2020 communication[4] that Rio Tinto is not showing an interest to reprofile the loans), we believe Rio Tinto should immediately formalise their response publicly of their desires and intentions, so that current and prospective shareholders of both Rio Tinto and Turquoise Hill can understand the group's thinking immediately in a clear and transparent way. 
In the absence of this transparency on the part of Rio Tinto, Odey believes that Turquoise Hill's stock is trading with materially misrepresented views of the risk profile compared to reality. Odey notes the great increase in the number of retail investors[5] who have acquired Turquoise Hill's stock recently, who Odey feel do not understand the detail behind the Turquoise Hill investment case. Odey believes has the potential effect of great value destruction to Rio Tinto shareholders given the entry price of such a large rights issue will be substantially higher than would otherwise be the case should Rio Tinto puruse this approach. 
 
Investment Agreement
The Mongolian government effectively had $8.3 billion of loans outstanding to Turquoise Hill as of Q3 2020[6]. This is in the form of $7.0 billion of shareholder loans to Oyu Tolgoi LLC and $1.3 billion of loans to Erdenes, both charging LIBOR plus 6.5 per cent.
Given the size of the existing loans that outstand between Turquoise Hill and the Mongolian Government, it is Odey's belief that dividends will never flow from Oyu Tolgoi to its shareholders, effectively rendering the Mongolian Government's equity stake in Oyu Tolgoi worthless. 
Whilst the 2009 Investment Agreement[7] did not set out for the Mongolian people to receive an equity stake worth nothing, in Odey's opinion this is not sustainable and must be resolved. 
Odey understands that in December 2019 the Mongolian Parliament voted[8] to carry out the findings of the Parliamentary Working Group. Odey can fully appreciate that the Government of Mongolia wishes to take comprehensive measures to make changes that will reset the Investment Agreement to be fair. The conclusions of these discussions are still yet to be public. 
It is Odey's opinion that the natural resolution is for the Mongolian Government to dissolve the $8.3 billion of shareholder loans and/or increase the royalty rate at Oyu Tolgoi, and for this to appear within the Definitive Feasibility Study, which needs to be approved by the Government of Mongolia. The first option suggested is not uncommon and was the course of action taken by the Democratic Republic of Congo through Gecamines in the Kamoto Copper Company, a subsidiary of Glencore.
Odey believes that both solutions would align the Mongolian Government with other stakeholders, and in particular will ensure that the people of Mongolia are not held accountable for the failure of Turquoise Hill to deliver what they promised over a decade ago in the original Investment Agreement. 
Further, such a structure would also allow the Mongolian Government to put the accountability of the power plant construction back to Turquoise Hill, without the people of Mongolia suffering any further dilution effects, which the current structure would effect. Odey does not feel it is appropriate to expect the people of Mongolia to finance the construction of a power plant for Oyu Tolgoi at a time when their finances are already strained. The revised Power Source Framework Agreement[9] continues to allow Odey's proposed course of action to take effect, which Odey sees as the most reasonable and sensible.
It is Odey's opinion that Turquoise Hill must be accountable for the failure of their promises made to the Mongolian people, not the people of Mongolia themselves. 
 
 Corporate Governance
There has been a great amount of unrest from Turquoise Hill's minority shareholders suggesting that Rio Tinto would be abusing Turquoise Hill minorities if a rights issue were to take effect at Turquoise Hill. 
Odey finds it disappointing that they are making this claim and wish to blame Rio Tinto. Even Turquoise Hill themselves have referred to their second largest shareholder having "the inattention to properly assets critical information" and having "a lack of understanding of the mining industry and the complexities of the Oyu Tolgoi project."[10]
In fact, Odey believes minorities have been relying on the provision of the Rio Tinto credit guarantee and they are not compensating Rio Tinto in a manner that reflects the risk that Rio Tinto is taking. It is time for Rio Tinto to address this and match their risk-upside with their risk-downside.
Whilst the definitive feasibility study estimate is due to be out soon, before the end of Q4, Odey believes it is only right and fair that these basic questions be answered, and made public, so that prospective investors in Turquoise Hill truly understand the risk they are taking when they decide to buy the stock and ensure there continues to be a transparent market in shares of Turquoise Hill and Rio Tinto respectively. 
Indeed, Turquoise Hill's CEO, on the Q3 2020 earnings call, used the excuse that the FS Agreement is "complex" and "complicated" as a reason for not answering questions on it in public, yet it is for that exact reason that Odey believes that Rio Tinto and Turquoise Hill should not shirk from answering such questions in public, but should do so in a clear and transparent way to all stakeholders.
Odey can appreciate that such questions may be uncomfortable for Rio Tinto to answer but it is Odey's opinion that it is only fair and proper for all stakeholders that you do so immediately.
 
Conclusion
Given Odey's inability either to get an answer to these questions in private, or to propose them in public to Rio Tinto, and the notice that we gave Rio Tinto over 19 months ago in our Letter, we do not think it is reasonable for Rio Tinto's shareholders to continue to tolerate the value destruction created by the lack of action by Rio Tinto towards Turquoise Hill.
Indeed, it is Odey's opinion that Turquoise Hill are using this lack of action as an opportunity to allow a false market to be formed in Turquoise Hill's stock, just before we expect a rights issue to be announced. This is due to our opinion that the market inaccurately represents the reality of the situation for the reasons discussed. We believe this to be of severe detriment to Rio Tinto's stakeholders.
As chief financial offer of Rio Tinto, and a director of the company, Odey believes that accountability for the value destruction surrounding Oyu Tolgoi's financing has moved to you since the project's previous sponsor, the current chief executive, has now resigned from the company. 
We are happy to see that, since the chief executive's resignation on 11 September 2020, you have now taken a swift U-turn on the 9 September 2020 Memorandum of Understanding signed just before his resignation. This change of tack was conveyed in the release by Turquoise Hill on 5 November 2020, but we believe further immediate action must be taken. In order resolve this issue and meet with your duties according to the Act to promote the success of the company and/or to exercise reasonable care, skill and diligence, Odey believes that you should immediately address the questions below in a public response:
1.     Why has Rio Tinto failed to file the Demand Notice as set out in the FS Agreement?
 
2.     Does Rio Tinto intend to seek to refinance the existing $4.4 billion project finance facility, in whole, with equity through a rights issue at the Turquoise Hill level?
 
3.     Does Rio Tinto intend to discontinue the credit enhancement currently provided by Rio Tinto to Turquoise Hill?
 
4.     Does Rio Tinto intend to seek to meet the funding shortfall in whole with equity through a rights issue at the Turquoise Hill level?
 
5.     Will Rio Tinto act conservatively and hence seek to include the top-end of the funding shortfall estimate, as well as include a provision for the power plant? Would such a figure be at or above a further $4.5 billion?
 
6.     Do you agree that it is unjust for the people of Mongolia to be held accountable for Turquoise Hill's failings?
 
7.     Do you agree that prospective Turquoise Hill shareholders should be aware of the reality of the situation behind Rio Tinto's relationship with Turquoise Hill and its intentions?
We can appreciate Rio Tinto's reluctance to answer these questions given Rio Tinto's commitment to Turquoise Hill in section 29 (b) of the FS Agreement, to refrain "from taking any action or making any public statement in connection with any such New Rights Offering" but Odey believes that section 30 of the FS Agreement provides exclusions to this, and Rio Tinto's and Turquoise Hill's listing requirements must supersede any inter-company agreements between Rio Tinto and Turquoise Hill. Given our view that a false market has been created in the trading of Turquoise Hill shares, and hence in Rio Tinto's shares itself, given Turquoise Hill's materiality to Rio Tinto, Odey believes that Rio Tinto not only has a right to break this clause and comment on the arrangements, as outlined in section 77 of the FS Agreement, but in fact has a listing requirement to do so. Odey is of the opinion that section 29 (b) of the FS Agreement has in fact itself inadvertently set up the situation that has created this false market.
We hope that you can appreciate our point of view as a shareholder of Rio Tinto and that this letter is in line with our responsibilities under the Stewardship Code.
With best wishes,
Henry 





[1] https://www.turquoisehill.com/site/assets/files/3662/2015-12-14_nr_trq_yfb2vv.pdf


[2] https://www.turquoisehill.com/site/assets/files/3662/redacted-copy-trq-fsa.pdf


[3] https://www.turquoisehill.com/site/assets/files/3724/2015-05-18_otumdafp.pdf


[4] https://www.turquoisehill.com/site/assets/files/5218/2020-11-04-trq-nr.pdf


[5] https://robintrack.net/symbol/TRQ


[6] https://www.turquoisehill.com/site/assets/files/5221/trq_combined_fs-mda_q320_final.pdf


[7] https://www.turquoisehill.com/site/assets/files/3722/oyu_tolgoi_ia_eng.pdf


[8] https://www.legalinfo.mn/law/details/14771?lawid=14771


[9] https://www.turquoisehill.com/site/assets/files/5169/psfa_amendment_june_2020.pdf


[10] https://www.miningweekly.com/article/proxy-adviser-glass-lewis-backs-turquoise-hill-in-halbower-rejection-2020-07-17/rep_id:3650


This information is provided by Reach, the non-regulatory press release distribution service of RNS, part of the London Stock Exchange. Terms and conditions relating to the use and distribution of this information may apply. For further information, please contact rns@lseg.com or visit www.rns.com.

RNS may use your IP address to confirm compliance with the terms and conditions, to analyse how you engage with the information contained in this communication, and to share such analysis on an anonymised basis with others as part of our commercial services. For further information about how RNS and the London Stock Exchange use the personal data you provide us, please see our Privacy Policy.
 
  END
 
 
NRAFZLLLBFLFFBD