An Open Letter from SailingStone Capital Partners to Turquoise Hill’s Independent Directors
March 15 2022 - 9:52AM
Business Wire
SailingStone Capital Partners, a long-time owner of Turquoise
Hill Resources Ltd. (TSX:TRQ) (NYSE:TRQ), has delivered the
attached letter to the Turquoise Hill Independent Directors:
Dear Independent Directors of Turquoise Hill Resources Ltd.,
We note with interest the recently announced cash bid from Rio
Tinto (“Rio”) to acquire the minority stake in Turquoise Hill
(“TRQ”) for C$34/share, or approximately $2.7bn. While we
appreciate that a formal process has now commenced, we want to take
this opportunity to highlight our perspective on the proposal.
As you must know, Rio’s cash cost basis in Turquoise Hill is
approximately $6.6bn or $63.70 per share, inclusive of their
participation in the January 2014 rights offering which was the
last time that Rio acquired equity in TRQ. Other than a write down
in 2013 related to the temporary closure of Oyu Tolgoi and again in
2019 related to their own incompetence, Rio has never impaired this
asset. Given the billions of dollars of capex that subsequently has
been deployed, the significant de-risking that has occurred, and
the coming wall of free cash flow that begins with sustainable
first production in 2023, we strongly suggest that any assessment
of fair value starts with Rio’s cash cost basis, particularly
considering the impact that a much more robust commodity outlook
and the time value of money have on TRQ’s valuation. An
additional premium to compensate minority shareholders for losing
access to an asset of this quality seems eminently
reasonable.
On a related note, it is obvious that as the entity responsible
for developing and operating the mine, Rio Tinto has access to a
significant amount of material information which has yet to be
released to the public. Specifically, TRQ management has
indicated that updates to both the underground mine development
plan and an open pit optimization are due in the next few months.
Presumably neither the independent directors nor management has
access to this information since it would have to be disclosed.
And, presumably, the news can’t be all that negative or Rio would
not be making a cash bid, although we are concerned that Rio now
is clearly conflicted in terms of providing fulsome updates to its
partners and the market. Given the history of poor governance
and repeated attempts at minority suppression, the structural
asymmetry of information, and the bid that is on the table, how can
you be confident that you are or will be informed sufficiently to
determine a full and equitable purchase price?
Third, we are confused by the sequence of recent events. In
January of this year, TRQ and Rio announced an amended Heads of
Agreement (“HOA”) which includes a mandatory minimum $650mm equity
raise by Turquoise Hill to help address the funding gap caused by
Rio’s inability to develop the underground mine on time and on
budget. While it obviously is extremely expensive financing (albeit
slightly less so after today’s announcement), the TRQ Board of
Directors agreed to the new terms. TRQ directors are required by
law to act in the best interest of all TRQ shareholders, not just
their respective employers. Rio’s bid is conditional on TRQ not
raising equity and, if successful with their proposal, will not be
injecting high cost-of-capital equity to finish the underground
development. Why does equity make sense when minorities are
forced to participate but not when the entity which created the
funding shortfall and which has been paid almost $1bn in fees has
100% control?
This leads us to our final point: valuation. Rio is bidding
$2.7bn to acquire the remaining 49.2% of TRQ that they don’t own,
compared to the $6.6bn spent to acquire 50.8% between
2006-2013. Even assuming much lower commodity prices than we
are experiencing today, Turquoise Hill shareholders can reasonably
expect a first dividend as early as 2025. Subsequently, free cash
flow available for distribution ramps up to between $0.5-$4+bn per
year, depending on your view of copper and gold prices. In other
words, the bid represents less than a year of potential free
cash flow for an asset that, according to Rio’s 2021 annual
report:
By 2030…is expected to be the fourth largest
copper mine in the world…It is also one of the most modern, safe,
sustainable and water-efficient operations globally...The size and
quality of this Tier 1 asset provides additional options, which
could see production sustained for many decades.
Rio’s reminder in their proposal that “should Turquoise Hill
investors not accept the Proposed Transaction, Rio welcomes their
continued investment and equal share of future risks and funding
obligations” is laughable. TRQ minorities are the only
investors with pure equity risk in this project and we have
suffered from Rio’s ineptitude along the way. Since Rio is
convinced that “the terms of the proposal are compelling for
Turquoise Hill shareholders,” surely the reverse is true as well.
We would be more than happy to participate in a proposal to
purchase Rio Tinto’s stake in TRQ for C$34/share.
These are not new issues. We first wrote to you on July 19,
2016, expressing our concern that Rio would attempt to leverage its
access to material, non-public information within the context of a
most advantageous governance structure to make an opportunistic bid
for the TRQ minorities’ interest. Furthermore, we have
highlighted repeatedly the potential conflict that exists
between the Turquoise Hill independent directors and minority
shareholders due to your lack of equity ownership. However,
Rio has provided you with a golden opportunity to prove us
wrong. We look forward to your response to their proposal.
In summary, this bid appears to be highly opportunistic, coming
in the midst of an equity overhang caused by Rio’s mismanagement of
both the project and the partnership and just ahead of mine
completion with the accompanying free cash flow that will benefit
all stakeholders for decades into the future. Furthermore, the
commodity backdrop is as attractive as it has ever been, placing a
premium on any long-lived, low-cost reserve base. We expect that
you will review all of your options and will undertake all steps
necessary to ensure that Turquoise Hill’s share price reflects its
status as the owner of one of the most strategically important,
structurally attractive assets in the world. We stand by, as
always, to help in any way that we can.
Best regards,
SailingStone Capital Partners LLC
ABOUT SAILINGSTONE CAPITAL PARTNERS LLC
SailingStone Capital Partners, a division of Pickering
Energy Partners, provides investment solutions in the global
natural resource space with a specific focus on the industrial
businesses, commodities and infrastructure assets which will enable
the energy transition. SailingStone manages concentrated, long-only
equity portfolios for institutional investors.
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SailingStone MacKenzie Davis
ir@sailingstonecapital.com
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