The world鈥檚 second-largest miner, Rio Tinto, (ASX, LON, NYSE: RIO) is facing stronger headwinds over how to finance its massive Oyu Tolgoi underground copper project聽in Mongolia聽after a US hedge fund threatened the company with legal action.
Pentwater Capital, the second-largest shareholder in Rio-controlled Turquoise Hill聽(TSX, NYSE: TRQ), against the mining giant.
The move is a statutory right available to聽鈥渂urdened鈥� 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聽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.
Pentwater Capital will file an 鈥渙ppression鈥� order if Rio Tinto does not allow its subsidiary to take on more debt to fund the $6.8bn underground expansion
鈥淲e do not undertake this lightly, but enough is enough,鈥� Pentwater chief executive Matthew Halbower said in .
鈥淭his 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,鈥� Halbower said.
The dispute over funding the expansion鈥檚 sudden cost increase started to heat up in early November when Turquoise Hill 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鈥檚 attempts to force Turquoise Hill to conduct an equity raise, despite the fact that the current equity price 鈥渟everely undervalues the company.鈥�
The fund noted there are 鈥渕uch cheaper and more advantageous financing options鈥� available to the Canadian company, such as streaming and bond financing.聽
This is not the first time Pentwater has taken issue with the way Oyu Tolgoi鈥檚 expansion is being handled. In April, it聽demanded a shakeup at operation聽over what it claimed was 鈥渁 massive devaluation鈥� of the asset.
Pentwater鈥檚 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 鈥減eople of Mongolia鈥ccountable for Turquoise Hill鈥檚 failings鈥� after it called the country鈥檚 government鈥檚 $7 billion-equity stake in the copper-gold mine 鈥渨orthless.鈥�
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鈥檚 three largest copper mines when operating at full tilt 鈥� now expected to be by 2025 at the earliest.
In January 2018, Mongolia鈥檚 government聽聽in back taxes 鈥斅� the mine鈥檚 second tax dispute since 2014. The company聽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聽聽after protests by Chinese coal haulers disrupted deliveries near the border.
The situation prompted Rio鈥檚 former chief executive Jean-Sebastien Jacques to visit Prime Minister Ukhnaagiin Khurelsuk to discuss how to build 鈥渨in-win鈥� partnerships. The trip was followed by the company鈥檚 announcement that it聽, focused on exploration and building local relationships.
The issue resurfaced later, when a group of Mongolian legislators聽recommended a review of the 2009 deal聽that launched construction of the mine. It also advised revoking a 2015 agreement allowing for an underground expansion.聽
Mongolia鈥檚 parliament聽ended up unanimously approving last year a resolution聽that reconfirms the validity of all the Oyu Tolgoi mine-related agreement. The decision brought an 18-month-long review to a close.
Behind schedule聽and over budget
Mongolia has also complained about overruns in the past. Much of Oyu Tolgoi鈥檚 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鈥檚 most important growth project. Once completed, it is expected to lift the mine鈥檚 production from 125,000鈥�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鈥檚 government and two-thirds by Turquoise Hill. Rio has a 51% stake in the Canadian miner.