How to hit the jackpot as a natural resources play

PUBLISHED : Saturday, 04 July, 2009, 12:00am
UPDATED : Saturday, 04 July, 2009, 12:00am
 

How do I turn my company into a natural resources play?

Given the rebound in natural resources and commodities stocks, it's like asking how to hit the jackpot.

The answer might be easier than you think, at least in a Hong Kong context.

Let me walk you through the presumed hurdles, drawing lessons along the way from a company named Bright Prosperous Holdings that has seen its stock price triple after announcing a plan to buy some forests.

Hurdle No1: I will need exploration rights to some natural resources with reserves and valuations proven by experts.

Not really. An agreement to negotiate for a purchase agreement will do.

When Artel Solutions Group, a computer component distributor, recently announced the signing of a framework agreement to start negotiations to buy 28 per cent of a mainland coal miner, its stock shot up 25 per cent.

Sure, it would be better if you actually had someone signing a contract to sell you something. It could be oil in Madagascar or coal in Mongolia. But in fact, any little known natural resources in any little known place on earth will work.

In the case of Bright Prosperous, it's a total of 270,000 hectares of forest in Russia and the Amazon region; plus a timber processing plant in Manzhouli owned by a Samoan company. (For those who need a map to understand this paragraph, I know how you feel.)

The price tag is HK$1.8 billion. You need the valuation to be verified by accountants and technical experts to get the shareholders' approval. Sounds too difficult? Wait.

The auditor, in this case, Grant Thornton, issued a disclaimer of opinion on the accounts of the Russian subsidiaries that hold the forests because the books made available for audit were incomplete.

It doesn't matter. The company maintained in its shareholders' circular that there is no reason to back down because it 'has inspected the titles' to the forests, 'obtained a legal opinion on the good titles', and 'conducted due diligence visits to the Russian forest'. It added that it 'intends' to engage a United States auditor to review the Russian subsidiaries' accounting system and would hire Russian accountants.

But what about the appraisal by an independent technical expert?

The Hong Kong stock exchange listing rules are more specific about the qualification of the expert and his or her valuation approach when it comes to mining. With forestry, the rules say nothing.

Another company, Samling Global, hired international forestry experts to conduct site visits and aerial surveys and ended up with a 313-page expert appraisal report.

Bright Prosperous hired a Hong Kong-based valuer, Greater China Appraisals, which based its valuation on the advice of a Russian valuer and Brazilian forest engineer.

The conclusion of its 21-page forest valuation report put the estimate at US$316 million. Greater China Appraisals multiplied the market price of the timber by the total volume of the forest. The appraisal was 'based on information supplied by the company and various government bureaus without verification', the valuer said.

With a contract, an audit report and an appraisal in the bag, the job is almost done.

But that brings us to the second hurdle: management expertise.

Naturally, you would assume that to become a natural resources play, a company would need proven and related expertise.

The answer is a big 'No'. The listing rules do not demand expertise. The fact is you don't even have to disclose who you are.

After buying into the forest with loads of new shares and cash, Bright Prosperous will see 92.9 per cent of its stake in the hands of a company named Winner Global. It did not disclose the owner of the shell company.

Despite this, the company's management could still maintain that it had 'obtained a thorough understanding of the operation of the business via discussion with the vendor'.

Isn't it easy? However, I hear some of you say: 'But don't I still have to deliver in the end to become a real natural resources play?'

The answer again is 'No'. You see, in real life, there are many reasons for a deal to fail. Say the seller asks for a higher price, a legal dispute breaks out, local rules ban foreign investment or something extraordinary happens.

Bright Prosperous had a bad experience in the past. In March last year, the company bought a mainland magnesite mine with HK$1.6 billion worth of shares and cash.

Six months later, the deal was cancelled because 'a large disorderly crowd of about 300 people' occupied the mining site and the operation came to a halt.

The company said the problem originated from a dispute between the seller of the mine and the local villagers - and the management was not in a position to estimate when and how the row would be settled.

Sure, the share price might have gone up significantly in between and some people might have profited from that, but as the management said: 'As the interruption did not occur until recently, the company could not have been aware of the matter during its due diligence.' How very true.

Okay, here we come to the last hurdle: Make sure you give your company a good name. That's very important. Remember when the swine flu hit, share prices of every pharmaceutical stock rose, even those that produce nothing but vitamin C. A name matters.

Bright Prosperous is a believer in the charm of a good name. In October 2007, it was called Anex International. In March last year, it became Magnesium Resources Corporation of China. After the disposal of the magnesite mine, it got its current name.

So, are you ready to give it a go?

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