Wednesday, June 17, 2020

Will the market lend USD500 million to a Canadian reverse merger with a collapsed stock, marginally unprofitable gold mines in China, and a non-legally binding State guarantee?

China Gold International (CGG-TSE) is a Canadian listed company with two not particularly good gold mines in China. One of these mines is very large (but is also directly mortgaged to Chinese banks).

The stock was a reverse merger back-in-the-day. But that was almost twenty years ago. The name on the original reverse merger document is Rui Feng. This is the same Rui Feng associated with Silvercorp Metals. Silvercorp had a famous but ultimately inconclusive fight with short-sellers who alleged fraud.

There are a long collection of past directors who merged in companies with names like "Rapid Results" and who have a record of association with collapsed reverse mergers but those people are long gone.

China Gold International has risen far beyond its origins. It has two real (but sharply underperforming) gold mines. And it has a very high quality shareholder.

Top if the register with over 39 percent is China National Gold.

China National Gold is
  • one of only about 100 centrally owned State Owned Enterprises (SOEs) in China,
  • the biggest gold miner in the world by ounces and revenue 
  • able to borrow as a AAA in China, and having recently completed large bond offerings at low spreads obviously fairly liquid.

This is a very high quality shareholder - especially for a company with reverse-merger origins.

The high quality shareholder however can't be particularly pleased with the stock they bought into.

China National Gold bought into what was then Jinshan Gold Mines Inc buy buying out a position held by (Robert Friedland's) Ivanhoe Mines. They paid Canadian $3.18 per share and they also paid out Ivanhoe on some minor debt provisions. You can find the original press release here (and original source here).

The stock had a little bit of a run-up and then a run down - and then in 2011 China National Gold purchased another 412 thousand shares in the open market. You can find the original press release here (and the original source here).

But since then the stock has just gone down and down and become very illiquid. Here is a chart for the stock over the past ten years courtesy of CapitalIQ.




The stock is now Canadian 56c down from a peak around $6. It is a little worse if measured in Yuan or US Dollars because the Canadian currency has also lost some value. Measured in Yuan the stock has lost well over 90 percent of its value.

The market cap is now Canadian 222 million or 163 million USD. The China National Gold stake is worth about USD65 million if they could sell it. They probably could not because the Canadian stock now has low liquidity.

This is consistent with mines that have (fairly sharply) underperformed the engineering and reserve studies laid out for them about a decade ago.

China Gold International traded debts

Being a shareholder is not the only relationship that China National Gold has with China Gold International. They are the (sole) customer for metal concentrates and gold doré produced and they provided most of the equipment and engineering services needed to actually build the two above-mentioned mines.

By the time you get to the 2013 annual report (copied here) the company has extensive related party transactions where the mines are developed almost entirely by paying China National Gold subsidiaries for detailed engineering services. By the end of 2013 the company owed China National Gold a lot of money (and it still had more money to pay to China National Gold). [The multiple pages detailing related party transactions start on P.16.]

In 2014 China Gold International with the support of China National Gold went to the Hong Kong market to pay for all this. They issued USD500 million in three year debt in 2014. That debt was repaid in 2017 and another three year debt was issued. The 2017 issuance is due for repayment in early July of this year and as of the time of printing China Gold International clearly does not have the money (though may be able to raise it).

This debt is issued through Skyland Mining (BVI) limited - a British Virgin Islands company that was at one stage the owner of the more valuable of the two China Gold International Mines. The debt is guaranteed by Canadian parent company.

I wondered whether it would default. That would of course make China Gold International (the guarantor of the debt) a great short. The combination looked pretty sweet to me. A large amount of short-dated debt and underperforming mines on a stock that is an old reverse merger is is the sort of thing that makes short-sellers salivate.

Alas it is not so simple. Bloomberg says pretty clearly that the debt is guaranteed by China National Gold.

Here are some cut-and-snips from our Bloomberg machine. Here is what Bloomberg says about the bond issue:



This clearly delineates the issuer as Skyland Mining BVI LTD and states unequivocally that there is letter of support by China National Gold Corp.

As China National Gold Corp is amongst the more solvent and liquid Chinese SOEs this debt trades as a quasi-Chinese sovereign debt.

If you go back to the press releases when the debt was issued Bloomberg also clearly states that the debt was issued with a letter of support.


And this is where a short-case ends. I do not feel like shorting the Chinese National Government. This debt trades at par, and if it is really supported by China National Gold it deserves to trade at par.

Trust but verify

I am however an intense fan of Ronald Reagan's approach to dealing with the Russians (or in this day-and-age the Chinese). The Reagan approach was to "trust but verify".

I went looking for the original offer document to find this letter of support.

Bloomberg had no document that verified that a letter of support existed.

So I looked a little harder. Actually a lot harder. And here is what I found.

The 2014 debt issuance

The 2014 debt issuance is explained in the 2014 CGG annual report. To quote:
On July 10, 2014, the Company, its wholly-owned subsidiary, Skyland Mining (BVI) Limited (the “Issuer”), China National Gold and Standard Chartered Bank, Citigroup Global Markets Limited, Merrill Lynch International and CCB International Capital Limited (the “Joint Lead Managers”) have entered into a subscription agreement (the “Subscription Agreement”) pursuant to which the Issuer has agreed to issue to the Joint Lead Managers, and the Joint Lead Managers have agreed, severally and not jointly, to subscribe for bonds in an aggregate principal amount of US$500 million (equivalent to approximately HK$3,900 million) at an issue price of 99.634% (the “Bonds”) bearing interest at the rate of 3.5% with a maturity date of July 17, 2017, rated BBB- by Standard & Poor’s. The bonds were unconditionally and irrevocably guaranteed by the Company. The net proceeds would be used for working capital, capital expenditures and general corporate purposes of the Company. 
On July 17, 2014, all the conditions precedent to the issue of the Bonds as set out in the Subscription Agreement were satisfied and the issue of the Bonds was closed. The Bonds were listed on the Stock Exchange of Hong Kong Limited on July 18, 2014. Details of the Subscription Agreement are stated in the Company’s announcements dated July 11, 2014 and July 18, 2014.
You will note that in this China National Gold was a participant in the subscription agreement.

Also to confuse matters the press releases are not dated 11 July and 18 July. They are in fact dated 10 July and 17 July. I guess this could have been an effect of the International date line between the Hong Kong listing and the Canadian listing.

That said you can find the 10 July press release here (original here) and the 17 July press release here (original here). They detail all the conditions of the bonds.

The 10 July 2014 press release starts as follows:

VANCOUVER, July 10, 2014 – The Board of Directors of China Gold International Resources Corp. Ltd. (TSX: CGG; HKEx: 2099) (the “Company”, the “Guarantor” or “China Gold International Resources”) is pleased to announce that on July 10, 2014, the Company, its wholly-owned subsidiary, Skyland Mining (BVI) Limited (the “Issuer”), China National Gold Group Corporation (the “Keepwell Provider”) and Joint Lead Managers as defined below, have entered into a subscription agreement (the “Subscription Agreement”) pursuant to which the Issuer has agreed to issue to the Joint Lead Managers, and the Joint Lead Managers have agreed, severally and not jointly, to subscribe for bonds (the “Offer”) in an aggregate principal amount of US$500 million (equivalent to approximately HK$3,900 million) at an issue price of 99.634% (the  Bonds”) bearing interest at the rate of 3.5% with a maturity date of July 17, 2017, rated BBB- by Standard & Poor’s.

This press release clearly states that China National Gold Corporation is a "Keepwell provider".

CapitalIQ also has the original offering documents. For those with a CapitalIQ subscription you can find them here - but I have downloaded here. This document confirms China National Gold as a Keepwell provider. [Incidentally the dates on the Capital IQ releases match the annual report again suggesting that it was a dateline issue.]

We can be pretty sure that the credit on the 2014 bond issuance was supported by China National Gold.

You would expect it to be money-good regardless of the performance of the underlying mines.

And it was. The issuance was repaid in 2017 and another USD500 million was borrowed in the Hong Kong market.

The 2017 debt issuance

The 2017 debt issuance looks somewhat different. Again we can find a description in the CCG annual report (in this case the 2017 annual). Here is the text:

On June 27, 2017, the Company, Skyland Mining, China International Capital Corporation Hong Kong Securities Limited, Citigroup Global Markets Limited, CCB International Capital Limited, Industrial Bank Co., Ltd. Hong Kong Branch and Standard Chartered Bank (the “Joint Lead Managers”) entered into a subscription agreement (the “Subscription Agreement”) pursuant to which Skyland Mining agreed to issue to the Joint Lead Managers, and the Joint Lead Managers agreed severally and not jointly, to subscribe for bonds in an aggregate principal amount of US$500 million (equivalent to approximately HK$3,880 million) at an issue price of 99.663% (the “Bonds”) bearing interest at the rate of 3.25% with a maturity date of July 6, 2020, rated BBB- by Standard & Poor’s. The Bonds were unconditionally and irrevocably guaranteed by the Company. The net proceeds are used for repaying existing indebtedness, working capital and general corporate purposes of the Company. 
On July 6, 2017, all the conditions to the issue of the Bonds as set out in the Subscription Agreement were satisfied and the issue of the Bonds was closed. The Bonds were listed on the Hong Kong Stock Exchange on July 7, 2017. Details of the Subscription Agreement are stated in the Company’s announcements dated June 27, 2017 and July 6, 2017.
This differs in one key respect from the 2014 disclosure. China National Gold is not a party to the subscription agreement.

The press releases dated June 27, 2017 is here (original here).

The press releases dated July 6, 2017 is here (original here).

Here again is the opening paragraph of the first release.

VANCOUVER, June 27, 2017 – The Board of Directors of China Gold International Resources Corp. Ltd. (TSX: CGG; HKEx: 2099) (the “Company”, the “Guarantor” or “China Gold International Resources”) is pleased to announce that on June 27, 2017, the Company, its wholly-owned subsidiary, Skyland Mining (BVI) Limited (the “Issuer”) and Joint Lead Managers as defined below, have entered into a subscription agreement (the “Subscription Agreement”) pursuant to which the Issuer has agreed to issue to the Joint Lead Managers, and the Joint Lead Managers have agreed, severally and not jointly, to subscribe for bonds (the “Offer”) in an aggregate principal amount of US$500 million (equivalent to approximately HK$3.88 billion) at an issue price of 99.663% (the “Bonds”) bearing interest at the rate of 3.25% with a maturity date of July 6, 2020, rated BBB- by Standard & Poor’s.

You will note that China National Gold appears nowhere in this. The "Keepwell" has disappeared. China National Gold is not mentioned in either release.

Again CapitalIQ has a page on this bond (here) and if you have a subscription you can download a longer-form offering document. I have saved it here.

Again it contains no reference to China National Gold or to a Keepwell agreement.

Bloomberg isn't right here - but it turns out it is not unequivocally wrong

Bloomberg is pretty unequivocal - the 2017 bond expiring in early July this year has a letter of support from China National Gold.

But that letter of support does not exist in China Gold International's own press releases.

Bloomberg however is a pretty reliable source normally and so after much scrounging we actually got a copy of the offering document from one of the original brokers. You can find it here.

This offering document lays out what is meant by the letter of support - because yes - there is a letter of support from China National Gold.

The Letter of Support is neither legally binding nor a guarantee, and the Company is not legally obliged to support the Issuer and the Guarantor in the manner contemplated in the Letter of Support. 
The Letter of Support is not legally binding on the Company [which in this case is the SOE]. See “Summary of Letter of Support”. It is not a guarantee by the Company for the payment obligations of the Issuer under the Bonds or the Guarantor under the Guarantee, and there is no assurance that the Company will provide support to the Guarantor in the manner contemplated in the Letter of Support. The Trustee will not, in any circumstances, be able to bring any action against the Company to enforce the provisions of the Letter of Support. Even if the Company intends to provide direct financial support to the Guarantor to meet its outstanding debt obligations, such financial support may be subject to governmental approvals which may not be obtained.
They go on in the offering documents. All it says is that China Gold International occupies a strategic position in the China National Gold group. And hence it is likely that China National Gold will support the debt. It is a non-guarantee guarantee.

Now those 2017 bonds are about to expire (early July this year) and so China Gold International needs to refinance them.

And it is fair to say that the underlying gold mines have sharply underperformed expectations in those three years with the company producing losses in both 2018 and 2019.

China Gold International are cumulatively unprofitable reverse merger with over a billion USD in debt and a collapsed stock price. They are not repaying the money unless someone lends them another cool half billion.

But as they have to come to market they are trying to come to market.

There is a press release in Chinese that explains that they are coming to market for a debt issue of unspecified size. The press release mentions a letter of support from China National Gold but no mention as to whether this letter is a guarantee (as per the 2014 debt issue) or a prop with no legal power (as per the 2017 debt issue).

I guess if there were legally binding state guarantee as per the 2014 issue then there should be no problems getting this done. I guess this is a test of what is required get a deal done.

But as it stands this is a test if a company which barely trades at all and with a collapsed stock and some sharply underperforming gold mines can raise a half billion dollars supported by what appears to be a fictional quasi-government guarantee.

But in this market even that seems likely. As long as it yields over 100 bps. Long live loose monetary policy.





John

Disclosure: we have no position in the stock. We have a small position short the bonds.

7 comments:

Anonymous said...

What mechanism did you short the bonds with? CDS? How can we play along at home?

John Hempton said...

I borrowed the bonds using a standard prime broker arrangement and sold them.

Alas I do not think you can play along at home.

Anonymous said...

China Gold International - China’s Love of Gold – 3-5X Return on Capital https://www.smartkarma.com/insights/china-gold-international-china-s-love-of-gold-3-5x-return-on-capital

Kelvin said...

John, even the Keepwell agreement in 2014 is not a guarantee. This issue is currently litigated in another unrelated case >>> https://www.fitchratings.com/research/corporate-finance/keepwell-structure-for-china-offshore-debt-faces-court-test-12-05-2020

Anonymous said...

Wow US$300MM issued at T+260 and BBB- rating from S&P with a cavalry charge of bookrunners. The listing on the Macau exchange seems somewhat apt.

Andre Surkis said...

I think that Reagans approach was to "trust but verify" can be used in any situation.

UplayOnline said...

How can we play along at home? คาสิโนออนไลน์

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