Ivanhoe: Giving Away the House to Rio Tinto?

Ivanhoe Mines taps mining giant Rio Tinto for much-needed help on a huge copper and gold project, but investors think Ivanhoe may be giving away too much leverage.
By Eric Rosenbaum ,

NEW YORK (

TheStreet

) -- The steep decline in shares of

Ivanhoe Mines

(IVN)

on Wednesday can be divided into two separate investor concerns: first, an immediate and negative take on valuation, and second, a sense that the speculative mining play is losing longer-term leverage to sell itself on the best terms.

Ivanhoe Mines announced concurrent to a new deal with

Rio Tinto

(RIO) - Get Report

to fund its Mongolian copper and gold project, Oyu Tolgoi, that Ivanhoe will be issuing $1.2 billion in shares. Ivanhoe also provided a capex forecast that was much higher than the company's previous capex plan.

Ivanhoe Mines shares were down 13% near midday, and trading of 7 million shares was well above the less than 2 million average trading volume for the speculative mining play.

The knee-jerk reasons for the selloff were the valuation call on the mining company's stock as a result of the dilution to come from the rights issuance, and the negative surprise on capex.

Earlier in the year, Ivanhoe Mines guided the Street to capex of $4.6 billion. Now the mining company is saying that after having already spent $1.4 billion this year, it still needs another $4.6 billion.

While Ivanhoe already had a rights offering on file, the amount that the mining company said it would seek to raise -- $1 billion to $1.2 billion, represented a 20% increase over its existing plan.

"The dilution from the additional shares and the additional need for capital are a negative. On capex, that's a material change from what the company has told us. Based on today's announcement I can understand why the stock is getting hit," said mining analyst Adam Graf of Dahlman Rose.

The longer-term read about Ivanhoe, though, may be related to the history of its CEO, Robert Friedland. Friedland was the main character in a book called

The Big Score

, and based on his successful navigation of the mining M&A game in the 90s, when he pitted nickel mining giants Inco and Falconbridge against each other in a bidding war for control of assets in Voisey Bay, Canada. Inco ultimately paid $4.3 billion, the largest takeover price at that time for a mining property.

Given Friedland's history and the end-game for a company like Ivanhoe Mines always being to involve the majors in a bidding war for the company, the latest machinations in Rio Tinto's control of the company might deflate the long-term hope of some investors that Friedland will be able to pull off another Inco-style coup.

With the new deal, Rio Tinto has become manager of the Oyu Tolgoi project.

Rio Tinto also now has the right to own up to 49% of Ivanhoe. Previously, Rio Tinto had the right to own up to 46.6% of Ivanhoe through October 2011. The 49% cap on Rio Tinto ownership is in place until January 2012.

Rio Tinto is also providing $1.8 billion interim financing for the Oyu Tolgoi project as the companies seek to complete an international project finance plan by June of next year.

The Ivanhoe announcement specifically said the corporate governance measures -- including a board composition agreement that Rio Tinto won't seek disproportional representation -- assure that the company is still working to achieve maximum value for shareholders.

However, not everyone was convinced. "Perhaps there's the feeling that Ivanhoe is losing some leverage to Rio Tinto with this agreement," the mining analyst said.

All of the terms of the deal, from the interim financing to the 49% interest, suggest that Rio Tinto is gaining leverage over Ivanhoe in any final type of purchase of the company, and the market may be interpreting this to mean less of an opportunity for a competitive-bidding scenario.

"The end game of a significantly higher price versus current market valuation may be less likely," the mining analyst said. "The straight valuation aspect to the selloff is understandable, but a sentiment trade about a lower takeout premium for Ivanhoe could be exerting pressure also," Dahlman Rose's Graf said.

Ivanhoe Mines has always been Rio Tinto's company to "take out," and Friedland has always assured investors that the company will maximize value for shareholders even though Rio Tinto has long been in the driver's seat among suitors. However, there may be a little more skepticism today about takeout premium with the latest leverage gained by Rio Tinto.

-- Written by Eric Rosenbaum from New York.

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