‘Never trust a smiling cat’ has the ring of a Chinese proverb about it. It should be committed to memory by anyone wishing to do business in the Middle Kingdom. Here are two stories that explain why.
The first concerns a British AIM-listed exploration company that decided to look for gold in the hills of south western China. Things progressed quite nicely at first but, as with all mining ventures, constant injections of cash were needed. Then a friendly Chinese investor came forth to offer a nice injection of capital in exchange for a share of the project. With this money in the bank, our explorer was able to prove there was a nice amount of gold just waiting to be dug out of the ground.
At this point the investor returned and announced that he would like to acquire 100% of the project. He named his price: five million dollars. This was so far below the value of the prospective gold mine that the British explorer first thought that the investor was simply trying it on. Then it gave him the benefit of the doubt and assumed that he was just naïve.
But it wasn’t the investor that was naïve, it was the exploration company. The investor then simply stated that if he did not get the whole project for $5m he would arrange for the water supply to be cut off.
In an essentially lawless country, the explorer could do nothing except concede defeat.
The tale of the two-faced shareholder
The second story concerns Kryso Resources (KYS:LON). Kryso has a nice gold project in Tajikistan, a country that has a border with China. So far, it has discovered three million ounces of gold. But the vein stretches further down the valley, and much more could yet be found. Assuming that the gold price stays anywhere close to its current level, the project offers handsome financial returns. But the question is – into whose pocket will the profits fall?
Key to this is the dubious intentions of Kryso’s major shareholder, the China Nonferrous Metals International Mining Co Ltd (‘CNMIM’). CNMIM holds 29% of the shares along with a large number of warrants. The latter are exercisable at 21p, and if exercised would take CNMIM’s shareholding to 44%. This would trigger an obligation to make an offer for the entire share capital at a price that could not be lower than 21p. Of course, if the other shareholders want to maintain their interest in the mine they could reject such an offer.
But adding to the intrigue is the identity of Kryso’s second largest shareholder. This is the Hong Kong based Golden Max investment group. They were originally responsible for introducing CNMIM to Kryso. Golden Max has 13% of Kryso’s shares. Their voting in favour of a take-over bid by CNMIM could deliver the company into the hands of the Chinese giant.
But is this CNMIM’s agenda? For now, there is a more pressing matter. Having put £11m into Kryso in return for its 29% stake, CNMIM now has two members on the board. One of these is the Chairman Mr Luo Tao. He is described as a communist and one of the three hundred men who run China.
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A loan that could be rigged to default
As I mentioned, CNMIM holds warrants and two places on the board of Kryso. It will lose the warrants and one of the board places unless it uses its ‘best endeavours’ over the next three months to help Kryso get the finance needed to build the mine. Although ‘best endeavours’ may sound woolly, it is enforceable under British law. It is not something that CNMIM can simply ignore.
So over the next three months Kryso is expecting CNMIM to introduce it to a number of potential Chinese lenders. That sounds reasonable enough, but there is a twist. CNMIM sits of a cash pile of $2.5bn and for the greater good of the motherland is under instructions to finance overseas mining ventures. So it would prefer to lend Kryso its own money.
That throws up another scenario. CNMIM could use its influence on the board to cause Kryso to default on the loan. Since this loan would be secured against the assets of the mine, a default could deliver the whole project into CNMIM’s hands without it having to make a formal take-over bid.
Although there is nothing to suggest that CNMIM has such dishonourable motives, the Chinese are not described as inscrutable for nothing. How will it end? If CNMIM tries to deliver the project into the hands of its lending arm, it’s certainly bad news for Kryso’s other shareholders.
But if CNMIM does the decent thing, secures finance and then sees the share price jump to 21p, it could than launch a take-over bid at a knock-down price. At this stage of the game, the Chinese are holding the better cards.
Until next time, happy investing! And remember, beware of smiling cats.
• This article was first published in Tom Bulford’s twice-weekly small-cap investment email
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