Fortune Lost: The short, brutal and costly ride of China Investment Corp. in Canada
Peter Koven and Claudia Cattaneo | May 29, 2015
As May 19th, 2015 approached, China Investment Corp. was faced with a scenario that every pension or sovereign wealth fund dreads: whether to allow one of its key investments to live or die.
SouthGobi Resources Ltd. has become a sad story in Canada’s mining sector. The Vancouver-based company, which operates in Mongolia, is almost entirely out of cash. Its operations are deep in the red. Its CEO recently resigned. And a Mongolian court this year fined the company US$18.2 million in a very dubious tax-fraud case.
SouthGobi had a US$7.9 million interest payment coming due to China Investment Corp. (CIC) on the 19th that it was in no position to pay. State-owned CIC had two options, neither very attractive: call the loan and potentially force SouthGobi into creditor protection, or defer the payment and let the company stagger along for another couple of months trying to seek rescue funding. Not surprisingly, CIC chose the latter.
The mess at SouthGobi is just the latest misfortune among several significant bad calls CIC ended up making in its investments in Canada. Since beginning to stake major capital here six years ago, the corporation’s short experience in Canada is a story of lousy timing, costly miscalculations, and an investment strategy too vulnerable to the allure of speculative ventures talked up by sophisticated stock promoters — and not enough on conservative plays better able to withstand volatile commodity markets.
The Chinese sovereign wealth fund’s involvement with SouthGobi dates back to 2009, when it committed an impressive US$500 million to the company. That same year, it invested $1.7 billion in Teck Resources Ltd. Those deals, which were done shortly after the global financial crisis, when many companies were seeking capital, were the first signs that CIC was interested in Canadian resource companies.
Todd Korol for National PostPhil Hodge, CEO of oil junior Pine Cliff Energy Ltd., has in previous jobs travelled extensively to China and made connections with Chinese investment industry representatives.
And as it turns out, they were only the start of its Canadian buying binge.
“They liked the stability of the investment climate, they definitely were looking for more resource exposure, clearly that was a mandate, and the CIC energy (investment) group had just been formed,” said Phil Hodge, CEO of oil junior Pine Cliff Energy Ltd., who in previous jobs travelled extensively to China and made connections with Chinese investment industry representatives.
Beginning in 2010, CIC made four strategic investments in the oilsands worth about $1.9 billion in total: $500 million in the initial public offering of Athabasca Oil Corp., considered one of the most overpriced IPOs in Canadian history; $1.25 billion in a pair of deals with Penn West Petroleum Ltd., which has been rocked by an accounting scandal and other problems; US$150 million in Sunshine Oil Sands Ltd., a junior oilsands company that at one point had to halt development of its West Ells project because it ran out of money; and MEG Energy Corp., where CIC invested $100 million before the company went public.
MEG shares have plunged 45 per cent since the 2010 IPO. Remarkably, that makes it the fund’s best major oilsands investment over the period. The other transactions were poorly timed near the top of the market, and the companies that received the money are among the very poor performers in the oilpatch.
The investments have led to massive losses and much soul-searching at CIC. Today, the corporation’s big bets on Canadian resources, not counting Teck, are worth less than 20 cents on the dollar.
“In hindsight, it’s unfortunate that with Athabasca and MEG and Penn West and Sunshine, they had some of the poorest investment returns we have had in our sector,” Hodge said. “It’s unfortunate that those were the companies they chose to invest in.”
Doug Kanter/BloombergThe mess at SouthGobi Resources is just the latest misfortune among several significant bad calls China Investment Corp. ended up making in its investments in Canada.
But given the role that Canadians played in CIC’s adversities in this country, we have nothing to brag about, either. What started off as a promising match of interests — Chinese cash looking for resource exposure in a stable country, and Canadian resource companies looking for money to boost output — failed miserably to meet expectations.
“We are blessed with a magnificent resource base and many other attributes that put Canada on the world stage,” said John Zahary, who was CEO of Sunshine Oil Sands after the junior company secured money from CIC and other Chinese entities. But, he said, we “are not decisive enough, we are not fast-moving enough, we are not entrepreneurial enough — though we fancy ourselves as being all of these things.”
We are not decisive enough, we are not fast-moving enough, we are not entrepreneurial enough — though we fancy ourselves as being all of these things
CIC has not made significant investments in Canada for the last couple of years. At this point, that is unlikely to change. The executive team in the fund’s Toronto office has shifted to focusing on trying to manage its best with the hapless investments it already has, in the face of a weak commodity price environment and with limited ability to recover its money.
The humbling experience has made CIC much wiser about what it takes to make money in a country like Canada, such as improving local relationships and investing with more knowledgeable partners. It’s more aware that, in a market economy, it takes more than winning government investment approvals to succeed.
The bullish Canadian entrepreneurs who lured the CIC and its deep pools of Chinese-state capital, no doubt started with the best intentions, but suffered from setbacks typical of emerging companies, including overly optimistic views about the potential of their projects and the rude awakening of a broad global downturn in commodity prices.
CIC was established in late 2007, and immediately became one of the largest money pools in the world. The holding company had two big pieces: a US$200-billion sovereign wealth fund that invested some of China’s foreign reserves abroad, and a fund that held domestic assets, such as government stakes in the Bank of China and the China Development Bank (together, the two funds are worth about $600 billion today). CIC had a very capable CEO at its launch in Lou Jiwei, a former high-ranking executive in China’s State Council.
Jerome Favre/Bloomberg NewsCIC had a very capable CEO at its launch in Lou Jiwei, a former high-ranking executive in China’s State Council.
After launching the sovereign wealth fund, Jiwei and his team immediately started looking for strategic resource investments in overseas markets. The Chinese government of the day was focused on rapid economic expansion that fuelled demand for commodities, and it was keen to buy up stakes in natural resource interests wherever it could find them.
The tricky part would be finding secure places, as several markets were growing wary of Chinese influence. In less stable parts of the world, including certain African markets, the Chinese were increasingly worried about the security of their staff.
But the United States had suddenly become a major question mark after powerful American political opposition in 2005 had forced China’s state-controlled energy giant CNOOC Ltd. to drop an US$18.5-billion takeover bid for Unocal Corp.
The Australian government, meanwhile, had introduced a rule mandating that every investment by foreign state-owned enterprises would be reviewed before approval, no matter how small.
They lost the Unocal deal, Australia got tough, and they looked at Canada and felt: ‘These guys are friendly, let’s go there’
Canada, on the other hand, looked like it made perfect sense for CIC and other Chinese firms looking to expand globally. This was well before Ottawa would pass its own laws restricting Chinese investment, following CNOOC’s 2013 takeover of Nexen Inc., and Canada appeared much more open to investment in natural resources than other Western countries. Most importantly, Canada had a surplus of large energy and mining companies hungry for capital.
“They lost the Unocal deal, Australia got tough, and they looked at Canada and felt: ‘These guys are friendly, let’s go there,’ without spending enough time thinking about the actual business and what it would take,” said Hodge.
Unocal via Bloomberg NewsUnocal workers are pictured at a Unocal gas facility in Thailand in this undated company photo.
When CIC opened its first foreign office in 2011, it stunned many onlookers by choosing Toronto ahead of New York or London. It was read as a signal that the company was excited about Canada’s investment prospects.
In 2009 and 2010, Hodge helped introduce CIC to many oilpatch executives, including at Penn West. He said it was the Chinese that were aggressively pursuing deals in Canada, not the other way around.
When word got out that China’s sovereign wealth fund was targeting Canada, CIC was inundated by pitches from investment bankers and stock promoters eager to get a piece.
Ultimately, CIC would take few of these pitches too seriously. But its first big investment simply came out of a one-time opportunity that was plainly hard to resist.
Teck Resources has long been a well-run mining major with a decades-long track record of success. But in the wake of the 2008 financial crisis, it had run into balance sheet problems and was on the hunt for a capital injection. CIC was happy to step up, making a $1.7 billion investment in the miner in 2009. The deal gave CIC a 17.5 per cent stake in Teck, and CEO Don Lindsay said it would provide his company with much greater knowledge of the Chinese market.
At first, the deal looked like a massive winner for CIC. It financed Teck at $17.21 a share, and the stock subsequently shot above $60. But plunging coal prices have since taken a brutal toll on Teck, which recently slashed its dividend and just this week announced it would shut down six of its Canadian mines for parts of the summer. The company’s stock now trades in the $15 range.
The firm’s next big move was the disastrous US$500-million investment in SouthGobi convertible debentures. According to a source close to the negotiations — who because of the eventual problems with the investment agreed to speak on condition of anonymity — the two sides found each other, with both firms very eager about the partnership.
SouthGobi was backed by Robert Friedland, arguably the world’s most famous mining promoter. But for the negotiations with CIC, SouthGobi called in another influential ally: former Canadian prime minister Jean Chrétien, who it had hired as a senior adviser. SouthGobi was pitching numerous Chinese firms for an investment at the time, including CIC, and the worldly Chrétien was proving to be an ideal ambassador.
THE CANADIAN PRESS/Chris YoungFormer Canadian prime minister Jean Chrétien was hired as a senior adviser by SouthGobi.
“(SouthGobi) would have these dinners where Chrétien would be wheeled out as a speaker,” the source said. “The generation of Chinese people at the time were fascinated to hear these anecdotes about the generation of leaders from 10, 15 years before.”
Much like Teck, SouthGobi was thrilled about a partnership with CIC, figuring it would provide closer links to the Chinese market. Indeed, CIC explicitly pledged to provide “advice and services” to SouthGobi as the miner tried to expand its sales of Mongolian coal to China.
In practice, that never really happened, according to the source. SouthGobi called on CIC numerous times as it tried to make headway with state-owned entities in China, and never felt it got much assistance. And while CIC had won the opportunity to nominate a director to SouthGobi’s board, it never bothered to exercise that right.
“Once the dollars were in the bank, there was no support,” the source said.
Once the dollars were in the bank, there was no support
The SouthGobi situation went off the rails in 2012, after Friedland agreed to sell a majority stake in the company to Aluminum Corp. of China Ltd. Mongolia, with its longstanding distrust of China, was furious to see one of its flagship mines slip into Beijing’s hands. SouthGobi soon found itself the target of a mysterious anti-corruption probe, and its business started to unravel. CIC may recover very little from the SouthGobi investment, apart from some prior interest payments.
Bill Andrew was the president and CEO of Penn West when the Chinese came calling in 2009. His company was trying to sell a big property in the Peace River region of the oilsands because it didn’t fit with its light oil focus.
CIC was just one of many groups that were knocking on Andrew’s door. The parade of interested buyers was so long that he recalls meeting several times a month with investors.
“The McMurray oilsands were booming at that time, and the dreamers among them saw an opportunity with the size of the asset,” said Andrew, who left Penn West in 2011 and is now running Long Run Exploration Ltd., a junior explorer.
Negotiations with CIC, which teamed up with PetroChina to act as its technical partner, took several months and many meetings in Beijing and Calgary. The Chinese visited the properties, although there was little activity happening there at the time.
They knew what they were doing, Andrew said. “Our engineering team went over there (to China), and they went into some of PetroChina’s operations in the interior of China, where they have been involved in heavy-oil production and steaming for decades,” he said. “I would say they were farther up the curve than we were on heavy oil. The Chinese technology on enhanced recovery is very, very good.”
In 2010, CIC paid $817 million for a 45 per cent interest in the Peace River project. The Chinese firm also agreed to pay $435 million for a five per cent interest in Penn West itself, hoping for a long-term relationship with the Canadian company.
Just four years later, however, Penn West would find itself in deep trouble, after the company admitted in 2014 that it had discovered senior finance and accounting personnel had misstated results. Things only got worse after the company grew strained with too much debt when oil prices collapsed that same year. Just this week, Penn West was able to strike a deal with creditors that would buy it more time, agreeing to sell assets to pay back bondholders. One of the assets on the block is the Peace River project. Today, the company’s entire market capitalization is worth barely more than the CIC’s original investment.
Handout/ Penn West EnergyOne of the Penn West assets on the block is the Peace River project.
While Andrew says he regrets that the deal didn’t live up to expectations, he maintains that the oilsands are a long-term game that will pay off over time.
But CIC’s investment in another oilsands play, Athabasca Oil’s IPO, would serve as another major letdown from a plan once so full of promise. CIC purchased $500 million of the company’s much-hyped $1.35-billion offering at $18 a share in 2010 — a deal that made a fortune for insiders including former chairman Bill Gallacher and former CEO Sveinung Svarte.
Athabasca’s stock is worth about $2 a share today. The company had a series of setbacks, including problems with oilsands partnerships with PetroChina.
CIC can claim at least one decent bet in Alberta’s oilsands: its investment in MEG Energy, the oilsands producer that has successfully developed several in-situ properties. Of course, like its peers, MEG has lately been heavily challenged by low oil prices. And CIC’s initial investment was, in any case, relatively small at $100 million. It has since been further reduced, although CIC hasn’t disclosed by how much.
These days, meetings at CIC’s offices over potential Canadian investments are far less frequent than they used to be.
Felix Chee, the former head of the Toronto office, stepped down in 2013 as major Canadian losses mounted, although he retains a seat on Teck’s board of directors. Chee was succeeded by Winston Wenyan Ma, a New York University-educated lawyer who relocated from Beijing. Ma is CIC’s only managing director outside of China.
Kevin Van Paassen/BloombergWinston Wenyan Ma, managing director and head of the North America Office for China Investment Corp., speaks during a panel discussion at the Bloomberg Canada Economic Summit in Toronto, Ontario, Canada, on Thursday, May 21, 2015.
The Canadian losses have contributed to CIC’s disappointing overall performance. From its 2007 launch to the end of 2013, the fund’s cumulative annualized return from its overseas portfolio was 5.7 per cent. That’s a far poorer record than the S&P 500’s, up 21 per cent over the same period (CIC’s 2014 performance numbers are not yet available).
Nor have all those bad bets gone unnoticed back in Beijing. In June 2014, China’s National Audit Office accused CIC of mismanagement. An audit found that there was dereliction of duty and inadequate due diligence in 12 investments made abroad between 2008 and 2013. It did not, however, identify the companies by name.
CIC has never commented publicly on its unpleasant Canadian investment experience. Perhaps the closest it has ever come was in its 2013 annual report, where the firm revealed that it overhauled its risk management strategy. CIC noted that it reinforced its “pre-investment risk identification” and closely scrutinized investments with “high concentration and underperforming strategies, sub-strategies and external managers.”
“As CIC embarks on steady growth, we will redouble our efforts to identify, monitor, evaluate and respond to investment and operational risks, and refine our risk management at all levels,” it added.
Certainly the oil downturn has been responsible for a lot of CIC’s lousy track record in Canada. But Hodge notes that the corporation had more than its share of bad luck. The companies it picked had some of the poorest investment returns in the sector.
They just didn’t choose the right management teams
“They just didn’t choose the right management teams,” he said. “If they had been invested in ARC (Resources Ltd.), or Vermilion (Energy Inc.), or Bonterra (Energy Corp.), they would have still suffered, because all the companies are down. But not nearly in the same degrees.”
At the same time, CIC did not get involved in the biggest and least volatile companies in the oilsands, such as Suncor Energy Inc. and Canadian Natural Resources Ltd. Of course, those firms didn’t need CIC’s money back in 2010, and perhaps they did not want the challenges associated with having a strategic Chinese investor.
“(CIC) doesn’t play in the market much. They want to have a direct connection to the company, and it takes two to tango,” said Joyce Lee, a partner at McCarthy Tetrault LLP who has worked on many deals between Chinese and Canadian companies.
To some degree, the poor performance was also partly self-inflicted by Chinese government policy. The country’s priorities changed under President Xi Jinping, who has favoured slower growth, more domestic consumption, and a reduced dependence on non-renewable resources. That change has contributed to globally weaker commodity prices, particularly oil.
SAUL LOEB/AFP/Getty ImagesChina’s priorities changed under President Xi Jinping, who has favoured slower growth, more domestic consumption, and a reduced dependence on non-renewable resources.
But Zahary, the former Sunshine Oil Sands CEO, said Canada bears some responsibility as well. He believes China’s poor performance reflects badly on the country’s investment market and other global investors are taking note.
The Chinese deployed their cash in Canada based on assumptions that this is a country that welcomes foreign investment and offers political and fiscal stability, added Zahary, who is now the president and CEO of Altex Energy Ltd.
In reality, what they found were unusually high costs, inefficient government decision-making, fierce activist opposition to new energy infrastructure, and a general ambivalence towards Chinese capital.
“The world is a big place and these are big (Chinese) companies and they can go to other locations,” Zahary said. “They haven’t given up on these assets, and they hope to reclaim their investment and make a good rate of return, but for the time being, they are not pounding lots of money into this until we get our act together.”
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