Bumi, Abu Dhabi and the Chinese sovereign fund: so who won?

Institutional Investor sovereignwealthcenter.com, October 2013

On October 9, China’s sovereign wealth fund, the China Investment Corporation, agreed a deal with an Indonesian mining company called Bumi Resources to swap $1.3 billion of debt into equity in a range of Indonesian mining assets. $1.3 billion is a lot of money in anybody’s book, even a sovereign fund, but the deal is more significant than that: it ends an unusual foray by CIC into being more of a bank than an investor, and it brings to an end a curious situation in which two of the world’s most powerful sovereign wealth funds found themselves on opposite ends of the same trade.

Since 2009, both the CIC and the Abu Dhabi Investment Council had made significant investments in two Bumi companies linked to Indonesia’s powerful Bakrie family and to the British financier Nathaniel Rothschild, a member of one of the most storied banking families in UK history.

Each sovereign fund was invested in a different entity, and their interests have until now never been aligned. And the lesson is that when two powerful funds end up positioned in this way, one thrives while the other gets burned.

China has been the victor in this arrangement, with its income partly, and indirectly, coming at the expensive of ADIC. Only now, with both sovereign funds holding equity in related assets, will they really both be looking for the same outcome. But the process of getting to this point has been tangled, and requires explanation of several years of bruised expectations.

*

Bumi Resources is an Indonesian coal mining company controlled by the Bakrie family, who have been part of the fabric of Indonesian business since the country’s time as a Dutch colony. Today, the Bakrie empire includes plantations, steel, telecommunications and real estate, and one of its members, Aburizal Bakrie, has held positions in government.

An earlier form of the company, then in hotels and tourism, was listed in Jakarta in 1990, and was acquired by the Bakrie family in 1997, who in August 1998 resolved at an extraordinary general meeting to shift it into oil, natural gas and mining. It acquired 97.5% of Gallo Oil and changed its name to Bumi Resources. It assumed its modern form in a series of acquisitions over the next few years, first buying 80% of PT Arutmin Indonesia, then the fourth largest coal producer in Indonesia with four open-cut mines, from BHP Minerals Exploration in 2001 (it gained the balance in 2004, then sold 30% of it to Tata Power in 2007); and then buying Kaltim Prima Coal in 2003, making it Indonesia’s largest coal producer and one of the largest thermal coal exporters in the world. This asset was subsequently divested into various different business units, and 30% of this, too, went to Tata Power in 2007, but the 65% it holds today remains the heart of the company. It also bought Herald Resources of Australia for A$552 million in 2008, bringing zinc, lead and gold operations in North Sumatra into the group; today those assets exist in a separate listed holding company called Bumi Resources Minerals, in which Bumi Resources holds an 87.09% stake.

The Bakrie Group has a track record of rapid expansion and then challenges with debt. It almost went under in the Asian financial crisis, then rebounded as the country did afterwards. While Indonesia largely came through the global financial crisis unscathed, debt-laden companies did suffer; on one occasion in October 2008 shares in Bumi Resources dropped 32% in one day following a plunge in world coal prices and were suspended. There was a clear need for more capital, and so in 2009 Bumi Resources announced an investment by the China Investment Corporation.

The CIC has a long-standing interest in regional resources plays, so in one respect this was no surprise. Around the same time, it was also investing in Mongolia’s SouthGobi Energy Resources, Singapore’s Nobel Group, Russia’s Nobel Holdings, and Kazakhstan’s JSC KamMunaiGas Exploration Production. But generally these investments involved buying a stake in a business or project, or in the case of South Gobi, investing in a convertible debenture with the potential to convert into common equity.

What was different about the Bumi transaction was that there was no equity element to it, neither at the time nor planned for the future. CIC, in its announcement on November 5 2009, called it a “strategic investment”, alongside a strategic alliance through which CIC may “facilitate or participate in the future financing needs of Bumi or its affiliates, including project finance for its expanding infrastructure.” Bumi Resources itself was more specific: the investment was what it called “a debt-like instrument”, with US$600 million repayable in year four, US$600 million in year five, and the remaining US$700 million in year six. “The investment attracts a 12% annual cash coupon with a total IRR of 19%, the balance payable at the time of final maturities,” said Bumi Resources in a note to shareholders. The funds, it said at the time, would be used for debt restructuring and capital expenditure.

While the investment was unusual for CIC, that 19% figure helps to explain the appeal. But what of creditor risk? “”Although the Bakries do get into trouble, they actually do repay their creditors,” says Chris Leahy, a member of the secretariat at the Asian Corporate Governance Association, and co-founder of strategic advisory group Blackpeak. “They don’t haircut people generally.”

Leahy is not, though, a fan of the way the Bakries do business. “Bumi Resources, the Bakries and the term ‘good governance’ shouldn’t be used in the same sentence,” he says. “This is a company and a group that time and time again has proven that it doesn’t really understand the concept, and chooses not to practise it.”

At this stage entered Nathaniel Rothschild.

Nathaniel is a member of the renowned Rothschild banking family, and is chairman of JNR Limited, an investment advisory business. It is important to distinguish him from NM Rothschild & Sons, the financial advisory group built by the Rothschild family, and from RIT, which is chaired by his father, Jacob. But nevertheless, his has been a lively career – former co-chairman of hedge fund Atticus Capital, former chairman of Russian oligarch Oleg Deripaska’s En+ Group – and that name does carry some weight.

His name and reputation no doubt helped him to raise £707 million on the London Stock Exchange in July 2010 for a company, Vallar, which had no assets whatsoever. Rothschild’s pitch was to use the funds to buy mining assets, particularly in emerging markets, within two years of the IPO. This is also where the Abu Dhabi Investment Council enters the story.

ADIC is one of the state investment arms of Abu Dhabi. Though smaller than the more famed and celebrated ADIA (Abu Dhabi Investment Authority), from which it was separated in 2007, it is considered more nimble: it has, for example, a special situations department for one-off opportunities, something that does not exist within ADIA. It also has a department devoted to infrastructure investment, and another for direct investment; several arms which would find a London-listed, professionally governed investment vehicle for emerging market mining, of interest. ADIC was one of the institutions that invested in Rothschild’s venture. Sovereignwealthcenter records put it at £100 million investment for 5.5% of the company, for 9.916 million shares.

In October 2010, Ian Hannam, a banker at JP Morgan, suggested to Rothschild that he consider investing in Bumi Resources. There was a useful coincidence of interests here: Rothschild could acquire stakes in Bumi Resources and another company within the Bakrie family, PT Berau Coal Energy, using the money from Vallar. Given that the Bakries needed money, Rothschild thought he could get the assets reasonably, and realize greater value in them through the London listing. That listing, in turn, had great appeal for the Bakries, because a London listing would improve their image, the corporate governance rules expected in London would give investors confidence, and so they could extract greater value from their Indonesian assets.

The deal was struck quickly: on November 16 2010, Vallar announced an intention to acquire 75% of the share capital of Berau Coal and 25% of Bumi Resources for $3 billion, made up of a combination of cash and new Bumi shares. The acquisitions took place on March 4 (Bumi Resources) and April 8 (Berau Coal) in 2011, and on June 28 Vallar was renamed Bumi plc. In the end, Vallar/Bumi wound up with 29.2% of Bumi Resources and 85% of Berau Coal, which remain its holdings today; the Bakries, in turn, got 55% of Vallar/Bumi, with Rosan Roeslani, who had been the majority shareholder in Berau, 13%. Nat Rothschild himself ended up with just 3.6%.

And ADIC? According to the 2011 annual report of Bumi Resources, ADIC held 4.15% of the company, with BlackRock and Schroder Investment Management also well represented.

Bumi, as Vallar, had listed at £10 a share in July 2010, and at first did well: the shares passed £14 in April 2011, when the second asset purchase took place. Around that time, the Bakries took to the markets again, this time syndicated lending, and used their Bumi plc shares as collateral for a $1.35 billion loan from Credit Suisse, which has long-standing connections with the Bakries.

Then things started to go wrong. The problems have been well-documented elsewhere and are not the focus of this article, but they did have knock-on effects for the sovereign fund investors, so here’s a summary: the price of coal started to fall, dropping from $120 per short ton to $80 within a little more than a week in late September 2008; Bumi’s shares started falling too, triggering a margin call on the $1.35 billion Credit Suisse loan in October that year. Concerns grew about the behavior of the management of Bumi Resources and Berau. “They’ve got one of the world’s greatest coal assets: the asset itself is one of the best producers of thermal coal there is,” says Leahy. “The problem is the people in charge.”

Nathaniel Rothschild identified almost $1 billion of suspicious transactions at Bumi Resources.  Unable to get the answers he needed, Rothschild wrote to Ari Hudaya, President Director of Bumi Resources, on November 8 2011 detailing his concerns very specifically – and then leaked his own letter to the Financial Times, which published it. Shortly afterwards, Bumi would write off a number of investments the Indonesian companies had made after PricewaterhouseCoopers, the auditors, could not value them. By now, the Bakries had sold half of their stake in Bumi plc to Samin Tan, an Indonesian businessman who secured a $1 billion loan from Standard Chartered to make the purchase, and who subsequently became Bumi’s chairman.

From there, the atmosphere got progressively more toxic: Rothschild presented evidence alleging accounting irregularities at Bumi Resources under Tan’s stewardship; London law firm Macfarlanes was appointed to investigate, prompting a 25% fall in Bumi’s share price and the resignation of Hudaya; Rothschild quit the board in October 2012, and then set about trying to regain control, lobbying to replace Tan and most of the directors; and in February 2013, Rothschild was voted down on 19 of 22 proposals at a shareholder meeting. Along the way, the Bumi PLC share price has continued to fall, and at the time of writing stood at £2.10, an almost 80% drop on the IPO price.

The consequences for ADIC are very clear: a considerable loss of money. “I imagine ADIC went in like a lot of long-only institutions who were sold this story of emerging market assets with UK governance by Mr Rothschild,” says Leahy. “But he has been outmanoeuvred.”

But the outcome for CIC has been rather different.

Firstly, it appears that whatever else has happened, Bumi Resources has been able to meet its interest bills to the Chinese sovereign fund – about $400 million a year. From Rothschild’s first involvement with the company, he had complained about that interest burden and argued for it to be refinanced, and in 2011, Bumi appeared to make some progress towards that, repaying the first $600 million tranche two years early. It should be noted that the repayment actually involved a refinancing, with a new loan, and the replacement facility has a debt load of 7% per year; Rothschild said in his leaked letter than the refinancing also included $14 million in arrangement fees. Nevertheless, Bumi Resources said that the refinancing should lead to annual interest savings of $72 million a year.

It is understood, though sovereignwealthcenter.com has been unable to confirm it, that the Bakries offered to buy CIC out completely at some point in the last two years, but were rebuffed. “CIC is a smarter trade,” says Leahy. “They’ve lent money, and it is heavily secured on the asset itself, and that’s the key.” CIC appeared to know a good thing when it saw it and had faith, perhaps a little more faith than the market, that it could continue to meet its debt burdens.

In this, it was perhaps unusual. In August, Moody’s downgraded Bumi Resources to Caa1, citing heightened liquidity and refinancing risks, weak financial metrics because of coal prices, high interest and debt, no headroom under its financial covenants, and structural subordination to its key subsidiaries. Moody’s noted that Bumi Resources had successfully refinanced $150 million due in August 2013, but “continues to face substantial debt maturities in H2 2013 and 2014,” including US$360 million in loans maturing in September at a subsidiary, $375 million of convertible bonds and $150 million of a loan from China Development Bank due in the third quarter of 2014, and $600 million of the CIC loan. “Bumi had unrestricted cash of about $90 million and unrestricted cash allocated towards debt repayments of US$109.1 million at the end of March 2013, compared with total debt maturities and short term debt of US$618.7 million,” Moody’s said.

But the situation couldn’t last. Simon Wong, vice president and senior credit officer at Moody’s, and author of author of the credit report on Bumi Resources, tells sovereignwealthcenter.com that “so far, they have been servicing the interest. The problem is that interest is now running at about $600 million per annum and eating up all of the operating cash flow they generate, especially with the current coal price. There is no surplus price for the servicing of debt principles or additional capex.”

And then, in October, came the announcement that Bumi Resources had found a way out of its debt to CIC. Under the terms of the deal, “a portion of CIC’s existing debt balance” – so not the whole lot, it appears – will be swapped into 42% of Bumi Resources’ holdings in s, 19% of its holdings in Kaltim Prima Coal, Indocoal Resources and Indocoal Kaltim Resources, and up to $150 million in new shares of Bumi Resources. The two remaining tranches owed to CIC, totaling $1.3 billion, will be settled. And “the residual amount” will convert into a three-year loan “at a competitive market rate,” according to Bumi Resources itself. The whole deal is expected to reach a close by the end of the year. Clearly, the big if is just how much is within that residual amount, but sovereignwealthcenter.com understands this refers to additional debt resulting from interest and redemption charges, and is therefore not significant; even if it was, “a competitive market rate” can’t possibly be anywhere near the 19% that it was previously paying to CIC.

This is exactly what analysts like Wong wanted to see happen. “At the moment the absolute debt amount is simply not sustainable,” he said, speaking before the debt swap announcement. “CIC is an investment company, not a finance company, so they will have some interest to take assets rather than giving out loans. I think there are incentives for them to do the debt-equity swap, given that some of the underlying assets are still quite attractive.” In Wong’s view, something along these lines was vital for the company. “First and foremost they need to deleverage, especially in a much weakened price environment. Through deleveraging they can substantially save on their interest expense.”

One would think that ADIC and other Bumi plc and Bumi Resources shareholders would welcome this news, since it finally frees the Indonesian miner from onerous interest payments that have been stopping the company from growing, either in terms of revenue or share price. In effect, the money of shareholders like ADIC has partly been used to fund CIC’s role as a lender rather than an investor. But for ADIC, this late alignment of interests may well have come too late to make a difference.

That’s because of a proposal to separate Bumi PLC from the Bakrie Group. Bakrie Group first announced this planned separation in October 2012, and has modified the method several times. The one on the table as of September 2013 involves a company called Borneo Lumbung Energi & Metal – a Samin Tan company – buying an additional 24% of Bumi PLC from Bakrie Group for $223 million. Then Bakrie would use that money to buy back Bumi’s 29% stake in Bumi Resources for $501 million.

If the deal eventually goes through in this form, it will separate the two sovereign wealth funds, just as they finally found themselves on the same side. CIC will end up with all the exposure to Bumi Resources and its Kaltim Prima Coal asset.

For ADIC, though, it will mean it no longer has any exposure to Bumi Resources, nor its key asset, Kaltim Prima Coal, which was surely not what it expected when it went in to Vallar with Nathaniel Rothschild. That said, Bumi PLC presents the separation as a clearing of the decks, allowing it to focus on the PT Berau asset; it has also said it may return capital to shareholders, potentially as much as $400 million of it. “Bumi plc will focus on organic growth, cost optimization and corporate governance,” Bumi PLC said in an investor presentation in May, saying there was a clear path to increase production to 30 million tons in the near term, with a strong balance sheet and positive free cash flow generation. The latest announcement from Bumi Resources, on September 15, said the separation should be completed by the end of November. When it is complete, in another attempt to make a break with the past, Bumi plc will be renamed Asia Resource Minerals.
Abu Dhabi’s state institutions have a reputation of being rather passive investors, but it is interesting to note that ADIC’s role as a shareholder did become a key player in how the Bumi story has unfolded this year. Running up to the February showdown between Nat Rothschild and the Bumi plc board, Rothschild was understood to believe that he had ADIC on his side; however, sovereignwealthcenter.com understands that when it came to the meeting, ADIC did note vote for many of his resolutions, and in particular, voted against him being reinstated as chairman.

For a story that has had some very vocal participants, most of the players are now unwilling to talk. Inquiries to Nat Rothschild go through UK PR agency Powerscourt; those for Bumi plc go to RLM Finsbury; and to the Rothschild Group itself, which advised Bumi, through Smithfield. All either declined to comment on behalf of their clients, or did not respond to comment. Dileep Srivastava, the director and corporate secretary at PT Bumi Resources, did not respond to detailed questions from sovereignwealthcenter.com. CIC and ADIC, unsurprisingly, did not respond to requests for comment. There is a sense that all of them want to move on and forget that the whole thing ever happened. Except, perhaps, CIC, which may end up being the only institution to come out of all of this smiling.