Foreign Investment in Australia, How Much is Too Much?

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What is the Australian Federal government’s position on Chinese investment in Australian resources?

Yesterday the Foreign Investment and Trade Board told Sinosteel to cool its heels for 90 days while the government figures out how much of Australia it will sell to foreign investors. Sinosteel, which, as you might guess, is a Chinese steel company, already owns 43.6% of iron ore junior Mid West (ASX:MIS and was given permission earlier this year to buy all of the company.

Sinosteel also owns about 2.4% of Murchison Metals (ASX:MMX). Sinosteel applied to buy Murchison as well. It wasn’t rejected. But as you can see from the official looking note below from the Treasury, published yesterday in something called the Government Gazette, the government basically told Sinosteel to go away for 90 days while it figures out what to do.

Chart: http://www.dailyreckoning.com.au/images/20080626DRA.png

You can’t have the benefits of foreign capital without giving up some ownership. The whole development of the Mid West region WA will depend on foreign capital and joint venture partnerships. Sinosteel is active there because all the good ore in the Pilbara has been locked up by BHP, Rio Tinto, and Fortescue.

If the Mid West is to emerge as an ore producer at all, it will need Chinese investment. The government probably knows this. But it’s nervous about how things will look to the public. After all, Sinosteel is owned by the Chinese government. You would have the most promising non-Pilbara ore project in the country owned lock, stock, and barrel by a foreign government.

So what’ll it be Wayne Swan? Matthew Stevens reports in today’s Australian that the government may set a 49.9% ownership ceiling on how much a foreign entity can own of an Aussie share. While mathematically pleasing because it suggests a foreign investor would not own a majority of shares in any Aussie company, in practical terms it’s not a large limitation on how much influence foreign investors would have on the locally-listed firm.

The concern is that if state-backed Chinese firms take a controlling interest in Australian mining companies, those companies will no longer be run for the benefit of shareholders, but will be used to deliver raw materials at low prices to industrial consumers in China. Is that a valid concern? If China Inc. really runs like a vertically integrated manufacturer, it probably is a valid concern.

But perhaps the Rudd government should ask Australian companies what they think. In our investigations at our small cap letter, and in Al Robinson’s research at Diggers & Drillers, we’ve talked to plenty of small mining executives who have made access to foreign investment part of their business plan. Many small Aussie miners will not get their projects off the ground without importing capital and even labour from abroad.

The government hasn’t done anything stupid yet. But give it time. It seems to be an unofficial law in human affairs that people find a way to deliberately sabotage their own success. Governments, being large institutions, are especially good at this. The U.S. government, standing unchallenged militarily at the beginning of the millennium, found precisely the way to get involved in two costly wars and simultaneously drive up the price of energy from historic lows.

Maybe nature abhors a surplus. Until recently, most human beings went through their whole life with very little margin for error. Prior to the twentieth century, most people worked growing food and scratched out a living as best they could. It wasn’t until labour-saving devices and cheap energy allowed people to move off the farm and into the city that real abundance became possible for ordinary people.

Now, 150 years into the world’s energy revolution, all that abundance and surplus is being challenged by massive demand growth in the developing world. More people want more calories, more leisure, and climate control. Australia looks like it’s in the position to ride this boom until something derails it…or until the country finds a way to shoot itself in the foot. We wonder which will come first.

But wait! Have we gone all soft in the head here at the Old Hat Factory? A reader quotes Sir John Tempelton over at our website, “Bull markets are born on pessimism, grow on scepticism, mature on optimism, and die on euphoria.” “You’re in there hard,” the reader says.

We have no idea what that means. But we think he means that we took a rather bullish tone in yesterday’s letter. He would be right about that.

There are still plenty of risks to the boom. Being too casual about them would be a mistake. Let’s say industrial production declines world wide as energy prices bite into globalisation. At some point, reduced industrial production leads to lower commodity prices and lower earnings for Aussie producers. Perhaps the revaluation of BHP and Rio from cyclical stocks to growth stocks gets undone if there’s a major global contraction.

We may also be overestimating the ability of Asian consumers to replace American consumers on the world stage. It’s clear it won’t be a seamless transition. But an increasing amount of Asian exports go within the Far East. Losing America as the big customer will hurt. But it will not be a deal breaker for the region’s development.

We are also trying to keep things exceedingly simple from an investment perspective. It was complexity and derivative value on financial instruments that undid so many people on Wall Street in the last ten years. By comparison, the resource industry is a breath of fresh air.

The value of projects is a function of costs and commodity prices. Companies can be held accountable for how well they execute strategies. Smart people don’t usually get involved in dumb mining projects. So following the smart people isn’t a bad start.

Are we overly euphoric? Nope. But there is a certain relief that comes when you have a clear investment strategy. Your strategy has to adapt to changing conditions. But the long-term conditions we see driving the resource boom (and the deflation of the global real estate bubble) are pretty favourable for Aussie investors.

Nothing is risk free. But Australia is on the right side of what we called “The Money Migration” a few years ago. It is the vast transfer of wealth, incomes, savings, capital, and standards of living from the West to the East. Maybe it’s overly simple as a metaphor. But for some reason-usually because it’s right in front of their face-people often miss the most obvious explanation for events.

Dan Denning
The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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Comments

  1. “Matthew Stevens reports in today’s Australian that the government may set a 49.9% ownership ceiling on how much a foreign entity can own of an Aussie share”

    You don’t need to be a net 50.1% stockholder (directly and/or indirectly) to have majority ownership. Companies with a fragmented shareholder base may have board members with far less than the absolute majority threshold being able to exercise controlling influence over their operations because the other non-consolidated constituents have negligible interest to affect financial decision-making. The farcical ownership ceiling is red herring to buy time.

    “The concern is that if state-backed Chinese firms take a controlling interest in Australian mining companies, those companies will no longer be run for the benefit of shareholders, but will be used to deliver raw materials at low prices to industrial consumers in China.”

    How can this be a VALID concern? Have we forgotten the Corporations Act which explicitly prohibits management acting against the interests of proprietors? The idea of ‘corporation’ under the Act explicates and emphasizes the staunch precedence of shareholder interests taking priority over everything else, even the public. Regulatory control and governance would ensure due compliance with these fundamental values through statutory prescriptions. That is unless we also auction the government to the Chinamen.

    We, the West, are the progenitors of democracy and free market enterprise – too late for second thoughts. If the Panda wants a slice of this pudding, I say let’em have it – for the right price. If they can afford to buy, we should be willing to sell. Business as usual.

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  2. It makes legal sense that China corp cannot act against the interest of its share holders but unfortunately in the real world of politics and the diminishment of sovereignty, it is a concern. I fear Aus will become a province of China, the US will do little if not make deal to passage such a takeover.

    Of course Aus has the Governor General to complain to her Royal Highness. Other EU and the remainder nations will welcome us to the new status of a colony of someone else.

    Is the World going to allow a small band of law abiding sun worshippers to be taken over by a more economically and politically (therefore) powerful nation by any means possible,………you betcha. Yea, just as long as the price does not include not being able to watch the footy, etc.

    Charles Norville
    June 30, 2008
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  3. […] Foreign Investment in Australia, How Much is Too Much addthis_url = […]

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