Source: The Financial Times              Date: 30 September, 2010

Rio Tinto is creeping its way towards control of Canada’s Ivanhoe Mines at a slow but relentless pace, drawing investors’ attentions away from a multi-billion dollar mining transaction that could be as significant for Rio as Canada’s PotashCorp looks to be for BHP Billiton.

Over the past six months a conflict has erupted between Rio and Ivanhoe, developers of Oyu Tolgoi, a copper project that many analysts consider to be one of the best in the world. With a stake in Ivanhoe that rose to 35 per cent recently, Rio can feel confident that it is best placed for an eventual takeover. It has invested more than USD1 billion in Ivanhoe and its Oyu Tolgoi mine since 2006.

But under Robert Friedland, the legendary mining entrepreneur, Ivanhoe has been making plain that Rio’s money will not buy its love. It has engaged investment bankers to assess “strategic options”. Over the summer it pushed through a shareholder rights plan, otherwise known as a poison pill, to protect against what it calls “coercive and creeping takeovers”.

The markets are giving credit to Ivanhoe’s maneuvers. One London-based analyst ascribed the performance of its share price to investors’ intrinsic faith in Mr. Friedland’s “wiliness” and record of coming out ahead. The Toronto-listed shares have stayed elevated since July when the company adopted the poison pill, causing Rio to launch arbitration against Ivanhoe. It canceled a restriction against selling more than 5 per cent of its shares to a strategic partner. But despite Ivanhoe’s much-advertised search for alternative options all year, no third-party offer has materialized. “This is completely in keeping with Robert’s personality,” said one banker who has worked for Ivanhoe. “He wants the best deal for his shareholders. He wants to make sure that Rio does not have a 100 per cent stranglehold on his company.”

Robert Friedland is a legend in the mining industry. The superlatives he enjoys range from “best entrepreneur” to “biggest genius” to “luckiest stiff”. This last tag refers to his big break in the 1990s. Mr. Friedland was a large investor in an exploration company called Diamond Fields Resources. In the course of exploring for diamonds in Canada’s Labrador province the company struck a motherlode deposit of nickel. The company’s sale to Inco netted Mr. Friedland a fortune that helped him launch Ivanhoe.

In 2000 Ivanhoe took over an exploration program in Mongolia, then an unpromising mining zone, from BHP Billiton. Ivanhoe spent several years proving that the Oyu Tolgoi copper-gold deposit is one of the biggest and world’s best new sources of copper. Mr. Friedland evangelized the promise of Mongolia to investors with his Steve Jobs-like knack for the grand narrative. He laid the groundwork for the Mongolia fever that has swept the mining industry since Oyu Tolgoi won government approval in October 2009.

An early convert to his vision for Oyu Tolgoi was Tom Albanese, currently chief executive of Rio. In 2006 Mr. Albanese headed Rio’s copper and exploration division, and he led the deal that created the Rio-Ivanhoe partnership. Both men appear to have an affinity for Oyu Tolgoi. They also are known to be personally friendly in spite of the widening rift between the two companies. Over the summer Mr. Albanese stayed at Mr. Friedland’s home in Ulaanbaatar.

Ivanhoe and Oyu Tolgoi stand to be the most important venture of Mr. Friedland’s career. That, say some, is why this owner of 20 per cent of shares wants to ensure a good outcome. Seeing the project through and possibly selling at a premium might also expunge his reputation as Toxic Bob, a name he earned in 1993 when one of his early gold projects leaked cyanide, causing an environmental disaster.

“He has gotten hundreds of millions of dollars from Rio so far,” the banker continued, “but the [Oyu Tolgoi] copper deposit is clearly worth billions.” Rio’s rigid agreements with Ivanhoe, which owns 66 per cent of Oyu Tolgoi, may give the Canadian miner less flexibility than is appreciated. In 2006, when its Mongolian project carried heavy political risk, it agreed a financing deal with Rio that essentially gave the Anglo-Australian miner a path to ownership that it could exercise in 2011. Over the years Rio has released project financing in return for tranches of equity. Over the past year it has raised its stake from 19.7 per cent to 34.9 per cent. In Canadian law there is no level above which a shareholder must make a bid for the full company.

Rio’s agreements with Ivanhoe, however, stipulate a maximum stake of 47 per cent until October 2011, when a “standstill agreement” preventing takeover moves lapses. It is toward that October 2011 date that both companies are hurtling, amid attempts to outmaneuver each other. Ivanhoe has pushed back the date of the standstill agreement by adopting a poison pill. So far the companies have not yet agreed on a Canadian arbitrator to hear Rio’s request that the defense be struck down.

Today the Oyu Tolgoi mine is taking shape in a bleak area of Mongolia’s south Gobi desert. Mongolia has become one of the world’s leading frontiers for metals and mining, largely because its rich deposits of copper and coal lie so close to the border of China. Oyu Tolgoi’s strategic position has led to speculation that Ivanhoe could find a white knight in a state-owned Chinese company.

But the 2006 agreement gives Rio right of first refusal over any offer made from a third party. This places Ivanhoe in the dangerous position of offering its shares to a bidder, only to see Rio pre-empt and possibly move to immediate control of the company. Ivanhoe’s best tactic, said one person involved in the 2006 deal, may be to find a bidder whose offer is so high that Rio cannot follow.

Chinalco, the Chinese state-owned aluminum producer, is one potential bidder for Ivanhoe, as it is attempting to diversify out of aluminum. Chinalco, however, is also Rio’s largest shareholder. That raises the possibility that Chinalco would be more likely to join with Rio to take control of the group than pay a high premium to buy Ivanhoe on its own.

“There aren’t that many players who can play,” said one Canadian banker familiar with both companies. “This project is about the big boy miners and governments. It’s about countries as big as China and companies as big as Rio or BHP. The permutations are very small.”