This report would offer a brief account of one of the ventures that Rio Tinto plc, a mining conglomerate, established in the year 1873, headquartered in London UK, is planning to setup. Rio Tinto plc is planning to propose a Foreign Direct Investment of £ 250 million in the Democratic Republic of Congo. The prime objective of the investment is the extraction of Iron ore from the natural reserves of DRC and to export it to the partly owned Steel establishment in china - The Angang Steel Manufacturing Plant.
I have been appointed as a senior analyst for Rio Tinto Plc and have been given the task of critically analysing the issues pertaining to the above mentioned investment proposal.
Some of the main factors what we see in this project is the feasibility of the investment in terms of financial risk assessment, the various sources of financing and also the Repatriation terms that Rio Tinto plc can undertake.
The details of the factors considered for these actions are explicitly provided in the body of the report.
INTRODUCTION
RIO TINTO PLC.
Rio Tinto is one of the world's leading mining and exploration companies. The Rio Tinto Group is further split into two parts, Rio Tinto plc and Rio Tinto Limited.
Rio Tinto plc is a London Stock exchange listed company headquartered in the UK, whereas Rio Tinto Limited is listed in the Australian Stock exchange and has its executive offices in Melbourne, Australia. Both the companies are joined as dual listed companies (DLC) and are structured as a single economic entity, called the Rio Tinto Group.
The list of products that Rio Tinto is currently extracting consists of various metals and minerals such as Iron ore, Bauxite, Aluminium, Copper, Molybdenum, Gold, Diamonds, Uranium, Titanium, etc. The company sources these metals and minerals from various countries such as US, Brazil, Canada, Chile, Indonesia, France, Zimbabwe, South Africa, Madagascar, Namibia, Papua New Guinea and many more including UK and Australia.
Rio Tinto is the world's second largest producer of Iron ore. Currently Rio Tinto acquires Iron ore from Hamersley & Robe River - Australia, South America, Canada, India and Papua New Guinea. The extraction and mining of Iron ore and Titanium is handled by RTIT - Rio Tinto Iron and Titanium.
Aim of the report:
Rio Tinto is planning to initiate a Foreign Direct Investment (FDI) of £250 million in the Democratic Republic of Congo to mine and extract iron ore and ship it to the partly owned Angang Steel Manufacturing Company in China. This report would emphasise on the risks and perks involved in proceeding with this project.
Economic Risk Assessment
An Economic Risk Assessment in this case would have to be done to gauge the viability of the project. Every International business conglomerate intending to invest in a foreign country would be first concerned with the returns on its investment. So as to foresee the amount of profitability in the new venture and also to understand the possibility of any financial losses that the company can undergo due to Political, economic or any other factors in the future, an economic risk assessment is carried out.
Macroeconomic Profits for the Democratic republic of Congo
Average exchange Rate:
Date
CDF/£ - (Congolese Franc per Great Britain Pound)
31/03/2007
837.9
31/03/2008
851.5
31/03/2009
1122.3
Average exchange rate for a period of previous 3 years
= 837.9+851.5+1122.3 = 937.23
3
Cross-Border Risk analysis:
Data of Democratic Republic of Congo (2009)
Congolese Franc (CDF) (Billions)
£ (GBP) (Billions) (Avg. Exc. rate -CDF 937.233/£)
GDP
7434.13
7.932
Gross fixed capital formation
1897.9
2.025
Change in Stocks
21.55
0.023
Depreciation [1]
216.975
0.231
Current Account Balance
-975.66
-1.041
Net Financial Services
-203.775
-0.217
Macroeconomic equation of a country's profits and costs can be represented by:
rVt = Xt - Mt + (Vt+1 - Vt)
Where:
r = the economy's internal rate of return in foreign currency.
V = the foreign currency value of the economy.
X = the foreign currency value of Exports.
M = the foreign currency value of the Imports.
T = for Time
Pound Sterling value of profits generated by the economy of DRC is given by:
X - M = Current Account Balance - (Interests and Dividends)
= - £ 1.041 bn - (- £ 0.217 bn)
= - £ 0.824 bn
Net Investment is given by:
(Vt+1 - Vt) = Gross fixed Capital formation + Change in stocks - Depreciation
= £ 2.025 bn + £ 0.023 bn - £ 0.231 bn
= £ 1.817 bn
Substituting these figures into the equation, we get:
rVt = Xt - Mt + (Vt+1 - Vt)
= - £ 0.824 bn + £ 1.817 bn
= £ 0.993 Billion
Foreign interest cover:
Foreign Interest Coverage Ratio can be defined as the ability of the foreign country's economy to meet its obligations. This ratio is given by the earnings before interest and taxes for a time period and divided by the interest obligation of that country for the same time period. The lower the FIC ratio is, the lower its value is perceived.
Foreign Interest Coverage Ratio:
= rV / Interest Obligation [2] = Macroeconomic profits/Interest Obligation
= 0.993 / 0.4
= 2.4825
Financial Leverage:
The vulnerability of a country to meet its obligations can be measure by the fluctuations of its expected profits:
= Macroeconomic profits (due to domestic residents) / Total profits
= Macroeconomic profits / (Macroeconomic profits + Net financial services)
= 0.993 / (0.993 - 0.217)
= 1.28
This is the ratio which is dependent on the percentage change in the macroeconomic profits accumulated due to the domestic residents and the total change in macroeconomic profits.
The various risks involved in shipping Iron-ore from Democratic Republic of Congo to China (The Angang Steel Manufacturing Plant), can be analysed by the change in the trade relations and the current maritime developments that have been taking between the two countries.
From the early 1960's, People's Republic of China established strong political relations with the Democratic Republic of Congo (DRC). Since then China has provided Democratic Republic of Congo with the necessary economic aids required. Recently China has invested $ 9.0 Billion in the DRC to build their infrastructure. Apart from the World Bank which provided DRC with the necessary economic resources to strengthen their stand, China is the next in line for improving the standards in the country. In return, China relies on DRC's exports of its natural resources such as iron ore, copper, cobalt, diamonds, etc. 47% of all exports from DRC are to China. Therefore this implies that the trade relations between the countries are relatively strong. DRC has exports to China of the total value of around $ 2.9 Billion in 2007 compared to $ 750 Million in 2006. The total imports from China to DRC were of the value of around $ 450 million in 2007 compared to $ 192 Million. This clearly shows that the trade relations between Democratic Republic of Congo and China emphasized more on exports from DRC to China than imports. Therefore, export of Iron ore would be considered as a regularised practise in the DRC.
The other factors which may affect the trading between the two countries can be the constant fluctuation in currency exchange rate.
Date
GBP (Great Britain Pounds)
CDF (Congolese Francs)
CNY (Chinese Yen)
31st March 2008
1
851.5
13.9
31st March 2009
1
1122.3
9.7
31st March 2010
1
1348.6
10.27
Other external factors which can affect the trade in terms of logistics, between DRC and China can be ever-increasing fuel prices, increased Insurance costs, and also the recent threats of Somali Pirates hijacking the Cargo Containers. Some of these factors can be overcome by encouraging positive attempts of lobbying with the politicians by the Rio Tinto executives in both the countries.
Source of Finances
For an industry as vast as the mining industry the source of finance can play a crucial role in acquiring and controlling the profits. There are two main criteria for the source of funding in case of Rio Tinto plc.
The main source of funding can be from the parent company itself - Rio Tinto plc - UK, i.e., utilizing of reserves or Equity from the parent company. This would allow a greater sense of control over the trade in DRC.
The second means of financing involves taking a long term debt from any centralized bank from Democratic Republic of Congo. This would give the sense of security of the investments.
Considering the various political and financial conditions that Democratic Republic of Congo is undergoing there is a high level of risk involved in investing large amounts of finances into the country, such as high level of public debt, fluctuating interest rates, inflation, negative current balance, etc. When various factors such as domestic instability, subversions, rebellions, foreign conflicts, constantly fluctuating political and economical climate are also taken into account, the option of taking a long term debt would be a sensible option.
The Foreign Direct Investment (FDI) Confidence Index gives Democratic Republic the ranking of 0.7 with China, USA and India leading the charts with 1.93, 1.67 and 1.64 respectively. This index comprises of a fair understanding as to how attractive a country is in terms of its investment opportunities and also the category of risk involved and the profitability of its returns in that particular country.
Considering the facts stated above it is advisable for the company to source 75-80% of its funds from a locally based source from DRC and the remaining can be sourced from the Reserves of the parent company itself. This type of investment ratio would ensure that DRC would retain high stakes in this venture, which would in turn ensure the unparalleled interest of the patrons of the country. Inclusion of local partner's contact and reputation would also enhance the access of Rio Tinto to the capital market of DRC and the public image of the firm being partially owned locally would improve its position in the country.
Profit Repatriation:
When any established local company takes Foreign Direct Investment (FDI) as an initiative in another country, the prime objective of this move would be to tap into the market demand in the new economy and earn larger profits through different strategies. Profit repatriation can be defined as the process of transmitting the profits earned by a company in a foreign country back to the country of its origin. Every country has specific terms and conditions when it comes to profit repatriation.
Not all the profits earned in a company that has been setup in a foreign country get repatriated to the parent company. The profits are shared between three elements:
The taxation issues pertaining to the foreign country, i.e., Democratic Republic of Congo in this scenario.
Some of the profits are diverted towards building a strong brand name and improving on their CSR in the foreign country (DRC).
Remaining profits are repatriated to the parent company, to its shareholders in London.
Taxation issues:
Part of the profits is reverted back to the government of Democratic Republic of Congo as Mining taxes and Profit based taxes. Mining tax or Mining royalty is calculated on the sales realised less various other operational expenses. It is at the rate of 0.5% for Iron ore and other ferrous metals. Whereas Profit based tax is at the rate of 30% of the net profits.
There are other taxation issues like double taxation, Annual traffic tax, etc., but Democratic Republic of Congo has bi-lateral agreement with the UK to mitigate many of these taxation policies.
Corporate social responsibility:
Since Rio Tinto is utilising the natural resources of Democratic Republic of Congo it is essential for the company to extend their support to the domestic issues in that country in the form of corporate social responsibility. Some of the profits acquired in the Rio Tinto venture at DRC can be utilized for the betterment of the local neighbourhoods in the Democratic Republic of Congo and also to instil a change in the standard of living of the local population. Some issues to be considered:
To provide employment opportunities to the local population and also guarantee fair wages to their services,
Improve the healthcare facilities provided to the residents,
Supporting the NGO's in establishing educational institutions,
To aid the clean drinking water projects in Democratic Republic of Congo
Supporting the environmental issues, to take up forestation as a CSR to negate the effects of de-forestation by the mining operation itself.
These factors would not only help to achieve a better Brand name but also to create a sense of trust amongst the citizens of Democratic republic of Congo. This will also give a positive impact on the Global presence of Rio Tinto in other countries.
Profits back to the country of origin:
The main purpose of setting up a mining operation in a foreign country is to achieve lucrative returns by taking the advantage of the demand for the product. Hence it is but natural to repatriate or divert back the remaining of the funds to the shareholders of Rio Tinto in London. The profits are used to pay on-time dividends to its share holders and by doing so; the company will be able to achieve the unparalleled support from their shareholders.
Dispute Strategies
In the past, there have been instances of disputes between the mining companies and the reigning government regime at Democratic Republic of Congo. Some of the potential risks that need to be considered are expropriation of funds, inconvertibility, nationalization, Insurrection or war breakouts, withdrawal of mining license, etc.
It is essential for Rio Tinto to formulate different strategies to tackle these various disputes that can occur in the future. One of the reasons to face any of these dispute issues can be breach of contract between the Democratic Republic of Congo and Rio Tinto. Therefore complete measures have to be taken to ensure that there is no breach in any rules or regulations stated in by the Bi-lateral agreement between the two countries and the also Rio Tinto plc and DRC.
Some of the mining disputes recently faced by other companies are:
Canada's mining initiative of First Quantum minerals in the Democratic Republic of Congo resulted in its license being withdrawn. The allegations faced by First Quantum minerals was that the means and modes it used to acquire the license to the "Frontier" and "Lonshi" copper mines in the DRC was illegal.
Pacific Rim Mining based in Canada has had disputes with the El Salvadorian government regarding its gold mining license. The government authorities of El Salvador argued that it is the country's right to conserve the environment and human health.
As a precaution Rio Tinto can consider opting for insurance coverage for the FDI against confiscation, nationalization, expropriation of assets and license withdrawal, government bodies similar to OPIC (Overseas Private Investment Corporation) which cover for these issues for most of the FDI's that US investors undertake.
As far as, non-financial dispute issues are considered, such as war breakouts, political and social unrest, declaration of emergency, etc. It is essential for Rio Tinto to have a precautionary measures setup in such cases. Utilization of the positive relationship between the politicians of Democratic Republic of Congo and the executives of Rio Tinto can be made, to get an upper hand in these issues. Political lobbying needs to be a major strategy while entering DRC for trade. Most of the dispute issues can be thwarted by utilizing the political contacts in the Democratic Republic of Congo.
Conclusion
An extensive assessment of various factors such as country specific risk, political and economical factors and ongoing domestic turmoil within the country gives us a brief overview whether to go ahead with the investment. As far as the economic risk assessment is concerned, the macroeconomic profits that the country is yielding are fairly low and the Foreign Direct Investment Confidence Index is also rated at a low ranking.
The ideal Source of financing for Rio Tinto would be to opt for a long term debt in the Democratic Republic of Congo. This would ensure decreased amount of risks as seen from Rio Tinto's point of view, it also brings in a high level of involvement of the patrons of DRC and would keep their interests vested in project.
The issues regarding profit repatriation would not involve any risky manoeuvres because the taxation rules in Democratic Republic of Congo are quite relaxed, but the company has to practise a positive corporate social responsibility so as to maintain an upper hand in its presence in the DRC. The remaining profits can be repatriated back to its share holders so as to have their support for further investments.
As far as strategic disputes are concerned, maintaining a positive relationship with the government authorities i.e., political lobbying needs to be practised by the Rio Tinto officials in the DRC, so as to thwart any upheaval that may rise against the company's objectives.
Even though the macroeconomic profits are projected to be low, the overall country risk is higher and many other negative issues would seem that investment in the DRC would not be rewarding, but the positive aspect that the country is providing the company, are the country's natural resources. Since it is an investment in natural resources of a country it can be viewed as a long term investment and would eventually start generating profits as the demand for the minerals around the globe increases.
