Sunday, September 25, 2011

Another…! Boy Who Cried Wolf

Cameron McRae, Rio Tinto’s country manager for Mongolia is the latest in the long line of fear mongers who are willfully misleading the markets. “An unstable environment, where changes to agreements are forced, leads to investors being very apprehensive,” was his comment on September 24 in Ulaanbaatar when it was suggested that Mongolia may ask for a properly negotiated agreement for the Oyu Tolgoi mine. He joins, in the Hall of Shame, the likes of Graham Hancock of the World Bank, Robert Friedland of Ivanhoe Mines, and Greg Anderson of Papua New Guinea Chamber of Mines and Petroleum for misleading countries regarding their capacity to participate in resource development projects. Under the guise of ‘scaring away investors’, his recent comments are the broken record of firms who have chosen willful fraudulent inducement to enter into sovereign contracts to prop up short term investment windfalls while directly contributing to the instability of countries. Somehow or another, his allegation of scaring investors ignores the risk to a young democracy – like the one being led by President Elbegdorj in Mongolia – which leads to civil war, violent conflict, and nationalization when a public learns that its leaders have been defrauded (or participated in a fraud).

To be abundantly clear, the following message is for the benefit of the intrepid (albeit frightened) investors in Ivanhoe Mines (NYSE: IVN) and Rio Tinto (LON: RIO) – a significant number of whom are readers’ pension and 401(k) institutional managers. Failure to renegotiate a grossly out-of-market agreement, advised in part by Goldman Sachs, presents far greater risk to your investment than listening to the empty cries from insipid, patronizing puppets.

The following information prepared by our team at M-CAM was presented to the Mongolian government in the late winter 2010 and early spring 2011, and to the Canadian Broadcasting Corporation in March 2011 for an interview which they never published. While representing the authors’ opinions, CBC failed to even publish the raw text of the agreements with Ivanhoe Mines or Rio Tinto for any reader to formulate his or her own opinion.

It is important to premise any discussion of the Oyu Tolgoi LLC Shareholder’s Agreement (the “SA”) with a reminder of the fundamental policy and structural failures embedded throughout the document and the project as a whole. On the policy/project side, it is, in this author’s opinion, an utter failure to protect the interests of the State of Mongolia (“Mongolia”) that any transaction involving the deployment of a strategic national asset (much less one the size and global consequence of OT) should leave Mongolia with ANY debt (particularly before any cashflows have been received) when it should have been paid a SIGNIFICANT (into the billions of USD) and UPFRONT fee just simply for granting a suitor the right to have the honor to steward such a unique and strategic asset.

On the structural side, the most significant and damaging items are:
1) The Capital Structure. The existence of, and extremely restrictive terms of, the Debt and/or Preferred Shares issued by OT (defined as Shareholder Debt or Funding Shares) as well as the Debt directly from Ivanhoe to Mongolia (defined as Existing Shareholder Loans) representing at least 40% of its entire GDP(!) which have the effect of transferring the value of OT from Mongolia’s equity stake to Ivanhoe as largely illustrated by:
a. Severe limitations on repayment of the debt
b. Exorbitant interest rates - far beyond any legitimate capital market rate
c. An inability to stop Ivanhoe from continuously authorizing the issuance of further debt under the same restrictive terms

2) The Illiquidity of Mongolia’s Equity. An impairment of Mongolia’s equity stake leaving it with no identifiable pathway to ANY Dividends OR the ability to monetize (e.g., sell or borrow against) its equity stake as partially evidenced by:
a. The irrevocable direction of ALL dividends (including Mongolia’s share) to Ivanhoe so long as any debt is outstanding
b. The inability for Mongolia to repay the “dividend absorbing” Debt or force OT to refinance the debt under more favorable terms
c. Restrictions on transfer of ownership (e.g., right of first refusal) and pledging of shares (as collateral to borrow money) that effectively block any ability to receive cash for its equity stake

3) The Lack of any Mechanism to Protect Mongolia’s Assets or Control Adverse Behavior by Ivanhoe. Mongolia has no contractual/legal pathway in which to block and/or remedy any adverse actions contemplated by Ivanhoe, including a protection of Mongolia’s minority equity stake or, more broadly, an ability to protect one of Mongolia’s most strategic assets as demonstrated in part by:
a. The complete absence of any protective representations & warranties and/or ongoing covenants (e.g., minority shareholder rights, performance obligations on Ivanhoe with associated rights and remedies)
b. The control of EVERY corporate governance and management decision through the control of: 1) all day-to-day operations, 2) the Board of Directors and 3) any Shareholder vote including, but not limited to:
i. The unhindered ability to force OT to enter into transactions to “leak” cashflows out of the Company, including approval of bonuses to Ivanhoe’s management
ii. The ability to unilaterally define the meaning of “available cash” for Dividends
iii. The ability to bury OT under Debt or sell its assets
iv. Ability to monetize Ivanhoe’s equity stake explicitly at the expense of Mongolia’s equity stake
c. The EXTREMELY out-of-market Management Services contract which pays Ivanhoe at least 3-5x what Rio Tinto (the 3rd largest mining company in the world) is conventionally compensated.

In summary, the SA effectively and elegantly cuts Mongolia completely out of the primary capital markets value chain around OT. Further, it straddles Mongolia with enormous liabilities and no legal way to protect itself or its strategic assets. It effectively delivers to Ivanhoe the entirety of OT’s value, including 100% of the economic value of Mongolia’s 34% equity stake, while leaving Mongolia with bankruptcy-inducing indebtedness and a lack of control or oversight mechanisms. The Shareholder Agreement should be renegotiated to remedy these structural failures and should hold, as the audacious standard, an agreement that meets or exceeds the standards of the agreements negotiated by Rio Tinto in G-20 countries.

It’s time for actual shareholders to step up and demand that corporate governance rules be a minimum standard for mineral and energy investment. If Rio Tinto and Ivanhoe can’t make money by operating in a form that doesn’t destabilize governments, than they shouldn’t be the recipient of managed funds and should not blight the public equity markets in New York, London and the rest of the world.

A complete review is available upon request.

Sunday, September 18, 2011

Scarcity in Search of Abundance

I just completed a weekend workshop with several intrepid University of Virginia students organized by the Student Entrepreneurs for Economic Development (SEED @ UVA). Over the course of the two day session, my concern for what passes as business education heightened as I watched students struggle with a lack of practical awareness of cross-border business. That this weekend seminar followed on the heels of a much more intensive workshop last week with an expanded group of exceptional globally minded collaborators, made my impulse to broaden commerce and finance literacy grow all the stronger.

While I could select countless topics to unpack in today’s conversation, the theme that struck me most profoundly is our unconsidered assent to the Malthusian principles of glut and scarcity. Its corollary – that economic goods exist when scarcity is present while abundance is ‘free’ – serves as a fundamental animating fallacy of our current economic understanding. To understand Malthus, one must apprehend his critique of his secular predecessor, Adam Smith in which he commends a deeper inquiry into the relative contribution of a consuming and working population in light of access to resources, command of application of labor thereto, and the consumption capacity of systems. The Reverend Thomas Malthus has a particular seat at today’s table as an Anglican clergy and Professor at the East India Company College – two sources of inspiration and patronage that undoubtedly shaped his work and are ignored at our present peril.

What neither of these seminal economists and (a)moral philosophers adequately addressed or understood was the tyranny of colonialism that shaped their understanding of systems. It is then, no accident, that in the application of their principles, colonialism (in its modern incarnation – mercenary military interests serving anonymous corporate patrons) is an absolute necessity. As treated in previous writings, the notion that ‘resources’ are ‘free’ is a principle that can only be promoted in an Occidental world view in which humans are sovereign ‘over’ all things. The notion that it is the role of human enterprise to manufacture economics around the controlled use of scarcity is as Anglican now as it was two and a half centuries ago.

However, there is a particular form of scarcity economics I find instructive and inspiring. It is a component of a very complex economic system which, by most historians’ accounts, led to an economic system lasting over 1,500 years. Credited to be the innovation of the great Chinese diplomat Chzan Tsan in the first century BCE, the Chinese refinement of industrial scale silkworm husbandry led to an impulse to use this manufacturing mastery to launch one of the most audacious efforts in global trade. Sending caravans from Beijing and Xi’an to Venice by way of Kyrgystan, Tajikistan, Kashmir, Pakistan, Afghanistan, Turkmenistan, Uzbekistan, Persia, Iraq, Syria, and Turkey, and then by boat to modern Italy, a great economic mystery unfolded. When one embarked on this journey, an elegant dance between abundance and scarcity played out in a rhythm and syncopation unfamiliar to modern business. Imagine the following.

When I’m leaving Beijing, my pack animals are laden with an ABUNDANCE of silk. For my own PROVISIONING, I pack some porcelain dishes, some paper and calligraphy in SCARCITY , and sufficient food and water to feed my crew and our animals. By the time I reach Turfan, several of my animals have been eaten as they passed through the inhospitable deserts and mountains and, as they die, I need to trade bulky silk for other artifacts. These trades have a particular dynamic. My ABUNDANCE of silk meets a relative SCARCITY of the same in the Gobi desert. In the Gobi desert, gold, weapons and some precious stones exist in ABUNDANCE. I trade my ABUNDANCE for local ABUNDANCE and the value of the trade is the uniqueness and SCARCITY made visible through my enterprise. At no point in this transaction is there any absolute SCARCITY or ABUNDANCE – just a shared IGNORANCE of each others’ context and provisioning. Along the way, my ABUNDANCE of silk is transacted across relative ABUNDANCE to local ABUNDANCE trades informed by the capacity I have to transact. Gold, and precious stones – much smaller and more transportable – start moving in relative ABUNDANCE until I reach Tashkent, Blakh and Merv where I trade more silk now for the local ABUNDANCE of spices. I even amplify the value of my trade by trading my SCARCE porcelain for even more local ABUNDANCE. In Qom, I trade for silver and smith work. In Baghdad, I trade for art and clothing and by the time I reach Tyr, I have relative equivalence of the legacies of my trading. All along the way, my endeavor brought my ABUNDANCE – unknown to my trading partners – into local ABUNDANCE – unknown to me – and in my transaction, I find neither Adam Smith, Thomas Malthus, John Maynard Keynes, nor Milton Friedman.

What makes this model compelling – beyond its obvious millennial success (in contrast to our barely 40 year old failed post-industrial model) – is that I realize that the enterprise value exists in the systematic REMOVAL OF INFORMATION ASYMMETRIES. Unlike the ignorance arbitrage that is central to all of our current economic systems where we rely on cabalistic monopoly collusion between governments and their corporate patrons, true value was discerned through the uniqueness and cultural enrichment of trading partners. And rather than pulling a ‘duty-free’ regression to ‘globalized monotony’, the value of the network is maximized when local uniqueness is celebrated and optimized.

It is regrettable that the commerce and business schools across the globe – including places once central to the Silk Road economy – fail to learn from the brilliance gleaned from principles of this amazing trade innovation. Seeking to pretend that modern economics somehow transcends these core principles insures that our students are incapable of functioning as moral citizens in a global community of transacting parties. It also blinds us to the ABUNDANCE from which we can be empowered and through which we can engage those around us. Here’s to Chzan Tsan – let his wisdom inform us again.

Sunday, September 11, 2011

Remembering a Day in September

On this day, the lives of many around the world still hold the fresh memories of unspeakable tragedy and loss. On this day, those who contributed to the events leading up, and subsequent to the tenth anniversary we mark continue to operate without public accountability or any consequence for the humanity that they took for granted, take for granted, and callously continue to exploit and deny. And, as long as their actions go anonymously by in the macabre parade of carnage in insensitivity, We The People continue to await the next predation which will, once again, rob us of vitality, purpose, and a sense of a productive future.

My tribute to these families is embodied in the dedication to my freshly published first novel, Coup d’ Twelve: The Enterprise that Bought the Presidency. In its pages, I trust that you find stories, warnings, points of illumination and a vision for the deep need for all of us to call for light where darkness continues to prey on the lives and fears of millions. Inspired by its premise, I trust that a few of us will begin to call for accountability before the next scene is acted out on their macabre stage.

The dedication page reads:

Dedicated to
My Lady
Spud & Zuke
The families and memories of those who have suffered and died in the stories rendered herein. That they neither died in vain nor suffer for the clandestine interests of those who breach their public duty.

Enjoy the journey at...

Monday, September 5, 2011

Gain the World, Lose Your Soul


For how is a person benefited if he gains the whole world, but suffers the loss of his real self? Or what will a person give in exchange for his real self?

Gospel of Matthew 16:26

Wisdom traditions across time and geography are filled with admonitions against the supplanting of lasting value for the seduction of short-term gain – or so we are taught to construe the maxim above. In the Mediterranean cultures from which this famous quote arose, the idea of transacting was inextricably part of the tapestry of social systems. Two thousand years ago, traders of knowledge, military power, goods and services plied the seas and organized caravans overland to trade what was locally controlled for what could be remotely obtained. Built on the understanding derived from a legacy of Babylon, Persia, and Egypt and inspired by influences from the Indus to China, the literal answer to this rhetorical question could very well have been a new question: Having gained the world, who would ever trade it for the smallness of a singular, individuated identity?

In the traditional King James translation, the question is asked: “For what is a man profited, if he shall gain the whole world, and lose his own soul?” My attention was drawn back to this phrase when I was reading a few Shareholders’ Agreements establishing the roles and responsibilities of the parties to gold mines in the Pacific. Specifically, I was intrigued by the aspirations I heard with respect to a much promoted, yet mythical benefit in what was described as a “profit-sharing” agreement. Now to be clear, most junior (and for that matter, senior) miners in the Pacific, South America, Asia and Africa know that many of the endeavors they fund will not materialize. Without exception, their rewards and those they share with their funding partners are initially and principally derived from financing activities (sale of speculative equity; trading in equity; debt-financing of local ‘participation’; treasury management and investment income; and tax losses or jurisdiction efficiencies which offset unrelated income). In the countless agreements I’ve studied, I have yet to see a single country benefit from the place where the majority of early value is created or exchanged. And, ironically, communities and governments around the world are seduced into trading their environment, their land and their water in exchange for future ‘profit’ never knowing that profit may never be the intention.

Bear with me as I ask that you, for the moment, ignore this most egregious injustice long enough to see the next level of madness in ‘profit-sharing’ arrangements. There are two costs in speculative mining ventures which erode profitability (in the majority of instances, the actual operating costs are handsomely contracted to related-owned entities and assessed against the actual producing mine). The two variable costs are: 1) royalty payments; and, 2) local employment. In other words, if a ‘profit’ is going to be declared in which a ‘sharing’ can happen, in most instances this comes on the back of an EXPLICIT REDUCTION in the benefit coming to, you guessed it, the very people with whom ‘profit-sharing’ is promoted.

Gain the world and lose your soul? Worse than that, using the carefully constructed shell corporations under Rio Tinto, Newcrest and Nautilus you can lose both!

But this inquiry leads down a pathway that felt to be a predictable, tired moralistic trap. And while, in no way do I wish to lessen the focus on this pathetic behavior of unscrupulous actors, I began asking a question that is going to be the subject of considerable future inquiry here in Inverted Alchemy and in conversations to come. I wonder how often ‘profit’ is a foil for a rather elaborate purveyance of ignorance. Is an enterprise ‘profitable’ if it is paid higher value than its contribution warrants or is it the case that it is over rewarded for something that has perceived, yet not substantiated value? Alternatively, is it possible that ‘profit’ is actually a surrogate for the amount of value that is explicitly NOT being measured in the cost of production? If I manufacture a garment that I sell at $50 profit, is it really profit or have I underpaid the laborer and, in so doing, established an unsustainable, volatility-predisposed ecosystem? If I lumber a forest, have I profited if I allocate no funds or resources to reforest the land? Does a ‘for-profit’ company exist or is it the case that in most, or all, instances, profit is a surrogate metric for the degree to which all-in-costs have NOT been factored?

These are questions. They are an inquiry inspired from a new look at an old problem. But what did surface in this inquiry was yet another look at the ancient (and possibly, future) models of commerce. The principle of ‘provisioning’ is a very different reality that seems to evoke a more viable enterprise. When I seek to provision the present, I seek all resources and utilities to achieve my objective. Throughout the course of my endeavor, I seek adequate provisioning to see it through AND, when applicable, be prepared for the next. Unlike a linear metric of temporal profit, the concept of provisioning says that the utility and productivity of the present must prepare me for both the certain present and the confidently uncertain next.

Emerging in this image is an ideal of an enterprise that achieves its effectiveness through the perfect optimization of resource utilization where appropriate inputs are aligned to produce optimal productivity without waste. By now, my frequently quoted Bloomberg interview in which I stated that Google had acquired “crap” from Motorola is one manifestation of the malignancy of ‘for-profit’. By falling for the siren song of the patent cold war strategy, Google paid $12.5 billion to buy protection that, had it used any disciplined inquiry whatsoever, would have been seen for its inadequacy. For a fraction of its Motorola acquisition – made possible from unconsidered ‘profit’ – it could have seen that EVERY patent it acquired has an equivalent that is in the public domain. Both Google AND its customers could have benefited. But in a world of unconsidered profit, they sold their soul. There is another path and, one day, I hope more of us find it.