Samsung’s ambitious mining foray backfires

Graphic Business Business News Jul - 19 - 2016 , 10:55

In June 2013, Samsung officials gathered in a park here to celebrate a landmark deal with an Australian tycoon to construct one of the world’s biggest iron-ore mines.

Crocodile steaks sizzled on the barbecue, while a senior executive thanked staff for securing the nearly US$6 billion contract.

Samsung had built megaprojects before, like the Burj Khalifa skyscraper in Dubai, through its construction arm, Samsung C&T Corp. It figured the Roy Hill mine, owned by Australian billionaire Gina Rinehart, would be another coup, tapping into the global commodity boom.

Instead, the Korean conglomerate best known for smartphones and refrigerators lost at least US$700 million in two years on its first foray into mining, Samsung C&T said.

Samsung’s troubles reflected bad luck as well as its own missteps. It comes as many companies lick wounds from bad bets in mining, which promised huge returns until commodity prices began falling.

Samsung hired a contractor that collapsed into insolvency within months, delaying the project.

Unlike many mining-services firms, Samsung C&T agreed to shoulder all the risk for cost overruns, while committing to Ms Rinehart’s aggressive timeline for iron-ore exports to start by August 2015. It agreed to pay penalties to Ms Rinehart’s company, Roy Hill Holdings, if it didn’t reach construction milestones on time.

Share overruns

Typically, mining-services firms share overruns—which are common in resources projects—with mining companies.

By the time the mine started up in December 2015, Samsung was embroiled in costly legal disputes with several subcontractors as well as Roy Hill.

Samsung, in a statement, acknowledged “some difficult challenges which had a significant financial impact on the project for the company,” but said it built good relationships with local contractors and was expanding in Australia.

Samsung C&T has since landed deals to help build two toll roads in Australia—but no new mining projects, with low commodity prices keeping mine expansions on hold.

Although a lower-profile business than Samsung’s electronics company, Samsung C&T reported roughly US$2.3 billion in net profit last year, and its performance matters greatly to the Samsung Group’s future.

Samsung’s controlling Lee family last year merged Samsung C&T—which holds substantial stakes in smartphone maker Samsung Electronics Co. and other affiliates—with the conglomerate’s de facto holding company despite objections from some minority shareholders.

Samsung said the merger, which strengthened third-generation heir Lee Jae-yong’s grip on Samsung Electronics, would also benefit Samsung C&T shareholders by boosting synergies between Samsung affiliates. Kim Woo-chan, a finance professor at Korea University Business School and a critic of last year’s merger, said these synergies have failed to materialize. The stock has fallen 30 per cent since the merger.

Facing slow growth at home, Samsung C&T has moved aggressively to find new opportunities abroad, with mixed results.

A deal to build a new stock exchange building in Saudi Arabia fizzled earlier this year when Riyadh froze the project amid falling oil prices. Cheaper oil also led Qatar to cancel Samsung’s $700 million contract for a railway project there.

Troubles of high magnitude

The Australia project presented troubles of a different magnitude.

Located deep in the Australian Outback, 200 miles from the nearest port, Roy Hill was especially complex. It involved constructing a massive mine along with a railway straddling eight waterways in the flood-prone wilderness, and dredging for a new port berth.

The goal was a mine producing 55 million tons of iron ore annually—equivalent to about four per cent of global iron-ore exports in 2014, according to Australian government figures.

Samsung submitted its bid in a relatively short amount of time to help ensure it won the contract, people familiar with the matter said. Samsung C&T had no prior experience constructing a mine.

Contract in hand; Samsung hired Forge Group, a small Australian firm, to help build the site’s US$1.1 billion processing plant. Samsung preferred Forge over more experienced candidates because it was willing to accept a slim profit margin, said Allan Crow, Forge’s former project controls manager.

Mr Crow said in a recent interview that Forge was aware at the time that it would be “almost impossible” to meet Roy Hill’s aggressive deadlines for project completion.

Forge became insolvent in February 2014 after two contracts to build power plants in Australia ran into trouble, causing some work to stop at Roy Hill. Forge no longer exists.

Samsung stepped into the role of managing construction on the mine site itself, and had to come up with approximately 1,500 new workers to make up for lost time, driving costs higher.

Hoping to recoup losses, Samsung feuded with its subcontractors. It made Duro and another subcontractor hand over money set aside to cover potential contract breaches. It also was sued by NRW Holdings, an Australian mining contractor, over payments.

Samsung’s relations with the mine’s owner deteriorated, with Roy Hill claiming last November that Samsung intentionally slowed construction to save money on-site, even though Samsung was paying A US$2 million in penalties daily for missed deadlines.

That dispute has entered private arbitration. Samsung and Roy Hill declined to comment.

Roy Hill loaded its first shipment in December, even though they remained locked in legal battle. Samsung handed over control of major facilities two months later.

Samsung acknowledged its US$700 million loss in January. In a public statement at the time, it said it wants to “focus on the future.”

Source: The Wall Street Journal