June 12, 2018
Board of Directors
c/o Company Secretary
Turquoise Hill Resources Ltd.
Suite 354 – 200 Granville Street
Vancouver, British Columbia
Canada, V6C 1S4
Dear Members of the Board:
SailingStone Capital Partners has been engaged in dialogue with the independent directors of Turquoise Hill Resources Ltd. (“TRQ” or “Turquoise Hill”) for several years regarding our corporate governance concerns. In February, we took a more public stance, outlining several high-level objectives which we believe are necessary in order for basic corporate governance standards to be met. While we appreciate the progress that has been made to date, we remain concerned that the entire TRQ board of directors (the “Board”) lacks a sense of urgency in addressing the serious deficiencies that continue to exist. However, the recent retirement of TRQ’s Chief Executive Officer, Jeff Tygesen, provides you with an opportunity to accelerate the transition towards a governance structure which is more consistent with a stand-alone, publicly-traded company. As such, we wanted to provide you with more specific steps that we believe will serve to protect and promote the interests of all Turquoise Hill shareholders.
To put the discussion in context, the following table shows TRQ’s stock price performance relative to peers and to copper over multiple time frames post the December 2013 rights offering.
While some may dismiss this persistent underperformance as a function of Oyu Tolgoi (“OT”) being a “development story”, or reflecting sovereign risk, those conclusions are inconsistent with the facts. First, the Oyu Tolgoi open pit is in production, has a copper-equivalent grade profile similar to Escondida, and has already generated more than $2bn of free cash flow since commencing commercial operations in late 2013, through the bottom of the commodity cycle. In fact, we estimate that the current open pit operation is worth between US$2.00-$2.50 per share, based on TRQ’s own public disclosures including the 2016 technical report and a $3.00 Cu/$1250 Au price deck. Second, considerable progress has been made to reduce the sovereign risk profile of the project, including drawdown of the project finance facility and the on-going positive impact that the project is having on both the local and Mongolian economy. The reality is that the stock price does not reflect improving copper fundamentals, does not reflect the value of the $9 billion of capital that has been invested to date and does not reflect the wall of free cash flow that will be generated when ore that is 6x the industry-average grade profile starts running through the mill, to the benefit of all OT owners. The reality, based on TRQ’s own investor relations surveys, is that the primary headwind for the stock is “corporate governance/the Rio Tinto overhang”. Perpetuating the same flawed corporate governance structure, in the face of such a damning report card, is simply irresponsible.
To address these concerns, we request that the Board implement the following three actions. We note that in no circumstances are Rio Tinto’s (“Rio”) existing rights being subjugated.
|1.||Hire an independent, non-Rio Chief Executive Officer. While we appreciate that there may be viable candidates within Rio Tinto, and that there may be some advantage to having a management team that is familiar with Rio’s corporate machinations, the benefits from having a truly independent chief executive are simply too compelling to ignore. Rio no longer has the right to appoint the CEO, so we believe that the Board should use this opportunity to quell the obvious market consternation around executive leadership and independence. As TRQ’s second largest shareholder, we explicitly endorse a compensation package that begins to reflect industry norms, if that is what is necessary to attract viable independent candidates. We suspect other minority owners would be equally supportive.|
|2.||Empower the independent CEO to hire an independent management team. If TRQ is going to be a functional entity, it needs to be staffed accordingly, by individuals who are solely focused on Turquoise Hill. In the current structure, all of the positions on the Oyu Tolgoi board, technical committee and operating committee that explicitly are intended to be held by TRQ appointees are occupied by Rio Tinto secondees. Rio can nominate whomever they chose for the positions which they negotiated, but TRQ’s appointees are intended to be independent. To take a step back, the effective ownership of Oyu Tolgoi is as follows: 34% by the Government of Mongolia (“GOM”), 33% by Rio Tinto (through their 51% stake in TRQ) and 33% by the minority public shareholders. Yet, those minority public shareholders’ only representation in the entire enterprise is the independent directors. The CEO, CFO, Vice President Operations and Development, head of Investor Relations and all non-GOM Oyu Tolgoi board and committee seats are Rio employees or secondees. This means that all decisions, and all information, flows through Rio Tinto, which by all accounts runs counter to the definition of “independent”. This situation is untenable, and can only be addressed by allowing an independent executive team to hire non-Rio Tinto professionals.|
|3.||Remove any and all reference to Rio Tinto stock or operating performance from TRQ executive compensation. We have written repeatedly about this, and while we appreciate the steps that have been made to reduce exposure to Rio Tinto, we can think of no logical explanation to justify why TRQ employees should have incentives related to anything other than TRQ and Oyu Tolgoi.|
We believe that these steps would meaningfully reduce the market concerns regarding Turquoise Hill’s ongoing corporate governance conflicts, and should be implemented immediately with the next CEO appointment. Furthermore, we contend that the creation of a more permanent, independent management and compensation structure becomes even more pressing as TRQ moves closer to the time when significant free cash flow will be available to return to its shareholders. As large, long-term owners, we believe that having TRQ’s stock price more accurately reflect the value of the underlying assets is an objective that all stakeholders should support. Given Rio’s cost basis in TRQ, it seems self-evident that they must share in our assessment of that value. Given the Board’s fiduciary duty to maximize value, you, too, seem highly incented to have the stock price be more consistent with the steady progress being made on the ground.
We thank you for your attention to these matters, and look forward to a prompt and detailed response.
|MacKenzie B. Davis||A. James Bruce|