Taking on Anglo

Santiago/London - Standing in the cavernous tunnel of what promises to become one of the world's biggest copper mines, it's easy to see why Chile's state mining colossus Codelco covets its neighbour - and why it could be humiliated by its botched attempt to buy a big stake.

Codelco has long hoped to take a stake in Anglo American [JSE:AGL] Los Bronces mine, which sits tantalisingly close to Codelco's Andina division in the Andes mountains just outside Santiago. Separated by a narrow wall of rock, in geological terms the two deposits are effectively one giant mine rich in copper.

But the deal has run aground after Codelco took the wrong strategy in negotiations and made a schoolboy error in underestimating an industry rival, assuming the latter would not risk upsetting its standing in Chile by selling a stake from under the state juggernaut.

Codelco was caught off-guard when Anglo American preemptively sold half of the 49% stake that in January Codelco would have been eligible to buy in Anglo's southern Chilean properties, which include Los Bronces, to Japan's Mitsubishi Corp.

Los Bronces aims to be the world's fifth-biggest copper mine and is a rarity in a market that has been defined in recent years by a lack of significant new deposits.

It would have been a multi-billion-dollar windfall for Codelco and the snafu is an embarrassment for deeply unpopular conservative President Sebastian Pinera, a self-made billionaire who is trying to run state enterprises like a private-sector business.

Chile is the world's No.1 copper producer, mining a third of global supply, and the metal is by far the biggest export and a top revenue earner in Latin America's most stable economy.

Codelco insists the long-standing option contract with Anglo puts the Chilean company on solid ground, although much will depend on how the courts interpret the pact.

Codelco maintains its option gives it the right to buy a 49% stake in Anglo American's southern Chilean properties, known as Anglo American Sur. Anglo says the contract gave it the right to sell a stake to Mitsubishi, because Codelco's window to exercise its option opens only in January.

"There are different interpretations of a contract ... But we're fairly certain that ours is the right one," Codelco CEO Diego Hernandez told Reuters after a bitter, public war of words with Anglo American.

Hernandez was furious when Anglo's deal with Mitsubishi was announced, cutting short a trip to a forum in Hawaii as he launched an offensive.

Legal experts say the wording of the option contract favours Anglo's case, although Chile's legal system gives significant weight to the "spirit" of legal pacts. Tapping a vein of nationalist sentiment amid the dispute, Hernandez was quick to warn that the contract was made under Chilean law.

Still, experts say Codelco may have put too much trust in the nebulous legal principle of "good faith".

Codelco has changed its rhetoric to stress it wants to defend the "value" of its option, and Anglo officials acknowledge some shareholders are concerned, suggesting the mining titans could settle. But the two sides and their legions of lawyers appear more likely to go into an extended legal battle.

Anglo American said on Thursday it was suing Codelco for breach of contract and said it wanted to void Codelco's option altogether, deepening the rift. Legal experts said the move could stymie Codelco from exercising its option during its January window, while the issue is in court.

Codelco gamble

Codelco surprised markets in October by saying it had secured a $6.75bn bridging loan from Japan's Mitsui & Co enabling it to exercise the option during a stipulated 30-day window in January at a price well below current market value.

Shares in Anglo tumbled to trade down nearly 5% the following day on fears it could lose a slice of one of its more promising operations, and on concerns over what it might do with the cash. But what Codelco had touted as the "deal of the century" unravelled just a month later.

Codelco insists it had to reveal its hand and give advance notice of the bridging loan, and hence plans to buy the stake, because of Japanese regulations governing Mitsui.

Sure enough, Anglo fired back with the surprise stake sale to Mitsubishi for $5.4bn, asserting the deal effectively cuts Codelco's stake option to a maximum of 24.5%.

An enraged Codelco, which bought the option from smaller state-owned mining company ENAMI in 2008, has since launched legal action against both Anglo and Mitsubishi, stating it ultimately seeks to reverse their stake deal.

A 2002 revision of the 1978 contract says that if a third party has bought a stake in Anglo's southern properties, that percentage must be subtracted from the 49% stake that Codelco was eligible to buy.

According to Anglo, Mitsubishi's ownership of 24.5% of the properties halves the percentage Codelco has an option to buy. But Codelco is touting the contract's stipulation of "good faith" to assert that Anglo violated the agreement by preemptively selling a share of its properties deliberately to undermine Codelco's option.

Most legal experts see the London-listed miner's reasoning as stronger, but warn that the Chilean legal concept of "good faith", though elusive in its definition, has proved crucial in past cases.

"In Chile, our contracts are relatively short ... and good faith is used to plug holes," said Fernando Bravo, a lawyer who specialises in mining and energy with the Prieto y Compania law firm in Santiago. "It's frequently used. But the specifics (of a contract) trump its generalities."

If Anglo and Codelco fail to settle, experts estimate the case could drag on for up to four years due to court backlogs and the complexity of the legal battle. Chile's judicial system is widely seen as independent from the government but it hasn't faced a multi-billion, tri-continental dispute of this magnitude involving the Chilean state.

"I don't see a risk of chauvinism or nationalism," Bravo said. "A battle in Chile doesn't guarantee a victory for Codelco in the slightest ... I wouldn't be scared if I were Anglo."

An embarrassing defeat for Codelco on its home turf could have deep consequences for the firm's leadership, the government and private miners in Chile.

A clutch of angry lawmakers even floated the idea of again raising mining royalties, which the government revamped in 2010 to help boost revenues for reconstruction after a devastating earthquake.

However, abrupt changes to the mining industry in Chile are seen as improbable.

A Codelco defeat would likely further hammer the government of Pinera, whom recent polls show to be the least popular Chilean leader since General Augusto Pinochet's 1973-1990 dictatorship. A stake in Anglo's prized properties would be a boon for the state coffers as Codelco contributes about a fifth of government revenues.

Chile's private miners, which include global heavyweights Xstrata and BHP Billiton, are warily watching the face-off and quietly hoping for a swift settlement.

They fear a long battle could sour relations between the government and private firms and possibly lead to tougher regulations and even a fresh revamp of the royalties they pay.

Negotiation breakdown

Hopes for an out-of-court agreement may be overblown.

It seems Hernandez, an efficient manager named copper man of the year for 2010 by the Copper Club industry group, and Cynthia Carroll, Anglo's first female and first non-South African CEO, have never seen eye to eye.

The executives both say they broached the issue of the option during the annual Davos economic forum in January this year.

The firms discussed in July the possibility that Anglo buy the stake option, but Codelco says the price offer was derisory. Contact petered out from there.

Hernandez, known for his pride and now at the zenith of his career, is seen unlikely to back down. Carroll has come under pressure over some of her decisions and investors have pressed for a steadier hand at Anglo, which has been cautious in recent years after fighting off takeover approaches.

While a personality clash may have derailed talks, the standoff is also testament to a metamorphosis at Codelco.

The 2010 arrival of Hernandez, formerly BHP Billiton's head of base metals, and changes in Codelco's corporate governance structure, have transformed the firm's management to resemble its more competitive, private-sector peers.

A bolder Codelco is executing a $17.5bn investment plan to boost output to more than 2.1 million tonnes by 2020 from an estimated 1.7 million tonnes this year.

It has also restructured its divisions and in October raised a record $1.15bn via bonds.

"Now Codelco is a state company, not a government company," said Juan Carlos Guajardo, head of the Santiago-based copper think tank CESCO. "The board doesn't respond to the country's political colour ... And you can tell. You see a far more proactive attitude."

Anglo also underestimated the revamped state miner, betting it wouldn't be able to muster enough funds to exercise the option, Guajardo said.

But Codelco is on the back foot, and the bid to buy its first major stake in a deposit to reinforce its position as the world's leading copper miner could backfire by denying it a key strategic purchase and exposing a major tactical error by Hernandez.

Codelco should have anticipated that Anglo could ultimately sell part of the eligible stake after the London-listed company invested $2.8bn in the flagship mine, and should have actively negotiated.

However, the government has made clear it is standing by Codelco, and by extension Hernandez.

Formerly called "The Disputed One", the Los Bronces mine is living up to its name.