SZLN: Acquiring PEM Harvard Case Solution & Analysis

Shenzhen Zhongjin Lingnan Nonfemet Co. (SZLN) is a Chinese company that is considering the purchase of an Australian mining company. Management should evaluate the merits SZLN acquisition proposals should be made, as it will be financed, and political consequences of purchase as the governments of China and Australia. "Hide
by James E. Hatch, Lifan Wu, Xingyun Liu Source: Richard Ivey School of Business Foundation 21 pages. Publication date: April 14, 2010. Prod. #: 910N07-PDF-ENG

SZLN: Acquiring PEM

Problem Statement:

Following are the areas that need to be analyzed

-           Calculate a discount rate to discount US dollar cash flows to equity if leverage remains unchanged at its current value.

-           Cash flows to equity.

-           Present value of the PEM equity per share in Australian dollars.

-           Using the price paid for Herald, what would be the comparable price for PEM and what might cause a doubt on such valuation.

-           Should SZLN buy PEM shares in the market, buy newly-issued PEM Treasury shares, or buy convertible debt issued by PEM. Advantages and disadvantages of each approach.

-           What might SZLN do to convince the Australian government not to block the transaction.



For the purpose of calculations, please refer the excel file.

Calculate a discount rate to discount US dollar cash flows to equity if leverage remains unchanged at its current value

For the purpose of calculations, following assumptions / data were used;

Projections as in 2011 are assumed to continue from 2012 to 2016.
No Debt is repaid from 2011-2015, and in 2016 Outstanding balance of 9.05 million is repaid (Pg 7).
Tax is assumed to be 35%
Debt beta is zero.
Short term debt


AU dollar
Long term debt


AU dollar
Total debt


AU dollar
Equity            148AU dollar
Exchange rate US$ toAU$


Exhibit 13
Shares outstanding       196.88Pg 10
To calculate the debt cost in the Australian market, the financing cost of 0.68 USD Million
on an o/s debt of 9.05 USD million is used.
Total debt         17.71US dollar
LoanPg 7


US dollar
InterestExhibit 13


US dollar
Debt rate


= Interest / loan


Using the given data, discount rate found for the purpose of cash flow discounting is 15.64%. Calculation is shown below;

Risk free rate


Australian 10 years treasury bond rate.
Risk Premium




Exhibit 14
Equity ratio


Tax rate


Debt cost


Net debt cost


Debt ratio





US treasury bond rates would not be used to discount the US dollar cash flows from operations because the circumstances and operations surrounding PEM’s shareholders, are affected by the Australian market and economical conditions, which thus requires Austrailian rate to be used as a risk free rate.

10 years Australian Risk free rate of treasury bonds is used instead of 5 years Australian treasury bond rate because the useful life of project is 8 years and therefore, 10 years period is a more appropriate option.


Cash flows to equity

Using Exhibit 13 and the following information, free cash flow are determined.

-       Assume that the entire ore reserve in Broken Hill is fully depleted at the end of 8 years.

-       Assume that the volume extracted is constant over the last 5 years.

-       Assume debt payments are as in the third para from bottom on page 7 of the case.

-       Make all the assumptions in Exhibit 13, and make adjustments and/or future projections based on these information.

-       Assume the spot price of zinc remains unchanged from 2011.

-       Assume that the buyers take out all the cash that is on the balance sheet in 2008, net of any inflows  that are required in 2009.

-       Assume PEM will eliminate exploration and development expenditure.

-       PEM also has assets in Flinder’s Project in South Australia and Mount Oxide Project in Queensland. Ignore these assets in the analysis, that is, assume PEM only consists of Broken Hill and that all figures in Exhibit 13 are for the Broken Hill properties.

What might SZLN do to convince the Australian government not to block the transaction

This whole merger/acquisition is required to be governed under the Australian rules where an Australian government body “Foreign Investment Review Board” (FIRB) would examine the proposal from SZLN as this is a foreign direct investment in Australia from Chinese company, which specially highlighted due to SZLN’s backing from Chinese Government. Thus to acquire approval from Australian government, SZLN need to give due care to the areas looked specifically by FIRB. FIRB looks into the points as;

-       Investments by foreign government entities must be independent from the foreign govt.

-       Investors with links to foreign governments may not operate solely in accordance with normal commercial considerations and may instead pursue broader political or strategic objectives that could be contrary to Australia’s national interest.

-       Investment may not hinder competition or lead to undue concentration or control in the industry.

-       It must not negatively affect Australian government revenue or other policies.

-       It must not affect Australia’s national security.

-       It must not negatively affect the operations and directions of an Australian business or its contribution to the Australian economy. This includes impacts on imports, exports, local processing of materials, research and development.

Thus in order to achieve the required approval, SZLN should present the case with due care mentioning relevant points as;

-           SZLN need to ensure that the acts of SZLN are purely commercial substance without having any political background. This area can be addressed by representation of a proper and independent board.

-           SZLN could also present a report on its past / historic performance representing SZLN’s past commercial decisions without any political influence.

-           SZLN may give an undertaking to properly adhere to the Australian policies.

-           SZLN should allow Australian regulators to conduct due verification of affairs of SZLN and show its commitment to report over this issue from time to time to the Australian regulators.

-           SZLN should show its willingness to respect and abide by the Australian competition rules.

-           Present the fact to the Australian government that SZLN’s entrance in the mining area of Australia would bring potential benefits of its entrance as;

a)     Synergies in the smelting area.

b)     Distribution network efficiencies resulting to related cost benefits.

c)     Benefits in the area of knowledge sharing and research & development.

d)     Benefits flown to a local Australian business (PEM).

e)     Improved Australian exports.

-           Ensure the authorities that SZLN entrance in the Australian market would never be an area of concern for Australia’s national security.


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