Does Firstgold Really Mean That CFIUS Has Gone Hostile?
The withdrawal of the Chinese acquirer in Firstgold transaction has ignited a debate over whether U.S. investment policy has become more restrictive with respect to China. In fact, Firstgold is unlikely to be a reliable indicator of the policy or regulatory direction of the U.S. government. Firstgold presented an unusual set of facts, did not truly involve U.S. critical infrastructure and has little economic significance. The regulatory outcome was determined well before the blowup between Google and the Chinese government occurred earlier this month. Commentators should be wary before generalizing from the Firstgold outcome, as incorrect observations may reduce offshore investment interest in the U.S.
The Financial Times reported earlier this month in an article bylined by its Beijing-based reporter Kathrin Hille that Chinese companies are expecting tougher scrutiny in the United States. This change is linked to Google’s announcement that Chinese hackers had accessed its systems and those of 20 other companies. Google’s stand might affect both inbound investors and companies already present in the U.S. The article reported that the failure of the Firstgold investment is an indicator of the Obama administration’s enhanced scrutiny of Chinese investment infrastructure.
The Firstgold investment was not a conventional inbound investment. The company’s SEC reports contain unusual facts. Firstgold has been an exploration stage company with only minor operations since 1995. Its assets are principally property and equipment for gold prospecting at four sites in Nevada. It is financially distressed. Its audit included a going concern qualification. It must raise capital to survive. Its two hedge fund investors sued it for securities fraud 10 months after making their loans. The Chinese investor, Northwest Non-Ferrous International Investment Company Limited, intended to not merely invest in Firstgold, but to acquire the outstanding senior secured debt from the hedge funds, loan additional funds to Firstgold and invest enough to own 51% of the Company’s equity. The total investment package was valued at $26,500,000 but less than $10,000,000 was an equity investment in the company itself. Firstgold did not file its application with the Committee on Foreign Investment in the United States (CFIUS) until three months after the deal was first announced. Firstgold did have a property located in Fallon, Nevada, 50 miles from a U.S. Naval air facility that tests advanced weapons. It was this proximity that led the staff of CFIUS to conclude that there were national security concerns.
Firstgold’s assets are not critical infrastructure. The regulations promulgated under the Foreign Investment and National Security Act of 2007 define critical infrastructure to be an asset so vital to the United States that the incapacity or destruction of the particular asset would have a debilitating impact on national security. Firstgold’s assets do not satisfy that standard. Critical infrastructure is not an issue in the case.
Firstgold has no economic significance. In its 15-year history, it has produced no material revenues. Because it is not an active mining operation, it is not a factor in the local Nevada economy. Its debt is in default, and it is subject to foreclosure proceedings. The real importance of the transaction was the bailout of its lenders who thought they could offload their position at a favorable price. The value of Firstgold’s stock is questionable, since there are outstanding cheap warrants equal to 26% of the outstanding shares, a significant overhang. In fact, there was a period during 2009 where Firstgold’s stock could not be traded since it had failed to file its reports with the SEC.
On the other hand, it truly is difficult to understand what CFIUS gained from blocking this deal, in which case it may be that its action can only be a signal for a new hawkish outlook. In November 2008 CFIUS published a list of 11 illustrative factors that it will consider in determining whether a covered transaction poses national security risk. The Firstgold deal seems to present none of them. The CFIUS Guidance also discussed transactions that have presented national security considerations because of the nature of the U.S. business over which control is being acquired. Geographic location is not mentioned as a determinative factor. Because Firstgold has no products, it is not able to have products that may have implications for U.S. national security. It is possible that CFIUS determined that the buyer was acting on behalf of the Chinese government. If so, CFIUS never mentioned it. Therefore, if CFIUS intended to send a message, the message may be that a Chinese investor has the burden of proving it is not acting for the PRC government. Given the size of the transaction and the relative obscurity of the parties, however, it is difficult that CFIUS meant for its action to be considered a bellweather for other China-originated transactions.
It’s appropriate for the media to be alert to policy changes that result from Google’s startling announcement. Reading tea leaves is a tricky business, however, and in the world of commerce, the media should refrain from issuing baseless alarms when the U.S. economy is earnestly seeking foreign direct investment. The rational view is that, all in all, there was little compelling reason once the national security monitors raised doubt as to the real reason for the transaction, for CFIUS to permit the Firstgold deal to go ahead. Had there been some compelling showing that the deal had a rational basis as a business investment, CFIUS would have approved it.
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