Commentary: Global mining M&A and investment in 2013

Like in any industry, supply-demand imbalances in mining products are at the root of dramatic price fluctuations and market upheavals. This is what has been happening in the mining industry in 2013: market imbalances have led to rock bottom commodity prices for many minerals. The most dramatic example of this downward tendency was the 35% plunge in gold prices in a matter of weeks in the spring of 2013.

The good news is that on the demand side, it is clear there is continued strength in most commodities, underpinned by growth in China. In fact, the much talked about “China slowdown” has little to do with price collapses in most commodities produced from mining. Demand remains very strong in China, and hence globally.

Undoubtedly, there has been a weakening of “growth momentum” (i.e., demand did not grow as much as expected by some), but actual consumption of the main commodities continues to be strong and growing. For instance, iron ore and copper imports to China have been at record levels in recent months, and consumption of most minerals will be at record levels for 2013.

A core issue confronting mining companies in 2013 has been an under-estimation of the onslaught of new supply coming on line for many commodities during 2011-13. This onslaught has tilted many commodities into a situation of prolonged oversupply, leading to dramatic and protracted price drops and rising inventories. (LME inventories of most base metals have risen by 50% over the last two years).

Notwithstanding the 35% price drop, 2013 is projected to be a record year for gold production.

Glencore Xstrata (LSE: GLEN) CEO Ivan Glasenberg was recently quoted stating, “While demand for the company’s coal, nickel, aluminium, iron-ore, zinc and copper remained healthy, prices had been falling for eighteen months owing to capex excesses … supply growth had outstripped demand growth in most commodities as a result of the high levels of capex.”

These factors have had a cascading effect through the cast of players in the mining industry, from mega majors to China, mid-tier and junior sectors and alternative financiers, as described below.

The mega majors

For the mega major mining companies, like Vale (NYSE: VALE), Rio Tinto (NYSE:RIO; LSE: RIO), BHP Billiton (NYSE: BHP; LSE: BLT; ASX: BHP), Anglo American (LSE: AAL; US-OTC: AAUKY), Glencore and Barrick Gold (TSX: ABX; NYSE: ABX) 2013 has been a time to reassess recent strategies and regroup. Many CEOs have been replaced, and there have been layoffs as well as writedowns of struggling projects or top-of-the-market mergers and acquisitions.

All these companies have been trimming back their project pipelines in recognition that each new project throws more supply into an already crowded market.

For example, Vale announced it has cut its 2013 capital expenditure budget by 24%, and BHP and Anglo have announced they are halving capital spending over coming years.

The mega majors have terminated or suspended many of their largest projects, like Vale’s Simandou iron ore mine in Guinea and Rio Colorado potash mine in Argentina. In September, Anglo American withdrew from the Pebble copper-gold project in Alaska. These are projects that would have generated significant new supply for many years.

The mega-majors have also been running through a process of selling off billions of dollars in non-core assets to generate cash and reduce debt. For example, BHP announced that it had generated US$7 billion from divestments during the first three quarters of 2013 and indicated it is considering divesting at least 10 additional assets.

Rio Tinto announced it had completed US$2.9 billion of divestments during the first three quarters of 2013.

A noteworthy transaction was the sale by ArcelorMittal (NYSE: MT) of a 15% joint venture interest in one of its Canadian iron ore operations for US$1.1 billion to help pay off debt.

Norilsk Nickel (MCX: GMKN), Russia’s listed nickel miner, announced it is planning to sell all its foreign assets.

Meanwhile, Glencore has refocused on brownfield expansions and producing assets as it puts several major development projects on the block. 

Since few of these divestment-minded majors are actively looking to pick up each others’ non-core assets, it means there are not many buyers out there capable of taking up the announced dispositions.

In fact, some of the major dispositions have been called off, or have dragged out far longer than expected. This includes Rio Tinto’s cancelled sale of its diamond business in Canada and Namibia, BHP’s suspended sale of the Naudesbank coal project in South Africa, and Anglo American’s decision to keep ownership of its US$6 billion Minas Rio iron ore project in Brazil, after looking for a partner earlier this year.

Mark Cutifani, CEO of Anglo American, was quoted as saying, “it has been very hard for potential partners to offer an appropriate value for the project in the current macroeconomic scenario.”

All these developments, and the Chinese side-effects discussed below, have had a cascading effect through the junior mining sector. 

China

Many in the industry expected Chinese miners — big M&A players in recent years — to step-up their M&A in 2013, given the volume of purportedly undervalued assets on the market. However, the Chinese have also scaled back on mining investments in 2013 for some of the same, and for some of their own, reasons. This has exacerbated a cascading effect through the market.

In our discussions with Chinese state-owned enterprises (SOEs) about recent news, many have expressed a concern with the well-publicized writedowns faced in 2012-13 by miners in the West. “How could this happen?” they ask. A big writedown is something Chinese SOEs want to avoid, and there has been a prevailing view that SOEs will need to be especially cautious in light of recent market developments.

The recent leadership changes in China have put decision-makers into a holding pattern during much of 2013. They have been reluctant to suggest initiatives like a major merger or acquisition until it is clearer what will be the top leadership’s strategic direction.

Undoubtedly, the Chinese have faced some of the same challenges in their outbound M&As as Western companies have experienced.

Several significant Australian mining projects, such as Sinosteel’s Midwest iron project, Metallurgical Corp. of China’s (HKSE: 1618) iron project at Cape Lambert, and CITIC Pacific’s iron project at Cape Preston, have announced project delays or suspensions due to cost escalations or higher than expected costs. 

At the 2013 China Mining Congress and Exhibition held in Tianjin on Nov. 2, China Mining Association vice-chairman Wang Jiahua stated that about 80% of China’s overseas mining investments have not yet been successful.

There is a general sense coming from China that the approaches traditionally being taken to mining investments abroad should be revisited.

Several of the Chinese mining SOEs and their lenders have faced liquidity difficulties associated with underperforming assets, leading to a tightening of
the purse strings, on the bank’s side, with respect to new outbound M&A.

Big drivers in Chinese mining M&A in recent years have been the steel producers looking to secure supply for their mills. However, facing their own problems of steelmaking overcapacity in China in recent years, low steel prices and plenty of supply of raw materials on the market, many of the big Chinese steel companies in 2013 were focused on finding ways to improve profitability in their core business, rather than seeking diversity upstream in mining.

Several Chinese prominent M&A transactions for listed African mining companies were unsuccessful in 2012-13, such as Sichuan Hanlong Group’s US$1.3-billion bid for iron ore junior Sundance Resources (ASX: SDL), and Cathay Fortune and China Africa Development Fund’s joint US$865-million bid for copper junior Discovery Metals (ASX: DML) – throwing more water on the already damp fire of outbound M&A.

Adding to this already complex mix were clampdowns or probes on corruption and excessive spending launched in 2013 by China’s new leaders against officials at various Chinese SOEs. These actions sent a shiver through SOEs generally and contributed to a pause in outbound investing and M&A while the dust settles.

The net effect of all these factors is that China has been surprisingly slow off the mark to buy some of the plethora of mining assets for sale, even though the acquisition market is in a better position than it was before, when Chinese buyers were more active in the market, and there are a lot of good assets for sale.

There have been a few bright spots in outbound China mining M&A so far in 2013. Most notable was China Molybdenum’s acquisition of the North Parkes copper-gold mine from Rio Tinto for US$820 million.

Surprisingly, the second largest announced Chinese mining M&A transaction was in the U.S. — a relatively new destination for overseas mining investment — with the US$544-million acquisition by ceramics and hardware fittings company Guizhou Guochuang of Triple H Coal, a Tennessee-based clean coal mining company.

The most prominent potential mining M&A transaction involving a Chinese party during 2013 has been the US$5-billion disposition of the Las Bambas copper project in Peru, as ordered by the Chinese Ministry of Commerce as part of an anti-trust approval of the Glencore-Xstrata merger. Two Chinese SOEs are reported to be the main contenders for the asset.

Other than that, the Chinese have been rumoured to be mainly kicking a lot of tires in the big deals, but not buying.

Chinese outbound mining M&A in 2013 have been more in the way of  restructurings, such as the following three examples of going-private transaction of affiliates: Shenzhen Zhongjin’s US$112-million takeover of Perilya and Yanzhou Coal Mining’s (NYSE: YZC) US$146-million takeover of YanCoal Australia, and Chihong Canada Mining’s $50-million take-over of the Selwyn lead-zinc project in Canada.

In the mid-market, similar examples are: Shanxi Donghui Coal’s US$181-million bid for coal miner Inova Resources in Australia; Shandong Qixing Iron’s US$140-million bid for gold miner Stonewall Mining in South Africa, Dingyi Group’s US$200-million bid for potash miner Elemental Minerals in Australia, and Shandong Energy’s Linyi Mining Group’s US$200-million acquisition of Rocklands Richfield in Australia.

There has also been a smattering of private placement investments announced from China into junior companies, such as China Blue Chemical and Guoxin International’s joint $32-million investment in Canada’s Western Potash (TSX: WPX), and China CAMC Engineering’s $11.7-million strategic investment in Canada’s Fortune Minerals (TSX: FT; US-OTC: FTMDF).

Compared to recent years, however, this is a very modest list of announced outbound mining and investment M&A from China.

Interestingly in 2013, private enterprises have begun to gradually replace state-run companies to become the leading players in overseas mining. China Mining Association figures are reported to show that in the first three quarters of the year, overseas mining investments by China’s state-run enterprises reached US$1.2 billion, while those by private investors amounted to US$1.9 billion.

Africa and developing countries

China remains active in Africa and other developing countries, with several major projects launched in 2013, typically in “state-to-state” negotiated investments. Reportedly, much of the Chinese interest in new projects these days is from railway and construction companies rather than traditional mining companies.

Major project announcements in 2013 include China Nonferrous Metals’ announced US$800-million joint-venture nickel project in Myanmar; CITIC’s US$70-million investment in Venezuela’s  previously nationalized mining sector in conjunction with US$20 billion of infrastructure investment by a Chinese consortium; and Tianjin Materials’ US$1-billion investment in African Minerals (LSE: AMI) and its Tonkolili iron ore project in Sierra Leone. 

Russia and environs

Interestingly, Russian and Kazakh billionaires, perhaps more nimble in their decision making in this environment, have replaced Chinese SOEs as the main drivers of big mining M&A deals in 2013. Four of the leading M&As for 2013 have been from these buyers, including transactions for Polyus Gold, Eurasian Natural, Kazzinc and Uranium One.

Polish copper miner KGHM has made successful international acquisitions, and is reportedly looking to expand its resources via the same route.

Mid-tier feast or famine

The opportunities for the mid-tier miner in this market depend heavily on their debt situation.

For sellers, several mid-tier miners undertaking project development or expansion projects have been challenged by a perfect storm of less-than-forecasted commodity prices, skeptical or closed capital markets, and/or production or development challenges.

These sorts of challenges have forced several mid-tier companies, such as nickel players Mirabela Nickel (TSX: MNB; US-OTC: MRBAF) , Talvivaaran Kaivososakeyhtio (LSE: TLAV) and Sherritt International (TSX: S), gold players Jaguar Mining (TSX: JAG: US-OTC: JAGGF) and Great Basin Gold (TSX: GBG: US-OTC: GBGLF), copper producer Mercator Minerals (TSX: ML), into publicly announced restructuring, insolvency proceedings or strategic reviews.

Eike Batista, formerly Brazil’s, and one of the world’s, richest men, has been forced to fire-sale his empire, including mining and related infrastructure assets owned by MMX Mineracao e Metalicos, in one of the most spectacular meltdowns in mining history.  

Cliffs Natural Resources (NYSE: CLF) has suspended indefinitely its huge chromite project in Ontari
o’s Ring of Fire.

For buyers, it’s a different story.

With the Chinese on the sidelines, a few mid-tiers miners not saddled with debt have entered the market to pick up prominent assets from the mega majors — in some cases, priced with reference to the cost the vendor incurred to develop the project.

For example, Lundin Mining (TSX: LUN: US-OTC: LUNMF) purchased the Eagle nickel-copper mine in the Upper Peninsula of Michigan from Rio Tinto for US$315 million and PanAust (ASX:PNA) purchased the Frieda River copper project in Papua New Guinea from Glencore Xstrata for US$75 million. Capstone Mining (TSX: CS) acquired the Pinto Valley copper mine in Arizona from Rio Tinto for US$650 million.

Probably this cycle’s final, top-of-the-market mega deal was the hostile take-over of Inmet Mining by First Quantum Minerals (TSX: FM; LSE: FQM; US-OTC: FQVLF) for $5 billion in March 2013.

Juniors: just famine

The Toronto Stock Exchange and TSX Venture Exchange have long been the lifebloods of financing for the exploration and development of new mining projects. Few of these exploration and development companies are intended to survive as producing mining companies — most expect to take a project to a certain stage and then sell it to a bigger company.

This has been a brutal year for this sector, with all indices trailing downwards as 2013 nears its end. The S&P/TSX Global Mining index is down 20% year to date, while the S&P/TSX Gold index is down 43%.

As mentioned, a big driver behind investing in the junior sector is the prospect of a sale to a bigger company for a nice gain. However, the big buyers are not buying much these days, so this makes it hard for juniors to raise money for their project (that is typically intended to be sold to a major or Asian investors).

According to the TMX Group, equity financings by mining companies on the TSX Venture is on track to total about $2 billion during 2013, about one third of what was raised in 2011. Mining IPOs are almost non-existent these days.

Kaiser Bottom Fishing reported that as of mid-May, of the roughly 1,800 publicly listed TSX and TSX-V companies involved in mining or exploration, 694 had less than $200,000 in working capital — basically the amount needed annually to maintain a listing — and  about 70% of all the companies in their database were trading at below 20¢.

Only a select few mining companies have been able to tap into the equity markets in 2013 in a substantial way, such as Canadian gold producers Barrick, Allied Nevada Gold (TSX: ANV; NYSE-MKT: ANV) and Detour Gold (TSX: DGC; US-OTC: DRGDF). Many of the significant stock offerings that have gone through were intended to “de-lever” balance sheets, rather than fuel growth.

Mostly, juniors have stopped spending or raising money. They are now focused mainly on weathering the storm.

Overall, volatility in the mining sector has had a noticeable impact on M&A activity in 2013, despite so much being for sale. The number of deals across the global mining sector fell by 31% in the first half of 2013 compared to the same time last year, which was already considered to be a slow time for deal activity.

There have only been a few notable junior mining M&A transactions in 2013, such as the Rainy River sale to New Gold (TSX: NGD; NYSE-MKT: NGD) for $300 million.

Our expectation is that this market — which has worked very well for decades at funding mining exploration and development — will take a little while to recover and heal its bruises. However, the lure of the “big score” will continue to feed promising and/or well-promoted projects.

Alternative financiers

A number of alternative financiers have waded into the mining sector recent months to fill the gaps. When precious metals prices were skyrocketing, “metal streaming” companies and royalty companies, like Silver Wheaton (TSX: SLW; NYSE: SLW), Franco-Nevada (TSX: FNV; NYSE: FNV) and Royal Gold (TSX: RGL; NASDAQ: RGLD) were able to tap into the stock markets for billions of dollars to partially fund mine development projects in return for a “stream” of precious metals produced from the mine — typically a by-product — or a royalty. 

In late 2012 and early 2013, these alternative financiers were the talk of the mining sector. Some of the big streaming deals straddled the two market eras. For example, while gold prices were still top of the market in early 2013 and base metal miners were looking for dispositions, Silver Wheaton stepped into fund $1.9 billion to Vale via a “gold stream” of the Sudbury nickel mines and the Solobo copper mine (essentially, a partial disposition of these assets).

With the fall in gold and silver prices in mid-2013, there has been a slowdown in these streaming and royalty financings. What are the prospects for these mechanisms in the presently muted precious metals environment is an interesting question. However, markets have continued to evolve.

In recent months, private equity funds have recognized the opportunity presented by the market swing in mining, and several private-equity funded mining investments have been announced.

Private equity funds announcing mining deals in recent months include Apollo, Resource Capital, Brookfield, Appian Natural Resource Fund, Waterton, Trafigura and Liberty Mutual. (As an aside, there was a time when the preponderance of private equity funds specifically excluded “investing in mining or commodities” in their constating documents, as mining was then considered a market too volatile for these vehicles.) A noteworthy example in this area is the $130-million secured loan by real estate and infrastructure firm Brookfield to North American Palladium (TSX: PDL; NYSE-MKT: PAL) to fund its mine construction.

It can be expected that private equity in mining will remain highly selective and operate very much below the radar compared to the more promotional junior stock markets. Despite all the talk in the market about private equity moving to back acquisitions of major assets disposed by the mega majors, there has been little action in this regard so far.

In addition to private equity, a few specialty mine finance companies have risen to prominence, companies such as RedKite. These firms provide complex debt, equity and off-take structures to “cherry picked” advanced-stage projects, with the intention of filling the gaps missed by the traditional financiers in present markets — i.e. stock markets, banks, big mining companies and Asian investors.

A noteworthy example is the $190-million funding provided by RedKite to Vancouver-based junior Asanko Gold, (TSX: AKG; NYSE-MKT: AKG) for its Ghana gold project, made by a combination of royalty financing, traditional project finance and off-take.

It will be interesting to see whether the speculation made by these alternative funders in the riskier junior sector will pay off. Our feeling is that it will, provided they back the right projects.

Outlook

One thing we know from the past, is that it can take a long time to re-stock project pipelines for mining after a whip-saw reaction of cuts in response to a low
price commodities environment. Mining projects take up to a decade to enter into production, especially in the current climate of heightened environmental and social licence approvals.

A prolonged period of underinvestment in capital spending will again lead to supply shortages, rising prices for commodities, lowering inventories, acquirers scrambling to buy projects through M&A, upstream consumers seeking to secure supply — i.e. the “same old thing” all over again.

Our view is that this will occur sooner than many in the market expect. London Metal Exchange inventories have finally started to dip down in recent months, indicating that the supply adjustments are having effect.

 Major overseas investing from the Chinese will continue — notwithstanding the regrouping — driven by the accumulation of foreign currency reserves, shrinking domestic resources and continued support by the national government to Chinese companies “going out”.

Emerging from the ashes of 2013 could be the next generation of Xstratas and Vales — players able to lock up distressed and undervalued assets during the down times so as to maximize their benefit when markets pick up. In fact, the ex-CEOs of each of these companies (and several others) are attempting to make such acquisitions via their own start up private equity backed vehicles.

As the “Year of the Snake” in the Chinese zodiac, 2013 has been a year for calculated reflection, strategy and patience amidst unfavourable odds. Perhaps, amidst the bearish undulations of the commodities markets, there will be some companies which exemplify the serpentine spirit of 2013 and emerge stronger for it.

— Based in Toronto, David McIntyre is a partner at Norton Rose Fulbright. He is a business lawyer for mining, mineral exploration and natural resource companies, with experience in M&A transactions, joint ventures and strategic alliances, commercial agreements (joint venture, farm-in option, royalty, off-take, product sales, assets sales, mine development and other mining-related agreements), corporate governance and corporate social responsibility.

Based in Beijing, Barbara Li is a partner at Norton Rose Fulbright. As a corporate and projects lawyer, she specializes in China-related cross-border transactions including mergers and acquisitions, joint ventures, inbound and outbound investment, development and construction of major projects, private equity, regulatory and commercial matters. She focuses on mining, energy and infrastructure industry sectors.

Norton Rose Fulbright is a global law practice with full business law service and more than 3,800 lawyers based in over 50 cities across Europe, the U.S., Canada, Latin America, Asia, Australia, Africa, the Middle East and Central Asia. Visit www.nortonrosefulbright.com for more information.