Resource Capital rides commodities bull market

You could say Ross Bhappu has the cactus ferruginous pygmy owl to thank for Resource Capital Fund’s foray into rare earths and its wildly successful investment in Molycorp (MCP-N).

If it wasn’t for the pygmy owl – a reddish-brown bird no more than seven inches long and weighing about the same as a tennis ball – Bhappu might not have joined the private equity firm and become the brains behind one of the greatest private equity deals in U.S. history.

In 1997, Bhappu was trying to launch a start-up in Arizona called GTN Copper with backing from an Australian investment group. But the U.S. Fish and Wildlife Service spoiled his plans when they added the pygmy owl to its list of endangered species. That decision forced Bhappu to sell the company.   

“For a little junior company to mitigate an endangered species is very, very difficult,” Bhappu says during an interview in Toronto. “But it’s funny how when one door closes, another one opens.”

The door that opened was to Resource Capital Funds or RCF – where he was wooed by the firm’s founder, James McClements, and joined in 2001. 

Bhappu had met McClements in the late 1990s when he was trying to get the private equity firm to invest in GTN Copper. McClements was impressed by Bhappu’s credentials – which included a master’s degree in metallurgical engineering and a doctorate in mineral economics from the Colorado School of Mines – as well as a seven-year stint at Newmont Mining (NMC-T, NEM-N), where he distinguished himself in many different capacities including
director of business development.

McClements started RCF in 1998 with his friend and former boss Henderson Tuten, chief executive of NM Rothschild North America.  

Legend has it that the two men came up with the idea to start RCF over dinner in 1997 in a Vancouver restaurant, mapping out what the company might look like on the back of a napkin. Since then, RCF has raised five funds during some of the toughest economic times in recent history: US$41 million in 1998; US$82 million in 2000; US$240 million in 2003; US$527 million in 2006; and US$1 billion in 2009.

RCF specializes in mining companies from the development and growth stage through to operating companies. 

“We don’t take exploration risks,” says Bhappu, “our bread and butter is the development of early-stage companies where somebody has already spent money to identify the resource. It doesn’t have to be a formal (NI) 43-101 resource, but it has to have drilling and trenching done and the ability to declare a resource of some kind.”

The company has grown to more than 50 employees scattered across offices in Denver, Colo., and Perth, Australia, and most recently Toronto. Most are specialists in geology, mining engineering, metallurgical engineering, process and civil engineering, and many have MBAs and graduate degrees in mineral economics.

It’s the technical expertise that sets RCF apart, Bhappu argues, explaining that the internal technical services team can take a company’s raw drill data and reach its own conclusions about the resource estimation results.

“We’ve avoided some pretty costly mistakes by doing that evaluation and verifying what companies are telling us,” he says. “It also lets us see upside where others may not see upside so it works in our favour in a number of ways.”

RCF’s typical investors are university endowments, foundations and charitable trusts, family offices, and institutional investors. Today RCF has about 100 institutional investors that typically commit funds for about 10 years. 

Raising money in the early days wasn’t easy. “In the beginning there were lots of cold calls, which was hard to do,” Bhappu recalls. “Since then, it’s been mostly word of mouth. You’d be amazed at how tightly knit these groups are and how they all talk to each other and if somebody is interested in natural resources their friends might recommend us… We have a very good track record and are very fortunate to have an investor base who are really happy with the way we have performed so they want to reinvest with us.”

Today RCF has investments in about 35 companies – but is perhaps best known for its investment in Molycorp – the strongest advocate of which was Bhappu.

In 2008, Bhappu and his team at RCF lead an investment group including Traxys S.A., a metals and minerals trading and supply chain management company; Goldman Sachs (GS-N) (who later sold to the other shareholders); and Pegasus Capital Advisors, a private equity firm; to buy the Mountain Pass rare earths mine in California from Chevron.

The group collectively invested about US$200 million, of which RCF put up over half. When Molycorp went public in August 2010 at US$14 per share, the company raised roughly US$380 million, the proceeds of which went to modernize Mountain Pass.

In February this year, RCF and other founding shareholders conducted a secondary sale of shares as part of a primary offering of the company – at which time about 25% of the founding shareholders’ shares were sold – leaving RCF with 23% of Molycorp.

Today Molycorp is trading at about US$64 per share and has a market capitalization of about US$5.3 billion.

“There was never any question in my mind that this would be a good investment,” Bhappu says. “I know some of my partners questioned it but at the end of the day after reviewing our due diligence materials, they all got comfortable with it.”

During the 18-month negotiations to buy Molycorp from Chevron, Bhappu was convinced the deal was right after talking with customers of rare earths. “We went out and interviewed the people who buy this stuff. And we’d go to these meetings and customers were saying they were 100% dep-endent on the Chinese and that they were concerned that the Chinese were slowly turning off the taps and they didn’t know if they could get the material for the next three to five years.”

Molycorp may be RCF’s best-known success story but the firm has parlayed other investments into big wins. In June 2007 an RCF-led consortium acquired the Sons of Gwalia tantalum and lithium assets from creditors in Australia for an undisclosed amount, but rumoured to be very low. In late 2010, it spun off the assets into two separate companies: Talison Lithium and Global Advanced Metals.

Last June, Talison Lithium merged with Salares Lithium (LIT-V) to combine Talison’s lithium minerals in Australia with Salares’ large-scale lithium brine exploration project in Chile.

Earlier this year, Global Advanced Metals announced it would re-open its Wodgina mining operation in Western Australia. The operation had been put on care and maintenance during the global financial crisis in 2008 and according to RCF, Wodgina along with Greenbushes contains the one of the world’s largest known resources of tantalum. 

RCF is also well known for its investment in EuroZinc Mining led by partner Ryan Bennett, who heads the Denver office. RCF made its original investment in 1999 when EuroZinc was a junior undertaking a feasibility study on the Aljustral zinc mine in Portugal, and provided multiple rounds of financing during a very depressed commodity cycle.

RCF eventually held more than 80% of the company and assisted EuroZinc in recruiting Colin Benner as CEO. In 2004, RCF helped EuroZinc acquire Neves Corvo for 128 million euros, which was four times the market capitalization of the company at the time. The firm exited its position in 2007 as part of the takeover of Lundin Mining (LUN-T). EuroZinc remains one of RCF’s most successful deals, returning more than 17 times the original investment.

In other deals, RCF invested US$5 million as part of a US$6-million placement in tungsten producer Malaga (MLG-T) in May 2010 and in January of this year invested another US$8 million in First Bauxite Corp. (FBX-V), following a small
er investment in mid-2010. On a fully diluted basis, RCF holds about a 15% equity stake in the company.

Bhappu and his RCF colleagues are constantly on the lookout for new opportunities and spend about half their time on the road. While its head office is in Denver, about one-third of RCF’s investment professionals are based in Perth, and recently RCF recruited David Thomas from CIBC to open its new office in Toronto. 

So far, RCF has invested in 34 different commodities as well as drilling and services companies, across 30 countries. RCF’s investments are about equally spread across precious metals, base metals, industrial minerals, energy minerals (uranium and coal) and bulk minerals (iron ore and aluminum).

“We try to identify what the exit strategy is going to be but it rarely turns out that way because things change all the time,” he says. “When we get into the investment we make sure we have enough money to continue to support the company and then we reserve funds for future investments to make sure they get through the development stage to the point where they no longer need our support,” he explains.

Sometimes RCF exits a company following a feasibility study but more often than not, supports the company through to development of the asset. Once the company is self-sufficient, the firm checks out as its role is done. 

“Our typical hold period would be between three and seven years,” Bhappu notes. “That’s what separates us from the hedge funds, which are looking at days to months…We strike a deal with the management team to add capital and help them advance the story.” 

RCF is active at the board level, contributing its experience and access to its network of mining professionals, ensuring that a company maintains its focus on its core strategy.

As for the smaller companies, which might have excellent geologists but no expertise in other aspects of the business, RCF helps them recruit new people, introduces banking and broking contacts, and identifies high-quality consultants that are appropriate for a project, location, or commodity.

In terms of size, RCF is willing to invest a few million dollars all the way up to US$150 million in equity and if that is leveraged with co-investors RCF could bring US$300-US$400 million into a deal.   

Bhappu has no regrets about the way his career has evolved – even after learning in 2006 that the pygmy owl was taken off the endangered species list.

“I have a lot of fun,” he says. “We have a team of people who are really great to work with. We’re very collegial and every deal we work on gets the benefit of input from everyone.

“I may be getting all the limelight for Molycorp but that’s unfortunate because I’m just one of the many people that made that happen.”