Capital strike puts focus back on capital optimization for Canada's mining juniors
(As originally published in the Financial Post, March 2013)
By Bruce Sprague, Practice Leader, National Mining and Metals, EY
Cash is king for Canada's junior mining companies. Cost and capital project execution challenges driven by pricing differentials, commodity costs and project cost overruns in the sector are behind a new class of risk-averse investors that are challenging junior mining companies' ability to grow — and stay alive. These new investors are more tuned in to changes in market conditions and less comfortable with longer-term returns — a trend that left very few options for early-stage explorers in 2012 and one that’s set to continue in the year ahead. These companies are now in survival mode, concentrating on cash preservation.
What can they do? Junior mining companies have to be much more creative when it comes to securing access to capital. This is especially true today for companies in the early exploration stage that are much more exposed to current capital constraints. Equity markets are very limited in what they’re willing to offer companies this size, and the ability to find farming partners is significantly reduced. And juniors may find options in high-yield debt markets — but that's a difficult game for these companies to play.
That's why these companies are pursuing unique, creative financing arrangements and thinking about how they can advance to the next stage. It’s not as easy as it was in the past, but opportunities still exist for juniors to secure financing. It's just a matter of balance.
Companies need to ensure the right balance between focus on short-term returns and investment in longer term growth. Smaller companies in particular need to be realistic in their projections about financing needs. Smaller funding requirements, linked to achievable, phased development targets, are more likely to attract investors, and less likely to result in disappointment of the market further down the line.
Juniors can distinguish themselves in front of investors by the quality of their management and board. Investors that are looking at the sector are looking for familiar names and track records that have had success. Majors, in particular, are paying more attention to juniors with high quality assets and teams. Global diversified miners managing the same sector capital strike are divesting non-strategic assets and evaluating minority interest positions in juniors as a way to return cash to shareholders while moving forward with a prudent pipeline of growth.
Consolidation is another means of growth between juniors with cash and those with property. If current economic conditions continue there may also be an increase in the number of mergers of equals that take place in the sector. That's not all, either. Companies in the pre-development stage are increasing attention around streaming deals, selling off a royalty interest from a non-strategic asset for up-front financing.
So while early-stage explorers may be feeling the full force of today's capital strike, options for growth exist. Diversifying sources and types of funding will help to spread risk, drive efficiency and limit exposure or loss of control to any one single party. Building of relationships with the widest range of potential capital providers will help to secure the right funding at the right price.
But to survive and thrive, junior mining companies must ensure a thorough understanding of the range of funding structures and sources available to them, and their associated benefits and risks. Major factors to consider include:
- Are the costs of capital commensurate with the immediate funding need?
- Are shareholders comfortable with the proportion of ownership of your business you are conceding?
- On what terms are you locking in off-take of your future supply, and what are the implications on your long-term growth?
- What impact will this funding partner or structure have on your ability to secure other sources of finance?
The capital strike by many companies and investors alike will continue until commodity prices recover sufficiently to encourage new investment in the sector — a shift expected in the latter half of the year when companies welcome back leaner business models and stronger balance sheets.
It's then that companies will re-focus on growth as the pressure to replace depleting reserves and maintain production mounts — but the question remains as to whether this will take the form of building or buying. Until then, and perhaps beyond, it’s all about capital optimization for Canada’s junior miners.