Tough times for miners bring longer-term value creation opportunities
Monday 23 February 2015 - Capital raising and allocation decisions have rarely been more challenging for Australian miners, but the bottom of the cycle is often when longer-term value is created, according to Paul Murphy, EY Australia and Asia Pacific Mining & Metals Transactions Leader.
The comments follow the release today of EY’s report, Mergers, acquisitions and capital raising in mining and metals, 2014 trends, 2014 outlook. Buy, build or return? which shows deal volume in the Australian mining and metals sector declined for the fourth consecutive year to 144 deals in 2014, down from 178 in 2013 and the lowest since 2003.
Overall deal value in the Australian sector also reached a 10-year low of US$4.7b in 2014, down from US$5.5 in 2013 and the lowest since 2004. Global deal volumes and value also hit 10-year lows in 2014, with 544 deals and overall deal value of US44.6b.
Murphy says that despite continuing commodity price volatility, deal activity in 2015 is likely to be fuelled by ongoing divestment programs, forced asset sales and an expected pick-up in the pace of private capital investment.
“Standing still is not an option for the sector. We expect to see mining companies continuing to review their portfolios and capital allocation with regard to growth options,” he says.
“As the sector enters the latter stages of a global supply rebalancing and new mining industry participants jockey to stake their position, companies are juggling shorter term financial performance with longer term value drivers to take the necessary capital decisions to optimise value creation.”
Buy, build or return: the case for buy
Murphy says the current sector focus on return on capital employed lends itself to short-term decision making, some of which has successfully instilled much needed discipline across the industry.
“But given the cyclical characteristics of the sector and the need to invest significant capital many years ahead of production and earnings, a longer term perspective must be overlaid,” he says.
“Following the cost reduction programs, internal capital allocation and productivity measures of the past few years, the really successful management teams will be those that have a broader focus on total shareholder return and take the necessary capital decisions today to support long term value creation.”
EY analysis of capital allocation trends of 30 of the largest listed mining companies globally between period 2003-2013, showed a clear underperformance by those companies which invested primarily in a “build” strategy over the time period, while “returners” outperformed, with “acquirers” not far behind.
“Acquisition options have often been taken off the table because of the significant impairments that have followed deals in recent years, and the stigma attached as a result,” says Murphy.
“This overlooks the huge returns that some acquisitions created earlier in the cycle, and the short payback that a deal, if executed well, may generate overall compared to investing in a portfolio asset. Given the sector is now back to the lowly M&A levels of 10 years ago, the question is when to move, as the rule of thumb tells us that the early movers will create the most value.”
2015 buyers: private capital, Asian acquirers, joint ventures
EY expects 2015 will almost certainly be a turning point for the deployment of private capital in the sector. Over the past few years, there has been a substantial increase in private capital ear marked for investment in the mining sector which has yet to be deployed.
“On the whole, sector-focused funds have patiently and conscientiously refrained from making significant investments in 2014, and this has proven to be the right strategy, given where share prices across the sector ended the year,” says Murphy.
“Along with depressed equity valuations, the pipeline of quality assets expected to enter the market as a result of portfolio reviews sets the scene for significant industry restructuring and the emergence of some new players to drive competitive growth.”
EY also expects to see more strategic joint ventures emerge as a way of sharing the costs and risks associated with accessing new markets, to realise synergies, as well as among Asian acquirers looking to secure supply.
“There could also be a flurry of opportunistic buying as companies fall under the weight of widespread price volatility.”
Capital raising remains complex
Globally, total proceeds from capital raising across the sector in 2014 were down 15% on 2013, falling from US$272.0b to US$230.8b. However, the headline number is misleading as most debt raised went into refinancing with little new equity coming into the sector during the year.
Beyond the majors, capital raising for projects remains complex and often requires multiple funding sources.
“Capital availability has become very selective and getting projects away requires increasingly sophisticated and innovative funding structures and sources,” says Murphy.
“Some of the more innovative project finance stories in 2014 came from mid-tier and advanced developers, including the US$7.2b funding package for Roy Hill iron ore project in the Pilbara, the year’s largest project finance deal.”
Innovative financing structures and sources seen in 2014 and set to continue in 2015 include financing arrangements with commodity traders and specialist funds involving offtake agreements and streaming and royalty deals.
Challenges for juniors and developers
“For advanced juniors and single-project developers, there are options but each comes with its own challenges and the markets are particularly difficult right now,” says Murphy.
“As a result, this part of the sector is stuck between a rock and a hard place – poorly considering financing strategies can be value destructive, but with no finance there will inevitably be growth stagnation,” he says.
Murphy says many juniors who had effectively suspended exploration and development activities to conserve cash would simply continue in “survival” mode.
“There are some positive signs. Australia had the highest volume of mining and metals IPOs globally in 2014, with seven listings raising US$76m, helped by the buoyancy of the broader IPO market in Australia.
“However, the lack of risk capital for junior explorers is having a significant impact on available funds for exploration, potentially setting up supply shortages for the next decade,” he says.
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