Divestments in mining and metals: extracting hidden value
Divestments are increasingly being pursued across the sector, as capital remains constrained and corporates look to rationalize portfolios to achieve maximum return to shareholders.
This is a relatively new approach, coming off the back of a sustained period of consolidation, where the emphasis was on growth through acquisition. There is a significant risk that management teams will not be able to call upon the necessary experience across the organization to execute a sales process effectively and secure the best outcome for shareholders.
As we look at how private equity (PE) — a sector very familiar with divestments — approaches exit, we will also examine what the mining and metals sector could learn from it.
EY undertook a survey called The Global Corporate Divestment Studybetween September and November 2015, interviewing over 900 corporate executives across sectors and 100 PE executives about divestment trends. The corporate responses received suggest there is so much that companies can learn from expert buyers and sellers — PE firms — regardless of whether they consider PE a likely buyer of their business.
Over the past three years, PE firms have divested in companies at nearly 1.5 times the rate at which they’ve acquired them; in fact, the 20 largest PE firms have each sold an average of 8 companies per year.
While the mining and metals sector is in a fairly unique position, it is clear from the survey results that many of the drivers for exit are consistent with other sectors. The obvious exception is that opportunistic approaches are less likely to be a key driver in the mining and metals sector as many of the portfolio decisions are driven by concerns over capital preservation.
With intrinsic value so closely aligned with the quality of underlying reserve base, it is easy to overlook the importance of preparing an asset for sale and presenting it in the best possible light. Often, there is a view that bidders should be able to identify and articulate the upside potential in a sales process, rather than the seller preparing the necessary documentation in order to ensure all bidders are approaching the opportunity consistently.
In this market, where the buyer typically has the negotiation leverage, it is critical to prepare and provide detailed evidence of any turnaround plan or basis for improvement in earnings to ensure that sellers stay in the process and attribute the appropriate value to these initiatives.
With a very limited pool of potential buyers, ensuring the ones that enter a process stay involved is critical. If the process falls over because the reserve price hasn’t been met, it is very difficult to reinvigorate it. Too often, processes are hurried and critical information is prepared too late or excluded entirely. While the seller may see this as something that any bidder needs to overcome, often the lack of detailed data can lead to such a significant breakdown in confidence that a bidder simply won’t continue in the process.
PE owners place their investee businesses under constant review, such that they can use their influence to change strategic direction quickly.
On the other hand, portfolio reviews in the mining and metals sector have historically typically focused on how best to diversify earnings and risk. Therefore, it is not surprising that the discipline and processes behind regular portfolio reviews post the super-cycle are relatively immature. Many divestment decisions currently being made are driven by financial constraints and concerns over balance sheet flexibility. Going forward, it will be critical for regular portfolio reviews to be undertaken with a far more strategic lens — the one that prioritizes shareholder return over diversification.
M&A and capital raising trends in 1Q16
M&A and capital raising activity continued its downward trend over 1Q16. Besides prolonged volatility in commodity prices, increasing distress and subdued investment appetite, further adversity may be expected before a significant turnaround arises in transaction activity.
Deal value plummeted 45% y-o-y to US$3.3b, while volume dropped 17% to just 72 deals.
The top three deals were all divestments.
Portfolio realignment and divestments to raise capital, particularly in the coal and gold sectors, remained key drivers of deal activity in 1Q16.
We expect deal activity to pick up in 2016; particularly asset sales driven by the need to reduce leverage and possible acquisitions of distressed companies by their debt holders.
Core, low-quartile assets are likely to be retained, unless there is a commodity or regional restructure. We may also start seeing companies looking outside of their existing commodity focus or leveraging existing operations to explore other opportunities.
Capital raising trends
Over US$60b of capital was raised in 1Q16, unchanged y-o-y, but down 24% q-o-q.
Market volatility, wider concerns surrounding US monetary policy and the pace of economic slowdown within China significantly reduced equity market liquidity. 1Q16 follow-on offerings declined by 59% y-o-y and primary listing activity remaining stagnant.
Debt financing performed better in 1Q16 with a 38% y-o-y increase in loan values and a marginal 5% y-o-y drop in bond issuance.
Loan values were skewed toward established entities, with the top-five transactions representing 76% of total proceeds.
As 1Q16 progressed, natural resource equity prices rebounded strongly, in parallel with commodity prices, particularly for iron, gold, zinc and tin. Although prices have since eased and economic uncertainty remains, sentiment may shift toward consolidation for realizing improved operating and financing synergies.
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