CAN PRIVATE EQUITY FILL A VOID IN OUR MINING SECTOR?
Whether or not junior miners will be able to seize this opportunity will rest on their ability to access funding. With public markets remaining difficult for miners, and investors looking to other forms of investment, the lack of available finance has created a gap for less conventional forms of finance to take on a larger role in the sector.
Morné van der Merwe, partner at Baker & McKenzie, says "there is some hope that private equity ("PE") will help fill the void left by the public markets. Traditionally, PE firms have been reluctant to invest in this space, mostly due to the fact that mining investments are considered to be high risk investments. As such PE firms chose in the past not to invest in the mining sector due to the intensive need for capital, long development lead times with the concomitant protracted return on investment, volatile commodity prices, a lack of technical knowledge of the sector and the fact that public markets acted as a sufficient source of capital."
More recently, the assessment by PE firms of risks associated with mining projects has evolved, as these firms have developed better technical and commercial capability to evaluate mining projects, as well as their understanding of the sector. This, coupled with the fact that valuations of mining assets have become more realistic and the availability of high quality mining assets in the market, as major players in the mining sector refocus their portfolios, holds the potential of high return on mining investments, attracting PE funds to the sector.
Some $2 trillion is invested worldwide by private equity funds every year, a portion of that is destined for junior mining companies. With the mining industry quickly evolving and actively trying to encourage new flows of finance into the sector, PE for junior miners are now a serious consideration.
PE firms offer a new investment approach to junior miners
PE firms focus on the bottom-line and often approach investments hands-on to maximize returns. Generally, firms will take a seat on the board of their portfolio companies to protect their investment. Their high level of involvement not only includes rigorous capital spending assessments and improvements in governance practices, but they are able to offer easier access to resources and services by tapping into other companies in their portfolio. Their involvement also allows management teams to focus on delivering the project, achieving operational optimisation and reducing costs, which in turn improves the return on investment.
Apart from providing capital to grow business, PE firms may also offer:
-An improved business plan
-Enhanced operational expertise to better support management and help solve problems
-Enhanced corporate governance, financial reporting and transparency
-Assistance with ensuring acceptable returns are made
-Assistance in identifying acquisitions
-Access to the firm's network of contacts and experts
-A more diversified and holistic view on company risks, based on their experience of a whole range of projects.
PE firms are in it for the long haul
Most of the projects in the mining sector are long-term, requiring long-term investment capital. The future-focused objectives of PE investors are well suited to deliver on this requirement. Other investors, who are focused on quarterly results, may not be willing to wait through the longer-term industry related problems to see the return of their investment.
PE firms approach projects differently, working with a fully-financed plan to create value so that when the market turns, the firm will have a strong partner and a project that is much more advanced. There is enlarged firm focus on mitigating the risks of the project, unlocking the fundamental value of resources and creating a good technical foundation. This presents a perfect opportunity for junior miners to expand their footprint at every level of the mining asset cycle, from early stage exploration projects to undertaking capital expansion on existing producing assets or even acquiring mature assets at the bottom of the cycle. Securing the PE funding for the long-term, enables the junior miner to balance out the short-term risk of market volatility and to take the asset up the value curve through a systematic and structured development and implementation plan without the fear of funding shortfalls.
PE has an increased insight into risk
PE firms understand that to earn positive returns, they need to take risk. The concept of what PE firms deem risky is likely to change as their knowledge of the mining sector develops, which may result in a more robust investment approach in mining opportunities.
While traditionally PE firms showed very little interest in investing in early stage mining projects, primarily because these projects are risky, capital intensive, and require extensive levels of resource and expertise to develop, as their understanding of these risks deepens, PE firms are likely to become more comfortable with the levels of risk and potential return on investment in these early stage projects. In the South African context and as the South African government seeks to restrict the concentration of rights in the hands of only a few of the major mining companies, the exploration activities of junior mining companies are set to be on the increase as more prospecting rights are granted to junior mining companies. The accessibility and availability of funds from PE firms will be crucial to junior mining companies who struggle to raise funds to finance the development of exploration projects.
While PE firms have become more active in late stage assets, the key issue is whether involvement will grow to include early stage assets as well. The fact that some PE funds have hired specialist geologists suggests that projects of this sort are increasingly being considered. Investment by PE firms at this level of the mining sector will significantly enhance the role played by junior mining companies, providing a potential lifeline to an ailing industry.
Van der Merwe says "PE offers a blend of capital and management expertise that is a good fit for the African market, particularly for junior miners who may be better placed in the current climate to seize opportunities in the mining industry resulting from the radical optimisation of asset portfolios by many mining companies." As PE firms adjust their risk perspective on investment in the mining sector, the objectives of PE firms and junior mining companies seem clearly aligned. The availability of PE funds to junior miners will provide a much needed injection into the industry and will go a long way towards creating sustainability in the sector even though the commodity down cycle and macro-economic pressures may still continue.