As the global economy limps through the second
quarter of 2013 in the shadow of dispiriting growth forecasts,
the news that the mining and financial sectors are
continuing their estrangement wont come as a surprise to
anybody in either industry.
The crisis of confidence which all but
paralysed capital markets after the financial crash in 2009 has
made new project finance for
mining difficult to come by via any channel, with hedge funds
becoming the latest cash sources to fall short.
|Fear of falling: wary investors have shied away from
backing mining projects through stock exchanges and hedge
funds (image: London Stock Exchange,
The average commodities hedge fund lost 0.8% in
the first quarter of 2013, an index compiled by the brokerage
firm Newedge has shown. This is on top of a loss of 3.7% across
commodity hedge funds in 2012, the biggest decline in over a
decade, according to the Newedge Commodity Trading
Collectively, the funds divested more than 20% of
their assets last year - a figure which the Financial Times has
calculated equates to a withdrawal of around $5bn from the
Combined with jitters on the stock markets, the
haemorrhaging of cash from commodity ventures has led the value
of many small and junior mining companies
to fall by around 70% since 2009, data collected by Bloomberg
With investor backing at rock bottom levels,
Bloomberg estimates that as many as 40% of companies in the
junior mining sphere lack sufficient capital to see out the
next sixth months.
Even larger mining firms are not immune from the
financial famine, Bloomberg has found, with spiralling capital
and input costs forcing these companies to put off acquistions
in favour of divestment and mothballing of
The breakdown in the relationship between the
extractive and financial sectors was the subject of a recent
meeting in London: Private Equity in the
Mining Industry A Long-Term Partner, or a One Night
Stand?, hosted by Bloomberg Industries.
With traditional mining finance in dire straits,
delegates heard, the industry is being pressed to consider
alternative, unconventional sources of finance, such as private
Bert Koth, director of Denham Capital Management
LP, pointed out that unlike most stock exchange or hedge fund
transactions, the majority of
private equity comes from investors who can commit large sums
of money for long periods of time.
Far from being a one night
stand, Koth said, private equity is by definition a longer-term
partnership. This is because private equity investments often
demand long holding periods to allow for a distressed company
to be turned around, or a liquidity event such as an initial
public offering (IPO) or sale.
Private equity consists of
investors and funds putting money directly into private
companies, rather than through a public exchange. It can also
involve investor buyouts of public companies that result in a
delisting of public equity.
Capital for private equity
is generally raised from retail and institutional investors,
and can be used for a range of purposes from general working
capital to simply strengthening a balance sheet.
The size of the private
equity market has increased steadily since the 1970s due to its
effectiveness as a model for delivering high returns before an
investment has begun to generate cash-flow, as well as for
allowing operational improvements to be made to the company
receiving the funds.
A recent example in the
industrial minerals industry was the buying of the minority
shareholder stake in Greek materials group S&B Minerals by
the US private equity firm, Rhone Capital LPin
January this year.
The offer for 38.74% of
S&Bs share capital was accepted by shareholders, and
Rhone Capital issued a statement saying that it intends to
delist this portion of the company from the Athens Stock
Exchange in the near future.
According to Ken Hoffman, senior metals and mining
analyst with Bloomberg Industries, hedge funds are becoming
less relevant to mining projects because, rather than buying
mines, fund managers can go directly to commodity exchanges for
direct exposure to markets.
With hedge-funding drying up, private equity
offers an attractive option for the cash-strapped mining
sector, since capital for such funds can be made cheaply
available on the market at present interest rates.
Hoffman estimated that around $9bn had been raised
for mining deals via this route in the last six months, and
mooted the possibility that the industry could see its
financing shift in this direction, given that leverage from
traditional finance looks unlikely to improve in the
Koth said that although miners often blame the
flagging economy for a lack of capital, the dearth of funds
available for mining projects has more to do with the fearful
investment climate than with prevailing macro-economic
Many people have lost their money [in mining
investments] over the last five years, Koth said, adding
that it was hardly surprising that people were shy of sinking
their capital into the industry.
Despite this, Koth hinted that there was scope for
investors to generate returns by investing directly in mining
ventures, if they have the ability to pick good
Plugging the gap
Lee Downham, lead partner for Ernst and
Youngs transaction advisory service, mining and metals,
said that the question of alternative financing lay more with
private, or venture capital, rather than private
This is because the kinds of private funding
available to the mining sector tend to be more characteristic
of venture capital investments, i.e., they account minority
stakes, rather than buy-outs; are based on cash alone, rather
than a combination of equity and debt; and are available mainly
to early-stage companies, rather than mature firms.
Last year saw a two-tier capital market for
the mining sector, Downham observed, saying that very
little had been raised from IPOs, meaning that companies were
looking to non-traditional sources such as bonds and mergers
and acquisitions to generate cash.
Downham said that while capital raised by private
funds and alternative investment sources was on the increase,
it has nowhere near filled the gap left by public
He added that companies that had turned to the
high-yield bond market for cash had found this route to be
largely unsuccessful, owing partly to the volatile nature of
Obtaining bank loans, for the most part, has also
proved futile, Downham said, with lending at its lowest level
since 2009, while loans that were issued were focused on
corporate debt, rather than new project financing.
Downham concluded that while private equity
investment couldnt accurately be thought of as a fleeting
liaison, based on analyst forecasts, the window of opportunity
for private capital investment in mining was destined to be
The movement of private funds into mining projects
will last for no more than two to three years,
Downham said, by which time, we expect major mining firms
to be sitting on a strong cash position.
External economic factors aside, the resource
industry is also facing worrying structural challenges that are
eroding the financial performance of mining firms, and
Hoffman said that wage increases in the
mining industry since 2000, which have been widely pegged as
rising by 50%, have translated to a 200% increase in actual
This is due to resource deterioration, Hoffman
explained because todays mines are much less
productive than they were 20 years ago, mining companies are
having to employ more people over more hours just to achieve
economic recovery rates from mineral deposits.
Hoffman also pointed to the rising cost of energy
in the mining sector, which is around 125% higher, on average,
than prices paid for power a decade and half
Koth added that a severe skills shortage in the
industry was responsible for many of the capex overruns in
Capex overruns of 40% are typical in todays
bearish market, he said. In the bull-market [pre-2009],
capex overruns of 70% were not uncommon.
Taking all of these factors into account, small
and junior miners are being urged to reconsider their business
strategies and adapt to adverse circumstances that show no sign
As part of this re-evaluation, Koth said that
juniors should look at the cost of being a public company as an
efficient use of scarce funds
Koth said that the high capital costs of being a
public company which he estimated as being between
$0.5m-$0.8m on average for junior firms was cash that
many companies could ill-afford to lose when incoming capital
Another drawback of being public company was the
amount of time spent on public and investor relations. Around
40-50% of a junior mining company CEOs time is spent in
this way, Koth said, suggesting that this could be better spent
advancing the companys business plan.
He added that the pressure to put out a press
release every time there is a significant event relating to
asset valuation was not only time-consuming, but also attracted
rival prospectors to an area reported to contain rich
resources, increasing competition.
Commercially, it might be better to operate
under the radar, Koth suggested, adding that, looking
into a tight credit future, private ownership might be a
sensible option for some junior companies.