by Andrea Heisinger
June 22, 2016

Why it’s ‘Prime Time’ for PE to Look at Mining Assets

Value can still be found in a sector that’s taken hits in the past few years. They key is to unlock the value of smaller assets.

Private equity’s relationship with the mining sector has soured in recent years, but not all of the negative sentiment is warranted, two experts tell Privcap.

Much like other areas of investment for the asset class, there is a lot of competition for prime assets. And beyond that, activity remains steady, two experts say, especially in smaller deals on the lower end of the market. And as the mining sector has been at least partly shut off from banks as funding sources, private equity has been seen as a valuable way to fill the gap.

“A significant amount of capital has been raised through private equity funds for mining, yet we haven’t seen a significant portion of that capital deployed into the sector,” says Cheryl Brandon, the CFA-Partner, Investment Management, at Toronto-based Waterton Global Resource Management. “It can be difficult for traditional private equity to compete with foreign buyers and publicly traded companies in the mining sector on competitive auction processes for tier 1 assets, given the lower cost of capital and return expectations for non-PE purchasers.”

Privcap spoke with Brandon and with Denham Capital’s director of mining in its Houston office, Caroline Donally, about activity in the sector, strategy changes in the down market, and why smaller deals make more sense than mega deals do for private equity investors.

Andrea Heisinger, Privcap: Can each of you give a brief summary of your firms and their focus?

Cheryl Brandon, Waterton: We’re a PE fund advisor solely focused on investments in the mining sector and we have just under $2B of capital. Our primary focus is on copper and gold projects in stable jurisdictions, primarily North America, in Canada and the U.S.

The types of projects that we focus on range from the development stage right through to the production stage. We’re happy to acquire projects that require significant technical, permitting and development expertise to advance through to the production stage. That is one of the differentiating factors between us and some of the other PE funds looking at the mining space.

Caroline Donally, Denham Capital: [At Denham] half of the [mining] team is based in the Houston office, and half is based in Perth [Australia]. Essentially, we follow the same model that the oil and gas team does in that we look for good management teams whom we can back with capital. And then those management teams go out and find projects for acquisition that they can develop into producing assets.

Cheryl, when did you raise the fund that you’re allocating out of?

Brandon: In Q1 2014, we raised just over $1B for the fund that we are currently allocating out of.

We’ve closed about 21 transactions in the current fund. Given the downward trending market, the last few years have been advantageous for completing transactions on high-quality projects at favorable valuations. We have a targeted, niche strategy that has allowed us to stay focused and get deals done.

Caroline, how many mining-focused funds has Denham raised?

Donally: Denham’s on its sixth fund and we invested across all three sectors from one fund.

Moving onto mining activity, where are you seeing opportunities for private equity to invest in the sector?

Brandon: The majority of the PE activity in mining up to this point has been focused on either pursuing equity financings—taking a passive equity position in publicly traded companies, and/or doing structured financing transactions to provide publicly traded companies with capital. We really haven’t seen a lot of asset acquisitions.

The real opportunity exists in acquiring assets that have been undercapitalized or are non-core

to a major mining company, and that haven’t received the attention from senior management

necessary to optimize the life-of-mine plan. The opportunity is not as great amongst the assets

that are in production with the lowest quartile of cash costs and highest margins.

We look at the world and say, “How can we take a two-tier asset and improve it by bringing the

cost structure down, de-risking and advancing the project, and controlling the process to unlock

value? If that opportunity doesn’t exist, the investment wouldn’t be interesting to us.”

Caroline, from your view, what is the state of PE investment in mining?

Donally: [In the past, there were] the mining juniors—small exploration businesses to companies that wanted to get their assets into production. They were companies doing exploration and starting to take assets through the various studies. They would raise money on a piecemeal basis for various work programs. For example, they would go to the market, raise $5M, go away, do some exploration and come back with some results. And hopefully the results were good and, therefore, the share price would increase, and then they’d raise some more money to do the next work program.

What happened in the past [made it] pretty clear that that model was broken. There were very few juniors who actually managed to progress their projects. And, as a result, retail investors started to lose money. More recently, there’s been a far more risk-off approach to the market.

So the typical fundraising mechanism for these companies was listed entities and tapping retail and institutional investors. Well, those investors aren’t investing in junior miners anymore. So now you have a situation where there is no money going into the sector.

Private equity’s been around in mining for quite some time, but it was always overshadowed by how much money was raised in the public market. As the money fell away from the public markets, private equity started to look like a far larger component of the money.

I’m curious about what you’re seeing as far as deal sizes. Are there more small deals being done?

Brandon: Larger deals are getting done in the mining sector. However, most of these deals are not seeing private equity participation. The higher-quality assets are being purchased by well-funded publicly traded companies and foreign buyers. We expect this trend will continue.

Private equity has had far more success getting smaller deals done. Given the valuation discrepancy between Tier 1 and Tier 2 assets, there are definitely more opportunities in the current market environment to achieve outsized returns by deploying capital into smaller projects.

There’s a perception that no one’s investing in mining. Is that true?

Brandon: There are a lot of assets in the mining sector that are low quality. We’ve evaluated hundreds and hundreds of projects over the last 10 years, and the majority of those projects do not make the cut. The process of evaluating projects is a very people intensive process, requiring the expertise of many disciplines. And when you go downmarket, it’s more difficult to justify allocating capital, given the performance.

So when you layer it all on top of each other, it’s fairly clear why very little capital has been deployed in the mining sector. That’s why we focus on the assets that we believe we can actually unlock additional value from. These types of deals tend to be smaller in size (sub-$1B) and are frequently overlooked.

Caroline, what are you seeing as far as activity?

Donally: We are deploying capital in this environment, and actively looking for new opportunities. And that’s an important message that we would like to get out into the world, whilst everybody’s been sitting around saying “There’s between $10 and $15B of mining private equity out there, but nobody’s doing any deals.” We definitely disagree with that. It’s a prime time in the market to be looking for assets, to be acquiring assets, to be developing those assets, taking them through into production.

What other trends are you seeing?

Donally: Given that the public market has effectively dried up, we’re seeing a lot more interest from public junior miners and public mining companies in going private. We’re also seeing new projects being put into private companies rather than into listed ventures.

Because that ability to raise equity is no longer there, many CEOs that we talk to now are seeing

the benefits of being private and having a capital backer. They’re realizing that a true capital partner that understands mining and can fully fund their project up until the point of production. [That] allows them to go out and develop the business rather than being on the fundraising road show every six months, which is what many of the C-suites at these junior mining companies are doing.

Brandon: Our strategy has always been focused on gold and copper projects in stable jurisdictions. The jurisdictional focus has not changed at all. However, the majority of the deals we have done more recently—20 out of 21—have been gold production-focused assets. That was because gold prices had been on a downward trend for four years, valuations were very low, and we took advantage of that market. At this point in the cycle, gold prices have improved and valuations have, to a much greater extent, improved. We’re now shifting our focus more to base metals—primarily copper projects.

The other trend that we’ve really started to see is renewed interest in M&A from intermediate and senior companies in the gold sector. Because of elevated valuations for gold companies, we are getting a lot of inbound interest from mid‑tier and major gold mining companies to acquire the projects that we’ve acquired over the last two years.

Donally: What we’re seeing now—and we have been for about the last year to 18 months—is that the assets that are substantially de-risked and more developed are at bankable feasibility study stage or thereabouts. We can acquire those assets for similar prices as we could get exploration assets three or four years back.

You take a lot less risk, and you’re much closer to production. Somebody else has spent the time and money doing the exploration, figuring out if it’s economically viable, in some instances doing the permitting as well. Our strategy over five years has changed dramatically from being one that was exploration focused to one that is far more focused on assets that are either producing and can be turned around or expanded, or assets where we can take them through construction and into production.

Value can still be found in a sector that’s taken hits in the past few years. They key is to unlock the value of smaller assets.

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