2007 was another record year for transactions in the mining and metals sector according to a recent report by Ernst & Young (E&Y), and the appetite for sector consolidation shows no sign of abating. High commodity prices, a history of under-investment in exploration and development, the long lead time for bringing new projects on-stream and a wish by companies to diversify risk have led to a continued drive for growth. Furthermore, mid-scale miners have increasingly been looking to acquire defensive scale as they seek to avoid becoming takeover targets themselves.
UK, US and Canadian miners made the most acquisitions by value during 2007. They were also the most targeted countries for acquisition. Demand is now being driven from the east. China and India lack sufficient natural resources to maintain their current high growth rates, and are seeking greater and more secure access to raw materials. Deals made by China and India, and also Russia and Brazil (the BRIC countries), increased by over 1,200 per cent between 2000 and 2007, and the trend looks set to continue.
Continued growth through acquisitions
The E&Y report found that nearly all of the world’s largest miners expect to grow through acquisition in the next two years. The report reflected the views of most of the top 40 global mining and metals groups, and reinforces the sector’s confidence that the boom in metals prices will continue, as evidenced by strong recent company earnings.
Ninety-six per cent of respondents had grown through acquisition in the past two years and 87 per cent indicated they would continue to do so. Michael Lynch-Bell, global mining and metals transactions leader at E&Y, comments: “The appetite for further transactions is strong and the sector is cash-rich. Concerns about resource security are inspiring new acquirers.”
The rate of consolidation could accelerate
The report found that the global downturn appears to be having little impact on the sector. While the cost of debt has soared, E&Y has yet to see delays in bankable transactions because of debt availability issues, as is starting to happen in other sectors. The report shows that nearly 60 per cent of all loans in the second half of 2007 were made to the mining sector.
Mr Lynch-Bell states further that the rate of consolidation is not only likely to continue but could accelerate in the short-to-medium term, "with the possibility of three $50bn (£25bn) plus deals before the end of the year". Longer term, the report sees the dominance of four or five diversified majors with strong representation in Russia and China.
Mining majors looking to expand, smaller groups seeking vertical integration, and new players – in particular from China, India and Russia – seeking to secure supply are increasing competition for assets and driving up prices. With a finite number of large projects available, majors are increasingly having to look at smaller projects offering expansion potential. Increased competition has also forced explorers to prospect in regions with higher political or operational risk. Whilst political risk is an important consideration, 43 per cent of miners surveyed stated that there were no regions which would be avoided.
Divestment is happening too. Eighty-one per cent of mining groups interviewed had divested assets during 2007 and E&Y expects to see further divestments through the rest of 2008 as companies continue to take advantage of high prices and discard non-core assets. Comments Mr Lynch-Bell: "This will be driven by the need to pay down acquisition debts, sell higher cost mines and in some cases make forced sales due to competition regulations."
Do acquisitions work?
Fifty-five per cent of respondents agreed that in most cases, acquisitions had increased their organisational capability; 68 per cent thought they had enhanced shareholder returns. The most important financial measurement of success for acquirers is return on investment.
Mr Lynch-Bell envisages the consolidation of junior miners to occur mainly by way of share exchanges, with cash being retained to fund project development. The resulting injection of good management and cash should improve the prospects of many struggling juniors.
Why has the consolidation of Aim miners not yet happened?
Despite the undoubted appetite for acquisition, the consolidation of junior miners on London's Alternative Investment Market (Aim) has yet to gather any sort of pace. E&Y's statistics show only four de-listings arising from takeover during the first quarter of 2008. A multitude of miners floated on Aim when capital was easier to raise. There now remain many companies of questionable quality. With financiers now much more discerning, companies running low of cash face intense competition for third party funding.
Incumbent management have been one obstacle to consolidation. Over-optimistic boards have dragged their heels over doing deals until their companies have reached death's door.
The crunch is coming
However, Mr Lynch-Bell sees the long-awaited consolidation of junior miners, particularly poor performers, to be finally close at hand. He quotes two statistics from the end of April 2008. First, 53 per cent of Aim mining shares were trading below their issue price. Second, 59 per cent of Aim miners had less than £5m in the bank (16 per cent had less than £1m). "The crunch is coming," he warns. "All the indicators suggest that consolidation has to happen."
TAKEOVER CANDIDATES
Driven by strong Asian demand, the commodities most likely to be targeted by acquirers seeking supply security are copper and iron ore. The rise in thermal and coking coal prices has also ignited interest in Aim’s coal miners, where an ongoing squeeze on supply should continue to make them attractive targets.
The strongest candidates are companies with large, high-grade deposits of proven reserves. These assets could be attractive due to their quality or, more probably, because the likelihood of their successful development is currently constrained by limited management skills or insufficient funds.
