Latest Mining M&A Figures Show an Industry in Transition

These are just a few of the findings laid out in Ernst & Young’s February 18 report on M&A activity and capital raising in the global mining industry.

Disagreements over price and a “capital strike” by majors slowed deal making…

In all, 941 deals were completed in 2012. That’s down 7 percent from 2011 and the lowest level since 2008. The total value of these transactions plummeted 36 percent, to a three-year low of $104 billion.

One key reason for the decline, the report points out, is a valuation gap between buyers and sellers. Put simply, volatile commodity prices have depressed miners’ share prices, causing risk-averse buyers to offer less money. Miners are responding by digging in their heels.

“Sellers were unwilling to accept lower valuations based on their depleted share prices in 2012, on the grounds that this unfairly reflected near-term uncertainties, rather than the long-term potential of their assets,” states the report. “Consequently, negotiations are taking longer and becoming more complex, resulting in sluggish M&A at best.”

Cost overruns at existing mines also contributed to what the report calls a “capital strike” being declared, with majors, under pressure from investors, focusing less on growth and more on making their current operations more efficient and ridding themselves of underperforming assets.

The Ernst & Young report notes that miners’ costs rose by 10 to 15 percent in 2012, which was one reason for a decrease in megadeals (or transactions valued at over $1 billion) last year. It also fueled a continued rise in what Ernst & Young calls “low-risk” M&A, or transactions that let companies share assets and pool resources.

…but investors from outside the mining industry filled some of the gap

The retrenchment on the part of traditional miners created more room for new players — including private capital, hedge funds, state-backed firms and sovereign wealth funds — to snap up mining assets. In all, this group accounted for 31 percent of the value of all deals in 2012, up sharply from 21 percent in 2011.

These investors’ goals vary widely. For private capital and investment funds, the goal is to take positions in companies that are well positioned to profit as commodity prices regain ground on the back of an improving global economy. State-backed enterprises take a longer view and aim to secure stable resource supplies to sustain their countries’ growth. However, instead of buying controlling interests in these firms, non-traditional actors satisfied themselves with minority stakes in 2012: according to the report, nearly 80 percent of deals by this group were for non-controlling interests.

Also this year, the number of cross-border deals overtook domestic transactions for the first time since the 2008/09 financial crisis, with fewer resource discoveries in established areas forcing miners to go further afield. In all, 52 percent of transactions were cross-border deals and 48 percent were domestic.

By commodity, steel led the way in terms of deal value, with $21 billion, followed by coal ($17.9 billion), gold ($14.2 billion) and copper ($13.4 billion). By volume, gold was far ahead with 339 deals, followed by coal (101), copper (78) and iron ore (58).

Financing remains tight — especially for mid-tier and junior miners

Meanwhile, miners continued to have difficulty raising capital to finance projects. The mining sector as a whole raised $249 billion last year, down sharply from $340 billion in 2011 and the lowest level since 2009, according to Ernst & Young.

Here too, risk aversion was the main theme. Loans dwindled to $106 billion as banks cut back on more speculative ventures and focused on meeting tougher capitalization requirements in the wake of the financial crisis. The number of initial public offerings also took a huge tumble, from $17.5 billion in 2011 to just $1.4 billion in 2012. As well, proceeds from secondary issues plunged 48 percent, to $26 billion. That all contributed to another year of tough sledding for junior and mid-tier companies

“The capital strike by risk-averse equity investors meant that early stage junior companies were faced with very few options in 2012,” states the report. “‘Last resort’ funding options are coming to the fore, often bringing loss of control over projects or onerous terms. Companies are in survival mode once again, with a symptomatic number of companies exhibiting signs of financial distress.”

Investors’ emphasis on safety and income did, however, create strong demand for corporate bonds, creating an opportunity for major producers.

“Investment grade borrowers took full advantage of this flight to quality as they issued long-dated bonds at pricing levels many banks struggled to match,” notes the report. “Investment grade issues totaled $73b for the year, comfortably exceeding the 2011 figure of $57b, as the large-cap producers raised capital for organic growth and to refinance existing debt.”

Future looks cloudy, but “buy” is likely to win out over “build”

Lee Downham, global mining & metals transaction leader at Ernst & Young, sees the pace of deal making picking up in 2013, with non-mining buyers as the driving force.

“We will see the continued rise of strategic and financial buyers in the sector throughout this year, motivated by the need to secure long-term sources of mineral supply and the prospect of quick returns respectively,” he said in the press release announcing the report’s release.

However, resource prices will have to firm up considerably to get major miners back in the M&A game.

“The capital strike by many mining and metals companies in the face of rising costs and softer prices in 2012 will continue until commodity prices recover sufficiently to encourage new investment,” said Downham. “The renewed focus by miners on cost savings and capital optimization will also see continued divestment of non-core or under-performing assets that began in late 2012,” he said.

But all of that cost cutting is likely to lead to fatter cash reserves and lower debt — and probably sooner rather than later. At the same time, rising costs will likely lower the appeal of building new projects from scratch, which would be another plus for M&A activity.

“Leaner business models and stronger balance sheets will emerge during the second half of this year,” said Downham. “We anticipate that companies will look to re-focus on growth in late 2013 as the pressure to replace depleting reserves and maintain production mounts.”

“The expected shift back to growth will likely be through M&A rather than organic growth, with lower valuations and large cost overruns likely to swing the pendulum back to buy over build,” he added.

Securities Disclosure: I, Chad Fraser, hold no positions in any of the companies mentioned in this article.