Mergers and Acquisitions In the Mining & Metals sector
Global macro-economic uncertainties took center stage in 2012, creating volatility in the equity and commodity markets. This severely hampered M&A activity as capital became constrained and greater uncertainty found its way into deal valuations. These are the main conclusions of Ernst & Young experts, which prepared an annual global review of mergers & acquisitions in the mining and metals sector.
The decline in commodity prices exposed margins to rampant industry-wide cost inflation. It is estimated that the industry experienced cost inflation of between 10% and 15% in 2011, with overall cost inflation averaging roughly 5%–7% in the last 10 years1. Furthermore, cost overruns at upcoming capital projects, running into billions in some cases, have become common place.
1 “Cost inflation is major theme for metals production: Deutshe Bank,” Commodity Online, 16 April 2012.
As a consequence, companies shifted gear from “growth for growth’s sake“ to “capital optimization“ during 2012, beginning with a review of existing portfolios. With low cost, long life assets (tier-one) the priority, investments in massive capital projects were revisited (e.g., BHP Billiton’s Olympic Dam), non-core assets were earmarked for divestment (e.g., Rio Tinto’s Diamonds business) and M&A activity slowed.
Major $10b-plus deals have remained elusive since the GFC, with the exception of BHP Billiton’s $11.8b acquisition of oil and gas company, Petrohawk Energy, in 2011 – such transformational deals gave way to low risk and strategic M&A in 2012. However, this could change in 2013, with the closing of the Glencore International-Xstrata merger and Freeport-McMoRan Copper & Gold’s proposed oil and gas foray2.
2 “Freeport-McMoRan Copper & Gold Inc. to Acquire Plains Exploration & Production Company and McMoRan Exploration Co. In Transactions Totaling $20 Billion, Creating a Premier U.S. Based Natural Resource Company,” Freeport-McMoRan Copper & Gold news release, http://www.fcx.com/ir/news_releases.htm, 5 December 2012.
Non-core asset divestitures gathered pace in the second half of 2012, as companies pushed to unlock capital. Only the largest players were in a position to capture the “once-in-a-decade” buying opportunities. Rio Tinto’s move to double its interest in the world’s largest titanium dioxide producer, Richards Bay Minerals (RBM), by acquiring BHP Billiton’s divested stake, is one such example.
A few large deals focused on geographical expansion were also completed, involving acquisitions of assets in traditional (low risk) mining jurisdictions. Among the other mega deals, downstream businesses and Asian sovereign investors acquired assets overseas to secure long term supply of raw materials.
Two main themes dominated M&A across the sector in 2012:
Low risk M&A. This type of deal focused on domestic consolidation for synergies and pooled resources, in response to cost inflation and fund raising difficulties. Quite often, low risk M&A transactions were pursued to achieve synergies in shared facilities, infrastructure, blasting etc. – for instance, the merger of Australian coal producers, Whitehaven Coal and Aston Resources. Alternatively, low risk deals were aimed at gaining greater control over an asset where a stake was already held, such as Anglo American’s acquisition of an additional stake in the world’s largest diamond producer, De Beers.
Strategic M&A. Such deals focused on more than just the transaction. The myriad of state-owned and sovereign wealth investors looking to acquire assets in return for security of supply via offtake are such examples, as in the case of Shandong Iron & Steel’s minority stake acquisition in Tonkolili Iron Ore. Strategic M&A deals provided much needed capital to the target entity in a capital-constrained market, with larger companies acquiring “toehold” stakes in prospective junior explorers. Such deals enabled acquirers to take advantage of equity devaluation in the junior segment to secure future growth options – a strategy that HudBay Minerals actively pursued in Peru, for example.
Another emerging trend in 2012 was the increase in the number of deals done for minority stakes rather than full-takeovers, which were very much the domain of the debt-financed consolidation phase that took place between 2005 and early 2008. Consequently, these minority stake acquisitions increased options for juniors, be it exit through an outright sale, or funding via a strategic investment that lends confidence to a project and enables future financing to be arranged. This trend is likely to continue as financing options remain tight and large-cap producers look to recycle capital – both being factors that will drive the pursuit of juniors, as well as strategic partners on projects.
The changing industry landscape in 2012 made deal execution difficult, with some major deals falling through or facing delays due to mismatched expectations on deal valuations and/or funding difficulties. In one such deal, the privately-owned Tinkler Group made a $5.5b takeover bid for Australia’s Whitehaven Coal, at a time when the latter’s share price had dropped to nearly three-year lows. However, the bid was eventually abandoned as deteriorating coal market conditions jeopardized efforts to secure funding for the deal3.
3 “Australia’s Tinkler pulls $5.5 billion Whitehaven bid,” Reuters, 24 August 2012; “Tinkler lobs late bid for coal miner,” The Sydney Morning Herald, 14 July 2012.
Buyer and seller agreement on deal valuation became difficult to achieve in 2012 due to the growing divergence between mining and metals equities and commodity prices. Macro-economic risks weighed heavily on mining and metals equities and commodity prices alike, but this is where the similarities ended. Commodity prices eventually found support from positive long-term fundamentals, especially once the industry’s capital strike took a sizable chunk of planned future supply off the market. On the other hand, mining equities were penalized for challenges and risks at the producer-level, particularly escalating operating costs and capital cost overruns. As a result, share prices fully reflected the negative impact of commodity price falls, but did not benefit from an equivalent upside when commodity prices recovered, leaving many sellers searching for large premiums which were difficult for buyers to swallow.
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. Consequently, negotiations are taking longer and becoming more complex, resulting in sluggish M&A at best.
Cross border activity
The growing scarcity of large, quality resources in traditional mining jurisdictions has led to increasing cross border activity over the years. Companies have increasingly ventured into emerging and frontier regions to secure metal in the ground, taking on greater political risk and even partnering with host governments for social and infrastructure development.
The year 2008 marked a cross-over, with cross-border deal activity overtaking domestic consolidation, following a long period of convergence. However, the GFC reversed this trend dramatically as companies looked toward domestic consolidation, seeking synergies and greater financial viability. With such significant capital flows out of Asia, post the GFC, this trend appears to have reversed once again, boosting cross-border deal share to more than 50% of deal volume in 2012.
The risks associated with resource nationalism are no longer restricted to the frontier and emerging markets alone. The introduction of the Mineral Resources Rent Tax (MRRT), a carbon tax and increases in state royalties in Australia during 2012 is case in point. Infrastructure bottlenecks have also become a concern in mature mining countries, including South Africa and Australia. Furthermore, the mining-led capex boom in traditional mining and metals regions has made cost inflation in these countries far more pronounced compared with general industry levels. Therefore we are beginning to see a more level playing field for M&A across traditional low risk countries and medium risk destinations.
Meanwhile, companies held back from making investments in higher risk countries in 2012, suggesting that these deals were possibly harder to justify amid greater shareholder scrutiny on capital allocation. The activity across frontier regions, as a result, tended to be conducted by Chinese SOEs for resource security. Frontier markets hold the promise of robust demand from an emerging middle class and are also home to tier-one mineral assets. Competition for the latter has greatly intensified, particularly among BRIC and emerging market players, with strong and steady support from their respective governments. China and India’s push for bilateral trade agreements with several African nations is testimony to this. The Democratic Republic of Congo (DRC), Sierra Leone and Namibia followed South Africa as top African destinations – primarily targeted by Chinese SOEs for copper, iron ore and uranium, respectively.
Australia was the top destination for mining and metals M&A in 2012, where M&A targeting Australian assets (inbound and domestic) accounted for 13% ($14b) of global deal value, driven by increased domestic consolidation, particularly among midcap coal miners to achieve synergies and mitigate rising costs. Although subdued by announcements of capital cost blow outs, inbound deal activity in Australia was driven by investments from Asian acquirers into coal and iron ore. China was the second most targeted destination, due to Government-led domestic consolidation to centralize control over China’s fragmented coal and steel industries.
We are also beginning to see growing interest in many of Europe’s resource-rich countries, driven by growing political support in the region to develop the mining industry in these low-risk jurisdictions, including Turkey, Sweden and Spain. Processing and manufacturing facilities in Germany were targeted by players looking to forward-integrate, with the added benefit of access to technological know-how.
Inbound M&A in Latin America was subdued by intense community opposition to mining, large capital cost blow outs, water and energy constraints, and growing protectionism across the region. Increasing demand for raw materials in the Asia-Pacific region drove Asian acquirers overseas to secure supply, with China and Japan, respectively, emerging as the most acquisitive countries in 2012. Asian SOEs and trading houses dominated this outbound activity. China, Japan and South Korea, together, accounted for over a third (37% or $39b) of global deal value in 2012.
North America was notably quiet in 2012, falling behind Europe as an acquiring region. The marked decline in the region’s M&A activity can be partly attributed to reduced domestic coal consolidation in the US due to difficult market conditions, resulting from weak demand, depressed prices and the threat of cheap natural gas. The overall slowdown in Canadian M&A activity was characterized by fewer inbound investments from the US, subdued domestic consolidation and smaller overseas acquisitions.
Steel led global deal value as the most targeted commodity, with domestic consolidation being the main theme, characterized by strategic moves to protect margins and remain competitive, including access to high growth markets, consolidation and vertical integration. The all-share merger of Japanese steel majors Sumitomo Metal Industries and Nippon Steel was the largest deal of the year, valued at $9.4b, which was driven by the need to remain competitive and achieve cost saving synergies, as well as to gain leverage over raw material suppliers4.
4 “Nippon Steel & Sumitomo to Push Cost Cuts Amid Competition,” Bloomberg, 1 October 2012
Coal deal activity was also largely driven by domestic consolidation this past year in the Asia-Pacific, compared with 2011 when the majority of this activity took place in the US. Power utilities and trading companies were also active acquirers of coal assets to secure supply. Looking ahead, an energy crisis in India in early 2012 highlights the country’s acute shortage of coal, making it a strong contender for overseas coal assets in competition with China, Japan and South Korea. Gold M&A activity has been dominated by domestic consolidation for years, but interestingly witnessed a shift in focus to outbound growth in 2012. Copper also witnessed a marked increase in cross border acquisitions, driven by the need for resource security amid growing competition for scarce, quality assets.
Vertical integration was the key driver for deals targeting rare earths and lithium, as well as energy-and-steel-making raw materials. Asian acquirers actively pursued uranium and iron ore assets overseas to secure their long term supply chains.
Long-term demand for the sector will continue to be driven by China and other BRIC (Brazil, Russia, India and China) and developing nations. The rapid cut-back of expansion and capital spending by many organizations is expected to slow long-term supply and prolong a “super-cycle” scarcity premium. Consequently, those with access to capital and a long-term view will seek to invest.
The capital strike is expected to continue until commodity prices recover sufficiently to encourage new investment. For example, we believe that the iron ore price would need to exceed $130/tonne for a prolonged period of time to unlock the next wave of expansion projects. Hence, M&A of iron ore juniors below that level represent an option over future supply shortfalls.
This capital strike will also impact the majors as a consequence of their 2012 asset reviews. A number of high-cost mines are high cost because they have been starved of capital in recent years. We expect a good number of these mines to be divested by the majors to owners with capital available for acquisition and reinvestment.
The 2013 capital raising environment is expected to be shaped by the continued shift from traditional capital markets funding to non-traditional capital providers.
The announcement in January 2013 of a delay to full implementation of, and changes to, Basel III liquidity requirements is unlikely to herald a significant change in lending behavior in the year ahead. As a result, we believe there will be a continued scarcity of longer-term commercial bank lending under Basel III, with private, strategic lenders, equipment providers and national and development banks taking the role of project financiers.
A slow and steady revival in equity markets is anticipated as confidence returns and a strong pipeline of cross border IPOs eagerly await the return of the market. Corporate bonds will remain a popular source of finance during the year ahead, and we see the potential for an increased flow of funds into the high yield sector, supporting the industry’s mid-tier growth as the investment grade market becomes saturated and investors chase greater yields.
Shareholders’ demands for greater dividends may threaten growth during 2013, where investors have been increasingly frustrated by weakening share prices and lower profitability. Shareholders are calling for companies to rethink capital allocation decisions, and this will inevitably result in a greater focus on capital recycling.
As a result, leaner business models and stronger balance sheets will emerge during the second half of 2013 as companies continue to rationalize portfolios, unlock capital through divestments and drive cost savings. We anticipate that companies will look to refocus on growth in late 2013 as the pressure to replace depleting reserves and maintain production mounts – but the question remains as to whether this will take the form of building or buying.
While it is likely to be both, we expect to see a stronger buy-cycle during 2013, underpinned by lower valuations and in response to large cost overruns at several greenfield projects. Buying opportunities will be pursued by those companies that emerge financially stronger and are able to access capital to drive M&A.
The material is prepared, based on the annual review of global metals & mining transactions, carried out by Ernst & Young. The full version of the review in English can be found on the website www.ey.com.