As many readers will be aware (some painfully so!) the history of the Australian mining industry is one characterised by repetitive boom and bust cycles. Indeed, many Australian mining investors (and those directly reliant on the mining industry for the sale of their goods and services) often seem to accept that conventional laws of physics apply equally to commodity price cycles and that what goes up, must inevitably come down.
By the end of September 2008, things were certainly looking down:
- Lehman Brothers had filed for bankruptcy
- the US Government had bailed out insurer AIG, and
- Freddie Mac and Fannie Mae were effectively nationalised.
Even against this backdrop, some optimism remained that the Australian mining sector could withstand a global economic downturn largely on the back of hopes that industrialising economies, especially that of China, would continue domestic infrastructure building programs and with it sustain demand (and prices) for Australian commodities.
As signs emerge that the global economic crisis is abating and that the so-called ‘green shoots’ of economic recovery are beginning to appear, it is timely to reflect on what implications the global economic crisis has had on the Australian mining sector.
This article examines the current themes and trends in the Australian mining industry which have emerged both in response to, and in some cases in spite of, the events that occurred in late 2008.
Corporate collapses and insolvencies
The recent global economic downturn has had a profound impact on the ability of some Australian mining companies to continue as a ‘going concern’. In these difficult economic circumstances, a number of Australian mining companies have been forced to appoint external insolvency administrators in order to take possession of the company or certain of its assets to repay financial indebtedness and to ensure they do not trigger insolvent trading liabilities for which directors bear personal liability.
Recent examples include CopperCo Limited, Monarch Gold Mining Company Limited, Windimurra Vanadium Limited, Matrix Metals Limited and Compass Resources Limited.
Most of these corporate failures can be attributed to one or all of the following factors:
- difficulties and delays in securing new credit facilities or extensions and roll-overs of existing facilities in order to fund working capital requirements or future cash flows
- cost blow outs and project overruns, and/or
- dramatic downturns in project revenues due mainly to falling commodity prices.
In short, the last 12 months have witnessed a dramatic increase in distressed asset sales as companies attempt to manage their cash flow requirements through the sale of core and non-core assets. Corporate collapses often present unique investment opportunities for those with access to readily available cash. Although once the domain of hedge and so-called ‘vulture funds’, domestic and foreign buyers are amongst those bidding for the assets of the failed companies.
Increases in foreign investment, particularly from China
It is prudent to remember that whilst economic conditions will change over time, the quality of the mineral resources in the ground rarely change. With signs emerging that the worst of the economic downturn may be over, buyers are being enticed back into the market by the opportunity to acquire quality strategic assets at bargain prices. Forefront amongst them are cashed-up foreign investors looking for cheap/strategic assets.
In our experience, foreign investors are focusing on:
- long-term strategic investments, and
- direct equity investments in the underlying projects through farm-in and joint venture arrangements rather than through the traditional offtake model.
With acquisition funding still difficult to secure, foreign entities (particularly those with strong cash backing) are well positioned to take advantage of current opportunities to secure strategic stakes in companies and assets in a sector where the investment fundamentals remain strong.
These acquisitions, particularly those involving foreign state-owned enterprises and sovereign wealth funds, have raised acute and parochial concerns regarding what is and is not in Australia’s ‘national interest’. On 17 September 2009, the Senate Committee Inquiry’s Report into foreign investment by state-owned enterprises was released. Overall, the committee was of the view that:
- the current ‘national interest’ assessment of proposals on a case-by-case basis works effectively and should not be changed, and
- the current regulatory framework for assessing foreign investment proposals, whether from private or foreign owned investors, is sufficient.
Strong support for equity capital raisings
Most readers will recall that the global financial crisis entered our vernacular as a ‘sub-prime crisis’ and then as a ‘credit crisis’ before it spread from the financial markets to the broader economy to then be coined, rather less imaginatively, as the ‘global financial crisis’ or ‘GFC’.
What these phrases do tell us, however, is that the origins of the GFC were in credit markets: firstly, by the provision of credit to those who did not possess the ability to repay it; and secondly, in the reluctance of financial institutions to extend credit, either to other financial institutions or to their customers and the effects that this had on the broader economy.
Not surprisingly, the capacity of Australian mining companies to fund new projects or expansions of existing ones has been severely diminished. Australian mining companies, used to days of easy credit and the ability to roll over debt facilities on similar terms, have had to learn, perhaps not for the first time, that ‘cash is king’.
Against this backdrop, there has been an observable increase in equity capital raisings in Australia in order to:
- strengthen balance sheets
- reduce gearing by repaying debt, or
- fund future acquisitions or expansions.
In the six months to June 2009, the Australian mining sector raised more than $A24 billion from the markets (out of the approximate $A60 billion raised overall).1 Whilst the biggest raising of all was done by Rio Tinto ($A19 billion rights issue) other mining companies have raised approximately $A5.76 billion between them since December 31 2008.
Acquisitions of opportunity
Not surprisingly, M&A activity in the Australian minerals sector has been slightly down in comparison to the previous few years. In the 2009 financial year, 872 transactions were completed worth over A$85 billion (well down from the A$135 billion worth of deals completed in the previous financial year).
As noted above, lower commodity prices and deflated asset and share values have seen a rise in the number of opportunistic acquisitions, particularly by foreign entities, as cash-strapped miners look offshore for critical injections of capital. Most notable among these acquisitions was the recent deal between MinMetals and Oz Minerals.
We are continuing to see an increase in the number of non-core assets being placed on the market. Whilst a number of proposed or contemplated transactions were scuttled by the effects of the credit crisis (for example, BHP Billiton’s withdrawal from a proposed takeover of Rio Tinto citing ‘continued deterioration of near-term global economic conditions’), a number did complete as vendors adjusted their price expectations and confidence amongst buyers rose as signs of a ‘bounce’ in commodity prices emerged.
In addition, many foreign investors are continuing to move away from the pure offtake model and instead looking to access direct equity in the underlying project assets through farm-in and joint venture arrangements.
Consolidation within the resources sector, particularly amongst the mid-tier mining sector, is expected to continue. This consolidation activity allows companies at differing stages of development to diversify production/development risk, or enter into mergers where there are compatible reserves and capital needs.
Whilst it is accepted that there is already a high degree of concentration across the sector, this is predominantly amongst the major mining houses. For example, in Australia:
- Iron Ore – BHP Billiton and Rio Tinto control 93 per cent of total production
- Gold – Barrick, Newcrest, Newmont, Goldfields and AngloGold Ashanti control 74 per cent of total production, and
- Coal – BHP Billiton, Xstrata, Anglo Coal and Rio Tinto control 63 per cent of total production.
Real opportunities exist for consolidation amongst the mid-tier copper, nickel and uranium players. As debt funding continues to be relatively inaccessible and as precious cash reserves are preserved for the development of existing projects, most consolidation deals and mergers are likely to full or part scrip consideration, particularly where no foreign bidder is involved.
We continue to see more of these consolidation and merger transactions implemented using the scheme of arrangement method. Schemes provide certainty of outcome and timeframe. Schemes are, however, only practical in friendly merger proposals. Where the approach is unsolicited, the takeover bid route will still be the only practical option.
Executive pay restraint and shareholder activism
Falling share prices may also lead to a new wave of shareholder activism. Signs have already emerged in the recent AGM season of shareholders opposing the grant of executive options, reappointment of directors and increases in non-executive remuneration.
Earlier this year, the Federal Government announced proposed reforms to the termination benefits regime under the Corporations Act 2001 (Cth) (Corporations Act). As a result, the Corporations Amendment (Improving Accountability on Termination Payments) Bill 2009 was introduced into Parliament on 24 June 2009 and draft regulations were released on 3 September 2009. These changes have far-reaching implications and will impact all companies including mining companies (whether listed or not).
If passed in their current form, the reforms will:
- significantly reduce the threshold at which shareholder approval is required for the payment of a termination benefit
- expand the range of people subject to the termination benefits provisions in the Corporations Act, and
- expand the definition of termination ‘benefits’ which are caught by the threshold.
Increases in project disputes
One of the common themes to emerge from previous downturns in the resources industry has been the correlative increase in the number of project disputes. Not surprisingly, most disputes surround a failure to pay. These disputes are often between principals and contractors and can lead to suspension of project works and/or contract termination. Companies looking to carefully manage their credit risk may also request changes to payment terms where uncertainty exists about a counterparty’s financial standing.
It can also be expected that there will be an increased incidence of disputes between project owners, most commonly joint venture parties. In tougher economic times, decisions relating to project expenditures are likely to come under closer scrutiny and vary according to the respective size, financial backing and capacity of each joint venturer. Failure to agree on future expenditure commitments may, depending on how the joint venture agreement is drafted, trigger dispute and deadlock breaking mechanisms.
We are seeing an increase in both the number of project disputes and in the unwillingness of disputing parties to use alternative dispute resolution procedures in order to resolve such disputes, preferring instead to take the matter directly to court.
Project interruptions and shutdowns
Sharp falls in commodity prices have forced a number of operating mining projects to become sub-economic. This factor, together with the drive to conserve cash in the face of highly constrained credit markets, has led a number of Australian mining companies to announce plans to suspend or close mining operations in the six months to June 2009.
Examples of recent project shutdowns include BHP Billiton’s Ravensthorpe nickel plant in Western Australia and the associated Yabulu processing circuit in Queensland, Norilsk Nickel’s Waterloo and Silver Swan nickel mines in Western Australia and Xstrata’s Sinclair nickel mine in Western Australia.
Contract variation, termination and renegotiation
Requests for contract variations are likely to increase as the realisation is made that deals struck at the height of the mining and commodity boom are no longer profitable or sustainable. Companies are closely examining their key contracts to identify material adverse change or hardship clauses which may be triggered by the changing economic conditions, as well as termination for convenience clauses.
In particular, we are seeing a rise in the number of enquiries being made as to whether a right of termination still exists in relation to a default under a contract which occurred in the past and was never actioned.
Stimulus initiatives to address capacity constraints
Whilst the GFC has eroded some of the supply-side constraints (such as those stemming from near full employment in the past two-to-three years), many remain. In particular, capacity constraints due to infrastructure bottlenecks remain a critical issue facing the industry.
The Rudd Government was elected on a platform to increase the core productive capacity of the Australian economy by investing in key infrastructure and people. Key issues were addressing transport bottlenecks and skills shortages. The government announced in the recent May 2009 Budget that one of the central features of Australia’s recovery plans would involve the outlay of some $8.4 billion in new road, rail and port infrastructure.