Jason Neal of BMO Capital Markets explains how mining financing trends have evolved over the last couple of years and what he expects going forward.

Jason Neal

GLOBAL CO-HEAD OF MINING AND METALS GROUP, BMO CAPITAL MARKETS

March 23, 2017

How did BMO’s role as a financial advisor change through the global mining downturn and what kind of behavioral shifts have you noticed from clients?

Mining is a cyclical business and commodity prices have been very volatile, so the main focus over the past few years has been balance sheet management. At the onset of the downturn, there was quite a bit of leverage added to balance sheets through acquisitions for cash, and investors were looking for balance sheets to be deployed rather than shares being issued. As a result, companies built up more debt. At the same time, there was cost inflation on the operations side of the business, and cash flow from operations was not generated as expected. In 2015 and 2016, there were opportunities to acquire assets that would typically not be sold, but were divested as part of deleveraging. BMO advised companies buying and selling these assets, or we were involved in financing companies that were acquiring these assets.

Royalty companies also rose in prominence in 2015 and 2016, as they had the opportunity to buy large streaming assets from senior companies. This strategy originated about a dozen years ago when streaming companies largely focused on arbitraging the value of precious metals within base metal companies. The next phase came about to support project development, and the third phase, which was very much the focus in 2015 and 2016 is where streaming and royalties were done as part of deleveraging. BMO advised royalty companies as well as raised equity to support these acquisitions.  In a depressed and volatile environment investors are more comfortable with the risk profile of the royalty/streaming companies and supported this equity issuance. The strategy of BMO’s Mining and Metals Group during the downturn was to follow these trends.

What are the benefits of an early-stage IPO or RTO versus private equity funding?

There are far fewer assets that are in the hands of private equity, but when private equity is involved, the asset is typically at a later-stage. Private equity companies are more likely to put up the money to invest in development when a resource is already established and risk is lower rather than fund exploration. Early-stage exploration projects are almost always funded by public equity and are funded often by flow-through share tax credits. Traditional private equity firms have not invested heavily in mining in part because there are many moving underlying price assumptions on both revenue and cost line. Hedging the revenue is one thing, but it is easy to get stung on costs. Mining companies are both producers and consumers of commodities, and they are more focused on margins.  Trying to fix revenue will not guarantee a return, so the fit into the private equity model is more challenging. There are, however, a few private equity firms who have dedicated money to the mining industry, which are managed by experienced and sophisticated managers and are willing to take the inherent risks, and there are several success stories. A significant part of a mining company’s value is optionality rather than what can be represented in static value models and therefore specialized managers have been more active.

What potential hurdles may arise during an international M&A?

As a jurisdictional target, Canada is M&A-friendly. There are many examples of cross-border investments coming into the country and not many impediments to acquiring Canadian companies. One of the most common transactions in mining is the acquisition of exploration and development companies, and there are many examples of this in Canada because Canadian capital markets are very supportive of the risk dollars that generate these projects. As far as funding this sort of venture, Canada is likely the best in the world, followed by Australia.

What are the key jurisdictional incentives that drive exploration?

There are a few factors that drive exploration. The flow-through share tax credit is obviously helpful, and every province must employ it or else they will lose business to other provinces. Geological prospectivity is also very important. The most important factor, though, is the feasibility of a discovery actually becoming a mine. That is why, for example, when a new government enters in an emerging market and companies expect the permitting process to become less cumbersome and local stakeholders to be more supportive of development, exploration expenditures increase. Canada is already a favorable jurisdiction for exploration because pretty consistently there is confidence in new a discovery becoming a mine, though timelines can be variable.

What do you expect to see from your clients in 2017?

Thus far in 2017, companies are focusing less on balance sheets and more on income statements and growing their businesses. We have recently spent more time on M&A deals, and we expect to see more consolidation, particularly among companies who have built assets in the past few years, as well as equity financing centered around project development. We also anticipate more IPOs over the next two years. Recently, investors have been more interested in base metals than they are in precious metals. There is good value to be found in mining investments now. There are many skilled explorers and developers who will generate projects. Exploration expenditures have been light, but improving. Before getting involved in any project, BMO sends its own geologist and engineer to inspect it. Most investors do not have the luxury of geologists and engineers who answer only to them and our diligence is therefore important to our equity franchise.

 

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