September 2013


Rationing capital in challenging times

By Mauro Chiesa

The mining sector faces a novel situation today. Past recessions involved a sick industry and healthy capital markets, but now it is the opposite. To boot, the capital markets are dominated by institutional investors focused on dividends, and they are not amused by pie-in-the-sky projects or by the industry’s total $43 billion of asset impairments in a single year. This makes it all the tougher for many exploring and drilling juniors that – assisted by tax flow-through shares – have been “raised” to depend on risk-oriented capital and eventual buyers.

As a result, both producing and non-producing companies must reassess and ration their resources while the capital markets remain risk-averse. They should, however, keep in mind that this capital attrition will choke off much future new supply, and by mid-decade any survivor will prosper for years thereafter. The solution for companies, as in most recessions, lies in the prudent management of assets: the more equity commitment and discipline they show, the better the terms that investors could bring. The company need only put itself in the investors’ shoes.

As a starting point, since many boards of directors have strong technical biases, a company should have a board whose skill-sets are suited to the broader range of strategic concerns including direct development and asset sales. Management must also include an internal managerial process as well as software systems to assist decision-making. Complex issues cannot afford silos. Complexity means more than geology; it includes capital costs, political risk, tax issues, working capital, permits, human resources, sustaining capex and infrastructure, many of which are often underestimated. Software to manage these issues can be installed and launched for a five-figure sum, while a regular meeting of the various internal group heads is both costless and priceless in value.

Many projects can generate capital during this crunch through realistic, pragmatic thinking. Companies should establish the all-in cash flow costs of their various mining assets and focus on the free cash flow (FCF) rather than the best internal rates of return (IRR), returns on equity or payback. To the markets, FCF means operational and capital self-sufficiency and the capacity to pay dividends. Early, modest and constant FCF can trump higher-risk and distant-IRR projects. Companies should sell or mothball those assets that do not make the cut – especially if a neighbouring mine has an ongoing concern or a marginal asset for sale. This is the tuck-in market.

Drilling programs can also benefit. Programs were once aimed at finding “El Dorado,” but as financial markets now look for greater certainty, a focus on enhancing the Proven Reserves and the Measured Resources as a percentage of the total could yield results.

Markets also hate permitting issues. Permitting cannot be priced and it has a triple-cost element: process costs, political costs and capex escalation as budgets bloat during this process. Starting the process earlier, and including both authorities and visible milestones, enhances the “P3 Reserves”: Proven, Probable and Permitted.

Investors still look for growth but need a better “map” to the assets in advanced development. The need for engineering milestones and third-party validation thereof should attract this market. A better and more flexible data room is required to meet the broader needs from institutional investors who now come in various niches: hedge funds and vertical offtake interests each have their unique information needs.

New projects were once wired for economies of scale to assure lower unit costs. This requires a re-think. With scarce capital, a phased approach may be a better way to attract the limited capital required for the initial phase. Infrastructure is also often an underused asset. As several mines are often located in the same region, bundling infrastructure (e.g. road, power, water), using fewer footprints or pooling the infrastructure with other users could be attractive for shedding assets from the balance sheet and for reducing costs. Comminution, of course, plays into this to improve the operational and capital leverage.

Other options exist to improve FCF. Downtown offices do not attract business or capital, whereas a location near an airport offers savings and greater productivity with less commuting stress. Also, more targeted mining show promotions are essential; these are a tradition from the pre-Internet days. Improve your website instead.

Mauro Chiesa has 33 years of experience in financing and advising extractive and infrastructure projects, including multinational banks in New York, the World Bank Group in Washington, D.C. and EDC in Ottawa.

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