Pension funds to invest more as global mining sector M&A heats up--PwC

A PwC briefing report says M&A activity in the global mining sector will soon resemble a ‘global arms race.'"

Author: Dorothy Kosich
Posted: Thursday , 16 Sep 2010

RENO, NV -

PricewaterhouseCoopers study published Wednesday says more large pension funds will invest in mining, "one of the few bright spots in the global economy."

In the PwC briefing "M&A in the Global Mining Sector-No Stone Unturned," PwC suggests, ‘As the potential for commodity scarcity escalates, M&A activity in the global mining sector will likely intensify, mimicking a ‘global arms race.'"

"With few large targets in play and diminishing key resource reserves, we expect global miners will continue to scour the globe for projects and broaden their deal strategies," PwC forecast in a special mining industry briefing. "Acquisitions in new geographies, including West Africa, Baffin Island and Mongolia, and a continued shift in senior producer M&A focus away from acquisitions of producing niche assets to acquisitions of a varied array of exploration and development assets, including rare earth elements is likely."

In their analysis, PwC noted that private funds have traditionally avoided the mining sector "due to long-term hold periods, an inability to control commodity prices and high political risks."

"At the upper end of the market, large pension funds may be attracted to the potential for long term returns offered up by a commodity ‘supercycle.' The deal trend thus far in 2010 is for the larger funds to shy away from a ‘buy and sell' business model towards a ‘buy and hold' model."

"This shifting focus may mean that the long term investment horizon of a mining play is not a deterrent for private funds. If active, funds are likely to focus investments on near developed or producing projects in politically stable regions," PwC speculated. As an example, PwC cited the rumored partnership between the Canadian Pension Plan Investment Board of China's Hopu Investment Management to mount a competing offer to BHP Billiton's $38.6 billion hostile bid for PotashCorp.

"Funds may also seek to capitalize on the mining boom, by investing in complementary lines of business, such as mining equipment, refining houses, etc. that will benefit from positive industry dynamics, but are inherently less risky and require much less capital investment," PwC advised.

Also among their predictions, PwC analysts suggested that Australian M&A activity will resume during the second half of this year because Australia's new minority government and its revised tax proposal will put "an end to the political uncertainty that has clouded the mining sector."

Nevertheless, PwC warned that currency risk will impact how deals are structured. "While we do not expect currency volatility to bring global deal making to a halt, we do expect that such short term volatility may translate into increased perceived deal risk, prompting some buyers to incorporate structures that allow for post-deal adjustments for sharp short-term movements in commodity prices."

In their analysis, PwC analysts noted that gold, silver, iron ore, coal and copper continue to dominate mining M&A activity as companies with interests in these resources represented 84% of all takeover targets by value and 74% of all targets by volume. "Gold remains the frontrunner as nearly 40% of all acquisition targets were of entities with a major interest in gold," PwC observed.

‘Meanwhile, interest in new types of resources is growing with fertilizer and rare earths elements being two near term areas of focus for global mining firms," the analysts said. The current takeover battle for PotashCorp, the most talked about global mining deal this year, is a case in point.

However, the aggregate value of global mining deals has dropped due to the decline in mega-deals (deals with values of more than US$500 million). Year to date, 28 mega-deals have been announced, well below the peak 54 mega-deals of 2007. "Scarce opportunities for mega deals have prompted more senior miners to acquire junior mines and exploration companies earlier in their life cycle," PwC noted.

For instance, Kinross Gold acquired 100% of junior explorer Underworld Resources in a $98 million deal. The junior explorer's main asset is the White Gold project in the Yukon Territory.

Singapore-based fund Temasek has provided $500 million in financing to Inmet Mining for the development of its Cobre Panama copper project, which will not ship its first concentrate until early 2016.

With few large deal targets and diminishing developed world reserves, PWC says seniors are looking to grow through assets in potentially higher risk geographies such as Asia and West Africa. Thirty-five percent of year-to-date deal targets were located in Africa, the Middle East and Asia.

"Geographic diversification is only being fuelled by margin compression in developed reigons," PwC observed. "In Australia and Canada, for example miners are faced with rising labour, transportation and equipment costs. According to a recent Mineweb report, the cost to produce gold in Australia is currently $1,000 per ounce, as compared to approximately $400-$500 in West Africa."

Recent notable deals to penetrate new geographies include Vale acquiring deposits in Guinea for $2.5 billion for what it called "the best undeveloped iron ore deposits in the world." Meanwhile Kinross has just acquired West Africa-focused Red Back Mining for $7.1 billion.

Nonetheless, PwC also highlighted the realities of political risk, specifically First Quantum Metals which is a victim of two expropriations by the DRC government.

In the briefing, PwC analysts said year-to-date, 1,324 global mining deals have been announced. "Consider that close to 8,000 deals have already been announced in the global mining sector during the past five years, with over 1,000 deals per annum announced post 2005."

"No other global sector has seen such a consistently high volume of deal making," PwC observed. However, the aggregate value of announced global mining deals this year remains well below the 2007 peak of $159 billion.

Meanwhile, although North American companies are the most active acquirers, Asian buying sprees of global mining assets have intensified. PwC said 49% of all global mining deals this year involved at least one Canadian or American buyter.

Nevertheless, Asian acquirers were involved in 21% of all deals year-to-date. "Most Asian-led deals this were strategic partnerships rather than 100% acquisitions," PwC noted.

"Miners are increasingly looking to secure offtake or royalty agreements with Chinese entities as a means to finance projects," the analysts said. However, Asian investment not only involves Chinese state-owned companies, but also includes pools of private Asian investors.

"Interestingly, many politically unstable regions welcome Asian investment due to a ‘no strings attached' investment philosophy," PwC noted.

While all commodities are in demand by Asians, PwC said "during 2010 there has been a notable rush to secure iron ore supply ahead of a move by the big-three suppliers (Vale, BHP Billiton, and Rio Tinto) from annual contracts to quarterly and spot pricing."