Miners forced to get creative as traditional financing sources dry up

http://business.financialpost.com/2012/07/24/miners-forced-to-get-creative-as-traditional-financing-sources-dry-up/

Nolan Watson’s phone is ringing off the hook these days. On the other end of the line are increasingly desperate mining executives trying to entice him to part with some of his precious cash.

As the chief executive of gold-streaming firm Sandstorm Gold Ltd., Mr. Watson, a youthful 32, represents one of the few options for miners to turn to as they struggle to raise a penny of new capital.

“The pendulum has swung from anyone being able to get any amount of capital on just about any terms, to nobody being able to get any amount of capital on any terms,” says the Vancouver-based executive.

Indeed. Capital raising for mining companies has dried up to a point that is unprecedented in recent memory. Equity financing, when it is even possible, is so dilutive at current share prices that almost no one is pursuing it. Debt deals are being called off just days after they are announced as investor appetite shrinks from one moment to the next.

It is all tied to the economic turmoil out of Europe and broader risk aversion in the market, which is knocking down commodity prices and turning investors away from volatile mining stocks. It has forced the miners to pursue unconventional financing sources.

Many experts have likened the mining finance environment today to 2008, when commodities were bottoming out amid a global economic meltdown. But Jason Neal, co-head of mining at BMO Capital Markets, thinks that comparison does not go far enough.

“It’s much worse for raising equity capital now than it was even in 2008 and 2009,” he says. “There were actually a lot of deals done back then, especially on the gold side.”

This environment puts the miners in a very tricky situation. After the scare of 2008, they have gotten used to the idea of maintaining conservative balance sheets when capital is scarce, and as a result, they are reluctant to spend any money right now. Yet at the same time, commodity prices are reasonably strong (especially copper and precious metals), meaning there is plenty of motivation for them to invest in their projects and grow production. The market has been brutal to miners that are facing capital shortages, whether they be small companies trying to keep the lights on or large companies that could be forced to delay projects.

The solution, experts say, is that they should think outside the box in order to raise money.

“It’s an alternative source of capital story now,” says John Gravelle, Canadian mining leader at PricewaterhouseCoopers LLP.

Creative financing options include strategic investors, royalty and streaming arrangements, selling a large chunk of a project for cash, selling one project to fund another, rights offerings, alternative stock exchange listings, equity lines of credit, acquiring a cash-rich company with stock, and even private equity.

A number of these options have worked in recent months. Companies producing strategic metals (such as lithium, rare earths and even iron ore) have had some success finding offshore investors looking for offtake. The rights issue, a popular tool in Europe, has been introduced to Canadian investors through Ivanhoe Mines Ltd. and other firms. And while there is almost no history of private equity deals in mining, they are rumoured buyers of BHP Billiton Ltd.’s stake in the Ekati diamond mine.

High-yield debt is also creeping back into the system, though it is only an option for existing metal producers. In April, New Gold Inc. raised US$300-million in a 7% senior notes offering that has traded well ever since. It was the most notable gold financing of the year and has drawn a lot of attention. Both HudBay Minerals Inc. and Coeur d’Alene Mines Corp. also announced debt deals, but they were called off when market conditions deteriorated and the companies could not get the terms they expected.

“We’re having very active discussions with companies about doing high-yield placements right now. It’s still a very active area,” Mr. Neal says, adding that fund flows into high-yield funds have been strong of late. That has obviously not been the case for resource funds that buy equities.

Perhaps the most logical move in a market like this is diluting at the asset level rather than issuing equity, as it is far less harmful for shareholders. Victoria Gold Corp. showed exactly how that can be done in the past few months, raising as much as US$77-million by selling three non-core assets in Nevada. That gave the company the capital it needs to develop a gold deposit in the Yukon.

Then there are the royalty and streaming companies, which are eager to get in at the asset level. Sandstorm Gold, along with larger rivals such as Franco-Nevada Corp. and Silver Wheaton Corp., acquire a portion of a miner’s future cash flow in exchange for upfront cash necessary to build the mines. Sandstorm has bought three royalties in the past two months and expects to acquire more soon.

“If the market stays like this, we’ll be doing many more deals,” Mr. Watson says.

The one downside for him is that financing conditions are so weak that Sandstorm had to give up on deals in which it was providing part of a financing package, because the other sources dried right up.

James Clare, a partner at Fraser Milner Casgrain, sees that challenge up close. He has a client trying to put together what he described as the first large-scale project finance package for a Canadian asset in years, and the simple problem is that no one wants to put the first dollar in.

“One of the benefits of streaming is that it can be put in place a lot faster than project debt. In this period of very limited access to funds, I feel people will move away from project debt and into streaming because it’s so much faster,” he says.

As financing becomes increasingly hard to come by, companies have adapted by deferring exploration spending, cutting back head office expenses and staging projects so less upfront cash is required. All of these have helped to a degree, especially when combined with a small capital raise, but they are not total solutions. At some point, they need more cash.

A lot of other miners are staying on course and simply betting market conditions will improve and they will have access to the capital markets in the near future.

Whether this is the right strategy is debatable. It worked during the financial crisis, as the equity financing window opened up quite quickly in mid-2009. But no one knows how long the financing window will be closed this time. In the meantime, experts say miners need to keep all their options open, as conditions could get a lot worse before they get better.

“We were hoping it would turn around by the end of the second quarter. It didn’t,” Mr. Gravelle of PwC says. “People who have cash are hunkering down and hoping it turns around soon. There have been some positive signs, but who knows.”