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Sep 30, 2008

Strapped for cash: consolidation in the mining sector

Rising commodity prices and tighter credit conditions lead to consolidation in the mining sector, with smaller companies particularly facing takeovers

Astronomical profits and talk of mega-deals may give the impression the mining sector is booming. Away from the spotlight, however, smaller companies are struggling to raise the money they need to continue operating. With funding hard to come by and cash running short, some will have to merge just to survive.

Jan Nelson, chief executive of Pan African Resources, a gold mining firm listed on London’s Alternative Investment Market (AIM) and in Johannesburg, says to expect consolidation in the sector. But his company is well placed to take advantage of the situation. For others, the lack of cash is becoming desperate.

Rising commodity prices and tighter credit conditions have resulted in investors steering clear of companies yet to establish themselves. ‘In this environment, resources companies in the small-to-medium end of the market are coming under financing pressure and some are starting to look cheap; mergers and takeovers are a natural consequence,’ says John Prendiville, executive director at Macquarie Capital Advisers. ‘Consolidation has already started to pick up and should continue to do so for the foreseeable future on AIM and elsewhere.’

Those feeling the crunch might feel like victims of circumstances beyond their control. What’s more, junior merges can be particularly painful if the rationale is to slash costs: management might, in effect, have to fire itself to keep the company alive. 

Options to avoid a merger include seeking joint ventures with a larger firm or selling assets privately to raise the required capital, according to Prendiville. ‘Some are selling quality assets at prices well above what the listed markets will ascribe,’ he comments.

London may feel the pinch more than other locations. A recent report by Ernst & Young that focuses on AIM-listed mining companies says several have reported difficulties in raising money on favorable terms. One firm comments that funds are easier to come by in Australia, South Africa and North America.

Another problem for London’s junior miners may be the lack of retail interest in the sector. This causes a lack of liquidity, making it expensive to move out of stocks, thus lowering the appetite for risk, according to Tim Williams, director of mining and metals at Ernst & Young. ‘There is practically no real retail investor market in London for these types of companies, unlike in Canada and Australia,’ he says. ‘If institutional investors try to sell in the market, the lack of liquidity on AIM can have a big impact on share price.’   

But funding on AIM remains available for low-risk projects, according to Ernst & Young, and capital raisings up to the end of summer looked strong compared with other sectors. By the end of August, the sector had raised £77 mn ($138.8 mn) in new issues, putting it fifth behind equity investment units, oil and gas, construction and materials and industrial engineering, according to a spokesperson for the exchange.

Market commentators predict less M&A activity among the big miners due to extensive consolidation over the last few years. But the recent £5 bn bid for FTSE 100-listed platinum producer Lonmin from Xstrata, which was quickly rejected, plus the ongoing pursuit of Rio Tinto by BHP Billiton, shows there is still room for maneuver in the big-cap space.