Beginning in the second half of 2016, the Canadian mining sector started to crawl out of the prolonged downturn that started in 2011, when commodity prices peaked and started a long, slow decline. That decline prompted many in the turnaround and restructuring sector to plan for a lot of work in the sector.
Ultimately, however, a much smaller number of formal restructuring cases than anticipated materialized, along with a much greater move by debtors and their stakeholders to find practical ways to implement turnaround strategies. The outcomes were positive for a large number of miners that are now working out what to do with their positive free cash flow—a good problem to have! How the Canadian mining sector responded to this slump and the actions companies took during the subsequent recovery that promoted this outcome demonstrate the resiliency of the miners.
A crisis of investor confidence that began in 2011 hit junior miners particularly hard. The slump was initially prompted by falling metal and mineral prices, which took away equity financing options, given the perceived volatility risk in prices. The market capitalization of junior miners fell 43 percent in 2012 and a further 41 percent in 2013. By the end of 2015, only about 20 percent of the capitalization that had existed at the end of 2011 remained. Cash balances shrank, given the reduced financing options available. By 2015, the average cash balance among the top 10 Canadian miners was about a quarter of the 2011 peak; for the top 100, it was about 30 percent of peak levels.
But mining companies are resilient. Miners big and small focused on severe cost cutting and reining in projects to hold on through these challenges. Mergers were also pursued as companies sought options to pool resources. Some 28 of these companies went on to pursue mergers in 2014 outside of formal restructuring processes, with more following suit in 2015 and 2016. Senior miners in Canada and around the globe were also forced to pursue cost cutting activities, including plans to sell noncore mining assets, such as those pursued by Barrick Gold, BHP Billiton, Anglo American, and Rio Tinto. Initially the focus shifted to improving the profitability of existing projects that were generating cash rather than investing in exploration or acquisitions.
Equity markets were largely closed to junior mining companies, and while some miners pursued creative debt financings to get necessary capital, this contributed to their cash flow issues in time as well. In particular, “streaming” companies, which lend money for a right to buy future production at a fixed price, were quite busy during the commodity downturn, playing an active role in providing companies with new financing to repay indebtedness.
Formal restructuring proceedings were not seen as a viable option for many of these companies. Most were highly capitalized with equity rather than debt, or had sufficient liquidity to survive until market conditions improved enough to allow them to refinance. Some companies had covenant-light debt instruments with limited triggers to initiate creditor-driven restructurings. Many of these companies also had assets in foreign jurisdictions that would be difficult to control in a proceeding.
Overall, the uncertainty of prices in the market meant that there were relatively few formal restructuring processes, and the ones that did take place did not go as expected—bidding on assets was limited and in some cases no bids were received, leaving existing lenders or interim financiers holding unsaleable assets. This uncertainty prompted stakeholders to be very conservative and patient in the down part of the commodity cycle, contributing to a level of uncertainty. This was reflected in the market, as companies with a perceived short- to medium-term liquidity concerns traded at a discount to their peers.
As the markets began to stabilize slightly in 2013 and 2014, midsize mining companies with strong track records and cash positions were in a good position to purchase some of the more senior mining companies’ assets. One of the major disappointments during the down part of the commodity cycle was the lack of transactions by private equity firms, despite rumblings of high-profile firms as potential bidders for a range of assets. By contrast, Chinese firms were quite active, picking up assets in cases where their Western peers were unable or unwilling to transact.
As demonstrated in the last cycle, miners have an innate ability to survive, and now many are starting to generate positive operating cash flow again after almost five years of cost-cutting, cash conservation, and recapitalization of balance sheets.
Miners have done some heavy lifting during the downturn on the cost side of the equation, and the majority of juniors—the plankton of the industry—have survived.
Companies like Kirkland Lake Gold, which historically had high operating costs, were able to reduce those costs during the last three years through operational improvements, allowing them to survive the downturn and eventually thrive. Kirkland Lake Gold wound up merging with Newmarket to create a leading intermediate. Other companies like Claude Resources were on the verge of bankruptcy but were able to change the mine sequencing (mining the high-grade zones in the deposit to maximize cash flows), substantially reduce operating costs, and increase free cash generation, and make themselves attractive acquisition targets. Claude Resources was ultimately acquired by Silver Standard.
During 2016, M&A activity was anticipated to be to the buyers’ advantage, as companies would be selling assets at “fire sale prices.” However, this was not realized in practice. Other than certain Chinese deals that were done at a premium, transactions were completed at valuations that were consistent with historic valuations (0.8x-1.0x P/NAV). This included Freeport-McMoRan’s sale of its stake in the Tenke Fungurume Mine to China Molybdenum, Newmont Mining Corporation’s sale of its 48.5 percent stake in Batu Hijau to an Indonesian consortium, and First Quantum Minerals Ltd.’s sale of the Kevitsa mine to Boliden.
One of the biggest stories of 2016 regarding M&A concerned assets that did not sell. Numerous large deals that were expected to be completed by early 2017 were withdrawn from the market, possibly due to the rebound in commodity prices. Among the anticipated deals that failed to materialize were sales of Anglo’s Australian coal assets at Moranbah and Grosvenor mines as well as Kumba Iron Ore in South Africa.
Analysts and market watchers had expected Anglo to proceed with those divestitures as part of the company’s announced debt reduction strategy. They had expected the Moranbah and Grosvenor mines to sell for more than $1 billion. Anglo’s decision to keep these assets showed that even in a declining market, companies will continuously reassess alternatives. Instead of monetizing the assets in full, Anglo was able to maximize cash flow from them and use those funds to reduce debt.
Commodity prices during 2016 rebounded significantly, which created an unexpected inflow of cash to the major miners. The increase in commodity prices led to increased free cash flow generation from assets, which was used to pay down debt. Historically, miners use free cash flow generated to invest in new properties or further develop existing projects. However, during 2016 Western mining companies did not make any major acquisitions, and CAPEX spending was at an all-time low.
Many miners are now working out what is the best use of the free cash flow they’re generating. The answer to this question will differ depending on the miner’s stage of development, its capital structure, and investor expectations. Large Western mining companies during 2016 focused on making debt repayments, and some stated publicly that they would be shedding noncore assets to that end. For example, Freeport sold its ownership stake in the Tenke Fungurume project in the Democratic Republic of Congo (DRC), and Anglo sold its niobium and phosphates assets in Brazil. Both of these assets were acquired by China Molybdenum. The excess cash generated from the sale of these assets was used to repay large amounts of debt that were causing a significant debt overhang in their respective share prices.
Miners are cautiously optimistic about future commodity prices and accompanying supply and demand metrics, but they aren’t yet outright bullish in their outlook. They take a tempered approach to decision making, particularly when it comes to how to spend cash. They are currently focused on strengthening their balance sheets before making substantial investment decisions. With the lingering effects of the commodity downturn still fresh, many stakeholders are asking: Have miners learned lessons from the past, or will they repeat the same mistakes as the industry recovers? Will they again fall victim to cost inflation, project overruns, expensive M&A, and undercapitalized balance sheets?
The industry is beginning to see green shoots in the equity and debt capital markets, investment by seniors in juniors, miners cautiously moving forward with long-term projects, and constant rumblings of M&A activity. These are all positive signs that mark the return to a more “normal” global mining market. Larger mining companies have been acquiring small pre-production companies, such as the announced deals for Goldcorp and Kaminak, Eldorado Gold and Integra, and Endeavour Mining and Avnel Gold. More of these types of transactions by seniors are expected as they continue to strengthen their pipelines through acquisitions of new assets.
There are reasons to be optimistic that miners have learned from the past and are making prudent decisions going forward that will add value for all stakeholders. This includes repaying debt, improving liquidity profiles by reissuing debt with laddered maturities, reinforcing their balance sheets with equity capital raises, and raising capital to expand. Of course, there will be some mistakes—there always are in such an inherently risky business—but the sentiment in mining is improving daily.