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Financing pressure eases as alternatives fill gap – TD Securities

Financing pressure eases as alternatives fill gap – TD Securities

Photo by Reuters

10th July 2014

By: Simon Rees

Creamer Media Correspondent

  

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TORONTO (miningweekly.com) – The financing pressures experienced by the mining sector are slowly lifting as alternative options become more accessible and increasingly popular, TD Securities head of global mining investment banking Michael Faralla told an audience at the Canada-South Africa Chamber of Business’s Innovative Financing symposium on June 18.

Equity performance remains muted but greater stability will help spur more investors back into the market. “We’re optimistic for continued stability in the outlook for commodity prices,” Faralla said. “And with investor expectations reset, they’ll see the value of investing in the commodities sector again.”

UPS AND DOWNS

The scale of the last bull market was such that many viewed that environment as the norm rather than the exception. As commodity prices climbed ever higher, company valuations followed suit.

“As a result, investors were attracted to the sector and a virtuous and reinforcing cycle increased the funds invested, driving share prices higher and attracting even more capital.

“In this environment, equity and convertible debentures were the main sources of financing for the junior mining companies as the availability of capital seemed limitless; any company with an interesting project in the right commodity had access to equity capital in size and on attractive terms,” Faralla noted.

Conditions experienced from 2012 to 2013 were the inverse of those experienced during the bull market. “All the trends that drove access to capital at the end of the last decade inverted as commodity prices reversed course,” he said.

“Commodity prices fell more than 30% from their 2010 and 2011 peaks and, of course, share price performance responded accordingly,” Faralla added, noting the severe impact on juniors.

“The primary reason for junior underperformance is twofold. Number one: investors in the sector sought the relative safety and liquidity of larger cap, cash-flowing companies. Number two: the developers’ lack of access to capital stalled project advancement, reinforcing the investors’ refusal to invest in them,” he said.

Therefore, explained Faralla, the virtuous cycle that drove widespread access to capital in the ten years turned into a negative-feedback loop, almost destroying the junior mining sector.

Resource-dedicated mutual funds in Canada felt the impact too. “They experienced decline of almost 50% to just over $5-billion today,” he said. “For gold-focused funds, that decline has been even more dramatic, standing at 67%.

“Portfolio managers are preserving any liquidity they might have for future redemptions. They have no new capital available to invest in companies,” he added.

GOOD NEWS

Fortunately, the measured recovery at the end of 2013 and into 2014 is still gathering pace, while alternative financing avenues are continuing to open up.

“The good news is that capital markets have recovered from the global financial crisis and there are several innovative sources of financing that didn’t exist, or were not very widespread ten years ago, that have stepped in to fill the gap,” Faralla added.

“The challenge for many companies is that [alternative financings] appear more expensive than traditional sources of financing. And in most cases they are,” he said.

“But the important consideration is not to compare the historical cost to capital, which doesn’t exist or is no longer available, but to make a relative comparison with the other sources of capital that are available or to the cost of doing nothing at all on your project,” Faralla explained.

In exploring alternative financing options, he considered several of the choices available and focused on the increasing presence of private equity investing in the mining sector.

He said perhaps three or four different types of private-equity involvement in the mining sector could be distinguished. "Firstly, there are the traditional, mining-focused private equity funds that have been around for several years,” he pointed out.

“Then there’s a new crop of mining-dedicated private equity funds that were often founded by management teams and former bankers,” Faralla continued, noting that there were also several highly-regarded management teams that were backed, in many cases, by substantial capital sourced from other private-equity trading houses and sovereign wealth funds.

“Finally, there are the traditional LBO [leveraged buyout] firms which are dedicating [more and more] time and resources to the mining sector."

He highlighted that all of these firms had had tremendous success investing in the energy sector and were seeking to translate that success into the mining sector, adding that many of these firms had in-house mining technical and management expertise to lead these efforts.

STEADY STREAM

Streaming deals continue to attract greater attention, although Faralla noted that some single-asset companies remain wary.

“Streams have grown in popularity as sources of financing for both junior and senior mining companies,” he said. “However, they’re not universally accepted as cost-effective financing alternatives. We find several management teams and boards remain sceptical about the suitability of streaming as a source of capital for a single-asset company.”

But, Faralla believed it made sense to look at streaming as part of any financing plan for a company, particularly a junior that continued to find access to capital constrained by recent market conditions.

“We also think that it’s important to consider a stream as a substitute for equity because a mining company is [permanently] selling part of the asset represented by the ounces or tonnes that underlie the streaming transaction,” he explained.

The popularity of streaming and other nontraditional financings would continue to grow, helping to replace the absence of capital represented by the closed-off equity markets.

“Yet it was also encouraging to see a small window for equity financings open up in the first quarter this year, although it’s a fact that equity financings have been bought mostly by companies’ current shareholders looking to support their existing investments,” Faralla stated.

For those holding projects with robust economics, the capital options remained much broader. However, management should still give consideration to all financing options.

“Capital is available for good-quality, well-sponsored projects,” Faralla said. “Nonetheless, it’s important to evaluate and compare all [financing] sources to determine which will be the most suitable for each individual company or asset.”

Edited by Creamer Media Reporter

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