There is a new face of private equity in the today's mining M&A market. Private equity is no longer willing to entertain opportunities which spruik only the potential for speculative capital gains. Rather, private equity is now increasingly focussed on investment opportunities which allow vertical integration of one or more of the other functions of its business.
2016 saw a flurry of M&A activity in the Australian resources sector, particularly coal, in what many expected to be an otherwise flat year. Despite the bearish view among many investors as to the future price for iron ore and coal, the planned strategic departures from the Australian resources sector by a number of the large cap miners during a period of depressed commodity prices, resulted in a number of assets, even some on care and maintenance, changing ownership during the year.
Whilst some of these assets have commanded large sale premiums (for example, Rio's planned sale of Coal and Allied (Rio's thermal coal assets) to Yancoal for a reported US$2.45 billion and Barrick's planned sale of its 50% stake in Kalgoorlie's Super Pit to Minjar Gold for US$1.3 billion), M&A activity has otherwise been dominated by small to midcap players, such as:
- Pembroke Resources and its acquisition of the Olive Downs coal tenements from Peabody Energy
- Batchfire Resources and its acquisition of the Callide coal mine from Anglo American
- Stanmore Coal and its acquisition of the mothballed Isaac Plains from Vale and Sumitomo
- Australian Pacific Coal and its acquisition of the mothballed Dartbrook coal mine from Anglo American
These buyers were able to secure the purchase of these coal assets a significant discount to what they would have commanded a mere handful of years ago. However, even at these depressed sale prices, it has been paramount to successfully completing transactions, that the purchaser secures external funding to support its initial operating expenditure or the replacement of the existing environmental financial assurance.
Over the last 12 to 18 months, Australian financial institutions have been moving away from lending to small cap miners on the backing of the value of the asset and the balance sheet of the purchasing entity alone. This issue has been driven by:
- The 'green' policies adopted by the larger financial institutions in an effort to reduce their exposure to the resources sector and appease negative public and shareholder sentiment towards the mining industry generally
- Specifically in Qld, the introduction of the Chain of Responsibility Legislation which, until tested or further guidance is released, where the banks are concerned that the legislation may leave them open to pursuit by the Qld government to recover from them (as the financier of a project) the cost of unremediated environmental liabilities
The lack of traditional debt funding from the banks has resulted in prospective purchasers looking for alternate funding sources. While private equity investment in the resources sector is nothing new, the asset sales that occurred in 2016 demonstrate that private equity is most interested in opportunities for which there is a compelling and well thought out strategy to transform the mine (noting many of the large cap miners are disposing of mines which are on care and maintenance or likely only marginally profitably) and where the investor can realise additional synergies or gains over and above a traditional equity investment.
Batchfire Resource's acquisition of the Callide Coal mine from Anglo American is a prime example of this strategy in effect. The Callide Coal Mine had been on the market since 2012 and had failed to attract a committed purchaser.
As a standalone asset, the mine was unremarkable. There is nothing particularly unique or special about the coal extracted at Callide, it is low in sulphar and ash and comparable to Indonesian thermal coal. As the mine's primary purpose was to be the sole supplier of coal to the adjacent power stations, the mine had no long term port or rail capacity.
Batchfire Resources' acquisition of the Callide Coal mine required it to secure funding to support its ongoing operation of the mine and the liabilities it would assume as part of the purchase. Recognising that private equity investors would be reluctant to invest on the identification of an opportunity alone (particularly in thermal coal), and cognisant of the increasing opportunities which Callide quality coal has in the South East Asian power market, Batchfire Resources developed a mine turnaround plan to achieve operational efficiencies and to commence export production to the South East Asian power market.
Avra Commodities represents the new face of private equity for the resources sector. The potential to realise a capital gain on an investment alone is likely to be insufficient to attract an investor in the current market (noting that the sale of many of these assets represented a capital loss for the vendor). Investors are increasingly focussed on opportunities which allow them to vertically integrate aspects of their own business, whether this is securing offtake rights, exclusive supply arrangements or logistics.
In the end, AVRA Commodities took both an equity stake in Batchfire Resources and was granted the right to market or off-take the export coal produced from the Callide Coal mine. For AVRA, as a specialist thermal coal trader in South East Asia, the investment allowed it to secure further coal supply for its customers in South East Asia (at a time when traditional Indonesian coal used by the end customers is in decline).
The key to successful M&A by small and midcap purchasers will be identifying assets and investors that have natural synergies for growth and development . Whilst the bulk of the 2016 M&A activity was predominantly within the coal sector, this principle is equally applicable to small and midcap players looking at any type of commodity. With Wesfarmer's coal assets already up for sale, Rio Tinto looking to finalise its complete exit from Australian coal and the possibility that Peabody's Australian assets will come up for sale once it emerges from its current US Chapter 11 proceedings, there will be no shortage of opportunities for prospective purchasers in 2017.