2010 did indeed mark the end of a historic decade in mining dealmaking. While it remains to be seen if we will ever see another decade like it, we do think 2011 will be another record-setting year for mining M&A. Our top five expectations are:
1. THERE WILL BE A HEIGHTED PACE OF DEAL ACTIVITY, ESPECIALLY IN THE "FIVE KEY RESOURCES." UPWARD PRESSURE ON DEAL VALUES MAY PROMPT SENIORS TO DEPLOY MORE CAPITAL INTO ORGANIC GROWTH.
The key deal drivers of activity in 2010 still hold for 2011:
- the economic evolution of emerging markets will underpin demand for scarce commodities, prompting a rush to secure production in order to capitalize on price strengthening; and
- a macro backdrop of low interest rates in developed nations, global asset infl ation, political instability and a depressed US dollar will sustain demand for precious metals.
In a rush to secure resources against this macro backdrop, miners will hasten their march forward into frontier geographies and into new and untested expanses (indeed, some corporates are trawling the seabed for minerals!)
At the time of print, 2011 was already shaping up to be a brilliant year for mining M&A, especially in our five key resource segments: gold, coal, iron ore, copper and fertilizers. Consider that, of the record $27 billion deals already announced in the first month and a half of 2011, 81% involved one of these five commodities. Notable announcements included:
- A $9 billion merger of equals between Inmet Mining Corp. and Lundin Mining Corp. (copper);
- Alpha Minerals $7.1 billion acquisition of Massey Energy (coal);
- Cliffs Natural Resources Inc.'s $4.9 billion acquisition of Consolidated Thompson Iron Mines Ltd. (iron ore);
- Newmont Mining's $2.1 billion takeover of Fronteer Gold (gold); and
- HudBay Minerals Inc.'s $520 million takeover of Norsemont Mining Inc. (copper).
In addition to the top five, during 2011 we also expect acquirers to seek out:
- Junior rare earth projects, as Japan and others seek to secure supply amidst concerns of Chinese market concentration and export restrictions;
- Uranium projects, as Asia and other regions set out on ambitious plans for nuclear build outs;
- Complementary extractive industries, including shale, as energy security becomes a more pressing global issue.
We also expect to see deals size expand through 2011, likely breaching the $10 billion price point. Our expectation is based, rather simply, on the rising market capitalization of miners. Consider that the market capitalization of Massey Energy at December 31, 2008 was $1.17 billion and at December 31, 2010, prior to its acquisition in January 2011, was $5.47 billion. Also consider that the 2010 year end market value of materials companies on the Toronto Stock Exchange, heavily weighted in resources, was $396 billion, up from $254 billion at the 2007 market peak and up from $83 billion at the start of the decade. Going into 2011, public market valuations in the mining sector on most exchanges have never been so high, which means, on a relative asset basis, deal making in 2011 will have a price. Even junior miners are not so "junior" any longer. Canada's Toronto Venture Exchange, home to junior exploration and development entities, had close to 100 issuers listed with market capitalizations over $100 million at year end 2010. This dynamic may have some second-order consequences for the M&A market. As deal targets become more expensive, the economics associated with organic growth may become more attractive. BHP Billiton, for example, recently announced plans for $80 billion of investment over five years, commencing 2011.
2. CHINESE ENTITIES WILL ENDEAVOUR TO EARN A SPOT AMONGST THE GLOBAL MINING ELITE.
As discussed in our 2010 coverage, while China has been an extremely active investor in global mining projects, it has yet to produce a diversified mining market leader to rival the likes of a BHP Billiton or a Rio Tinto. Going into 2011, Raw Materials Group estimates that Chinese interests control only 1% of production outside of China. We believe this will begin to shift in 2011. From an M&A perspective, we expect the Chinese to engage in two types of activity that will alter the global mining landscape:
- Chinese entities will take a more aggressive approach to outbound M&A in 2011. Announcements from the Chinese themselves in late 2010/early 2011 support our claim:
- In January 2011, Andrew Michelmore, global head of Minmetals
Resources Limited, the Hong Kong unit of China's biggest metals
trader and former CEO of Australia's OZ minerals, stated that
Minmetals Resources will aggressively seek out deals in the near
According to Michelmore, China Minmetals, the group's parent has
"given us a remit to go out and grow this business in the international market. We would be looking to spend at least the equivalent of the market valuation of Minmetals Resources... It's got to be significant; it's got to make a difference..."
- In early 2010, on the heels of its 100% acquisition of
debt-laden South American Itaminas iron ore mine for $1.2 billion,
the East China Mineral Exploration and Development Bureau, a mining
entity owned by Jiangsu province, one of China's wealthiest
"China has the will, and more acquisitions are waiting in the wings."
- In January 2011, China Investment Corp. (CIC), China's $300 billion sovereign wealth fund, announced plans to open a Toronto office. While CIC has made no official comment other than that its Toronto office is aimed at enhancing long-term cooperation with business partners and exploring new areas and opportunities for investment in Canada, some market analysts interpreted the move as signal that it plans to ramp up its investments in Canada's resources and energy sectors.
- In January 2011, Andrew Michelmore, global head of Minmetals Resources Limited, the Hong Kong unit of China's biggest metals trader and former CEO of Australia's OZ minerals, stated that Minmetals Resources will aggressively seek out deals in the near term.
- Chinese entities will develop and consolidate the fragmented Chinese mining sector.
- In addition to a more aggressive approach to outbound dealmaking, we also expect to see Chinese interests more active on the domestic M&A front. In a deal that we viewed as a sign of a turning tide, in December 2010, Chinalco and Rio Tinto announced a joint venture (JV) to explore mainland China for mineral deposits. With an estimated 15% of global mine production actually taking place in China, the JV could well be the beginning of a Chinese controlled mining powerhouse. Unlike predecessor deals with Rio Tinto, in this instance, Chinalco has secured the right to be in the driver's seat, with a controlling a 51% per cent interest in the JV and rights to nominate the chairman of the board. We anticipate an increase in similar China-controlled exploration ventures, as well as a further fl urry of consolidation amongst mining interests in the broader Asia region.
The wildcard for this expectation is what the international reaction would be to such a strategy. Even in a largely free-market economy, protectionism, as we clearly saw in 2010, should never be ruled out.
3. INDIAN ENTITIES WILL SEEK TO SECURE INDUSTRIAL RESOURCE SUPPLY VIA STRATEGIC M&A.
- While we have seen some activity by Indian owned entities in the mining sector, Indian buyers represented a mere 1% of buy-side volumes in 2010.
- We expect this to begin to change in 2011. Standard Bank, among others, has predicted that India's growth rate will overtake China's by 2012, suggesting that it will be a key source of resource demand growth over the medium to longer term. Chief among India's needs are iron ore, copper, and aluminum, all necessary for the nation's ambitious $500 billion infrastructure build out plan. India will also have massive demand for coal as, among other drivers, the Indian Government plans to double coal-fired electricity generation capacity by 2017. (Consider that India is already the world's third largest coal consumer and imports approximately 12% of its consumption.)
- Because securing supply will be India's chief concern, we expect that many Indian led deals will resemble typical China-led deals in the period 2000-2007, often structured as private placements (debt or equity) with offtake or royalty agreements. We also expect that some Indian steel and power conglomerates will take toehold positions in larger iron ore or coal miners, continuing upon the trend of vertical supply chain integration we observed through 2010. During 2010, we observed a small number of these types of transactions including:
- Adani Enterprises Limited, a private Indian power producer, entered into a deal with Australia's Linc Energy to buy its Galilee coal project in a cash and 20 year royalty deal worth, over the long term, approximately $2.7 billion. The deal should provide Adani with access to about 7.8 billion tonnes of reserves with production potential of 60 MTPA.
- Indian conglomerate Essar Group, with interests in steel and energy, acquired West Virginia based Trinity Coal for $600 million. Essar's deal in the United States came on the heels of other similar deals by Tata Power Co and Reliance Power Ltd, all of which were motivated by a desire to secure overseas coal assets ahead of expected increases in Indian power demand.
- Dealmaking will not be limited to the private sector. We also expect state-owned companies such as Coal India, ICVL, and NMDC to be acquisitive overseas. Acquisitions by state-owned entities have been talked about at length in the past few years, however, a fast-track mechanism now proposed by regulatory authorities to expedite decision making, may mean that the coming year will finally see such transactions.
4. FRONTIER MARKETS WILL BE AT THE FOREFRONT OF MINING M&A. UNDERSTANDING AND MANAGING POLITICAL RISK WILL BE CRITICAL TO DEAL SUCCESS.
- With limited assets in developed regions and soaring demand for resources, miners eager for growth have, and will continue to have few other options than to move into frontier markets—high risk regions with underdeveloped mining sectors. (Frontier markets are not to be confused with broader emerging markets. The former are regions that have a relatively recent history of steady mining activity. Numerous emerging markets, like Peru, Chile and Brazil have longer track records of inbound investments in the mining sector and many miners are well acquainted with the regional risks and rewards.)
- Among the myriad deal implications of this kind of geographic diversification, the most critical is political risk. We view the assessment of political risk before, during and after deals as being the most critical component of deal success in frontier regions. To this end, PwC has collaborated with the Eurasia Group to contemplate the deal implications of so-called frontier markets. Our colleagues at the Eurasia Group have outlined five key expected risks for 2011 on the accompanying special insert, as well as meaningful suggestions on how acquisitive miners can mitigate and manage risk.
5. INCREASED STAKEHOLDER INTERVENTION TO CREATE CLOSING HURDLES.
- Deal market forecasting is not just about where the deals will be and who will be doing them. Equally important for dealmakers is the question: how will deal processes change in 2011? We expect that the biggest change will stem from increased stakeholder criticism of the current direction of mining M&A, which can make closing a deal challenging and even increase integration challenges. To avoid deal disruptions due to stakeholder concerns, we anticipate that through 2011:
- Mining companies will need to improve collaboration
with Non-Governmental Organizations (NGOs) in acquired project
regions: While rich in resources, many frontier regions
tend to have poor infrastructure, healthcare and education systems.
A large number of NGOs are mandated with ensuring that acquirers in
such regions share with its citizens the spoils of their ancestral
lands. NGO interests are not confined to these regions. Even in
developed countries there exists a wide spectrum of NGOs that have
to buy in before projects can be launched. Take, as an example, the
high degree of infl uence that aboriginal groups exert in approving
mining projects in countries such as Australia and Canada. While
this is considered a sensitive topic, we do believe that in order
to expedite deal processes, acquisitive miners should take care to
identify and work with relevant NGOs associated with deal targets
as soon as practicably possible. NGOs welcome such collaboration.
According to Canadian Hunger Foundation:
"Within the NGO community you will find a full spectrum of responses to the mining industry, from the radical antimining organizations to those who see a potential for partnership and co-operative co-development. The tide is steadily shifting toward the latter as more and more large corporations establish clear ethical standards and reach out to the communities where they have a direct impact. These more pragmatic NGOs acknowledge that they and well managed mining companies share a common interest in ensuring that the local people share fully in the benefits of a mining operation in their community."
- Mining companies will need to answer to the collective shareholder voice: During 2010, we observed increased instances of shareholders demanding a greater voice in a variety of corporate issues, including mergers and acquisitions. Through 2011, we expect shareholders in the mining sector to become even more vocal, with some exhibiting activist tendencies. Pension funds and sovereign wealth funds in particular will want to have a say on the prudence of pursing acquisitions against a macro backdrop of record high commodity prices and in regions where rules of law are vague—both of which arguably put shareholder value at risk. During the first month of 2011, for example, shareholders of a number of leading mining companies began publicly demanding that their firms deploy cash via share buy-backs and dividends over M&A, some even reportedly penning letters to boards. Activism is not limited to large investors. Consider the example of ActionAid, a charity that purchased one single company share of Vedanta Resources in order to gain access to the company's AGM and protest the planned opening of a bauxite mine and alumina refinery in the Niyamgiri mountain region of India. In order to avoid disrupting a deal or its integration, mining companies will need to proactively dialogue with shareholders about corporate strategy and M&A processes (within relevant legal parameters) as well as be prepared for shareholder scrutiny on both fronts. In fact, we recommend that all acquisitive miners be prepared to disclose detailed reporting about the impact of deals on share price, as well as the social or environmental impacts of deals.
- Mining companies must be aware that government stakeholders are becoming more active in the sector: Despite the prevalence of free-market systems in most deal making regions in the world, governments can have a final say in what deals get done and on what terms. Going forward, we expect that increased government intervention will be a new consideration for all acquisitive miners. In what is now a geopolitical game of chess, governments are closely watching mining deals. Acquirers will need to consider what concessions they are prepared to provide to national interests in exchange for extractive rights—anything from infrastructure build-outs to support for social programs may be required. As well, dealmakers should all be watching each other, evaluating the direct and second order implications of M&A deals that may, in fact, be laying a framework for a new world order.
- Mining companies will need to improve collaboration with Non-Governmental Organizations (NGOs) in acquired project regions: While rich in resources, many frontier regions tend to have poor infrastructure, healthcare and education systems. A large number of NGOs are mandated with ensuring that acquirers in such regions share with its citizens the spoils of their ancestral lands. NGO interests are not confined to these regions. Even in developed countries there exists a wide spectrum of NGOs that have to buy in before projects can be launched. Take, as an example, the high degree of infl uence that aboriginal groups exert in approving mining projects in countries such as Australia and Canada. While this is considered a sensitive topic, we do believe that in order to expedite deal processes, acquisitive miners should take care to identify and work with relevant NGOs associated with deal targets as soon as practicably possible. NGOs welcome such collaboration. According to Canadian Hunger Foundation:
In closing, like any good economist or accountant, we want to caveat our entire report by highlighting the wildcard for 2011—the pace of the industrialization of the emerging world. The common thread behind all mining M&A deals is an assumption that China, among other emerging world nations, will consume massive amounts of resources in what is a historical third industrial revolution. Many of these resources are expected to come from places within the emerging world, including Africa and the Middle East. While most of us view the emerging market growth story as an inevitable truth, others question the sustainability of such meteoric growth. Indeed, on the date we finalized this piece, severe unrest erupted throughout North Africa and the Middle East and the term "China bubble" appeared in 10.1 million news stories around the world. On this matter, we revert back to our theme "You Can't Always Get What You Want"—and in this case, it's a definitive answer.
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