Consolidation in the mining industry: Gathering momentum at last?

March 2012

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Industry dynamics

The mining industry continues to go from strength to strength compared to other industries, as all economies face the challenges caused by geo-political tensions, the uncertain global recovery and the fallout from the global financial crisis. Commodity demand continues to be driven by strong growth in the emerging markets and strong investment demand for commodities such as gold. Supply constraints caused by lack of historic investment in exploration, the liquidity squeeze, rising cost base in the mining industry and, even, the fact that the world is actually running out of some commodities are starting to have an impact. The demand/supply equation continues to drive prices for commodities and as a result the industry as a whole continues to go from strength to strength.

Mining industry consolidation: key trends

Against this background, there are a number of trends emerging which point to the gathering momentum of industry consolidation. These trends include:

  • The strength of the industry majors’ balance sheet - the industry majors continue to strengthen their balance sheets in a strong commodity price environment. This gives the industry majors the firepower to boost their future growth by way of acquisitions at a time when their new project development pipeline is not generating enough investment opportunities.
  • The rising cost pressures facing the industry - Since the start of the global financial crisis there has been a significant upward shift in the cost base in the mining industry. This has occurred as a result of increasing energy prices, rising construction costs, the emergence of a skills shortage, the fact that new resources are being discovered in increasingly challenging places and increasing resource nationalism in many countries. These costs pressures are having an impact on margins even in a strong commodity price environment. Hence we will see consolidation driven by the increasing economies of scale.
  • The liquidity squeeze - The global financial crisis has fundamentally changed the risk profile of the mining industry. Whilst finance providers continue to chase the majors when it comes to making available their balance sheet, the liquidity squeeze is starting to impact companies in the junior space looking to develop new projects. When faced with liquidity constraints, there are pressures on such companies to sell or merge to reduce risk through diversification. This will drive increasing consolidation in the junior to mid-cap space.
  • The “risk on/risk off” mentality of the equity markets - There is no doubt that one of the consequences of the global financial crisis has been the increasing volatility in the equity markets across the world. This has been caused by the “risk on/risk off” mentality of the equity investors in all the leading markets which have a reputation for providing equity finance to the mining industry. This mentality has meant that it has become increasingly difficult for junior and mid-cap mining companies to raise equity finance for their businesses. Whilst there is no doubt that as a generalisation the boards have managed their balance sheets extremely well, there always comes a point when a company looking to develop its business will require investment capital. That investment capital is increasingly difficult to source from the equity markets - particularly for the junior miners. This inevitably means that these juniors will have to look for other strategic options - namely merger or acquisition.
  • The “Asian phenomena” - A number of the Asian governments have taken the view that it is strategically important for “their” companies to control or have influence over a wide range of resource assets in a range of geographies. Historically many of the Asian economies (such as China, India, Japan and Korea) were happy to be buyers of the commodities in the international market. However, the rising commodity prices have made many Asian governments re-assess that strategy. The new approach from a number of the Asian governments (particularly China, India, Japan and Korea) is to encourage their companies to invest directly in resource projects with a view to securing the off-take. The ownership interest gives them significant influence over what happens to the commodities which are produced. As a result, over the last few years, we have seen companies from China, India, Japan and Korea increasingly becoming participants in resource M&A. Whilst the conventional valuation techniques still form the bedrock of how Asian companies value a resource asset in the context of an M&A transaction, the strategic value of a resource asset can lead to such companies outbidding majors and other traditional investors in such assets.
  • Traders as owners of assets - Historically, the major commodity traders focused on internationally trading commodities by buying at one price and selling at a higher price to make a margin. However, in an increasingly competitive resources market, a number of traders have sought to become increasingly vertically integrated. The rationale for this approach is to capture more of the margin in the commodity cycle but also to secure their access to supply. This trend has been aggravated in a rising commodity price environment as many of these traders now have balance sheets which enable them to invest and own the assets.
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2012 and beyond

The trends referred to above clearly point towards increasing consolidation in the mining sector. In this context, the proposed Glencore/Xstrata merger is an important transaction. If that transaction is completed, we may well see the floodgates open. If that transaction does not complete for whatever reason, that is likely to drain some of the confidence which currently exists in the sector and the gathering momentum for consolidation may be delayed. However, what is clear is it will consolidate further.

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Our participation

With our global network across the major producer and finance jurisdictions which are key for the mining industry including Australia, Africa, America, Russia, Kazakhstan and Asia combined with our unique sector expertise and recognition in all the areas relevant to the mining industry, we are well placed to support the inevitable consolidation in the mining sector.

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