EY: Capital Squeeze on Mining will Pressure Deals in 2016, Could Drive Mergers, Joint Ventures

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Written by Richard Finlayson, Senior International Editor for Industrial Info Resources (Sugar Land, Texas)--The mining and metals markets are under pressure from sluggish demand and the concomitant squeeze on production efficiency and capital investment. This will shape merger and acquisition deals in 2016. In this environment of volatility, divestment in projects is expected to increase as the timing of a recovery remains uncertain.
br> An Ernest & Young (EY) (London, England) report, "Mergers acquisition in mining and metals 2015/16," focuses on the trend of declining deal volumes and values for the fifth consecutive year. The increasing levels of financial distress will trigger more divestments, spin-offs, joint ventures (JVs) and the possibility of hostile takeover bids.

With a glut of assets available, scarcity of capital, selective buyers and market conditions forcing accelerated sales, getting divestment processes right will be paramount to achieving a sale for even the best quality assets.

Overall mining and metals deal volume in 2015 sank globally to the lowest level since at least 2000, with just 358 deals completed. Excluding the $8.7 billion demerger of South32, overall deal value dropped globally to $40 billion, with a strong bias to domestic deals and assets in developed markets.

"A company's positioning on the cost curve in the current market conditions, presenting robust information to potential buyers, is pivotal in order to provide confidence that cost reduction and productivity measures are sustainable," said Lee Downham, EY global mining and metals transactions advisory leader.

"Similarly, anticipating transaction risks such as separation and regulatory and JV approvals take[s] on greater importance in this market. Prospective buyers are thin on the ground and they will reduce valuation, or even walk away, if these issues are not adequately addressed," Downham said.

He added: "Perhaps the greatest concern within the industry is that nobody is sure how long the current downturn is going to persist, and companies cannot sit back and wait for an improvement in market conditions. This is forcing many corporate [firms] to downsize portfolios, and be pragmatic on valuation, which in turn will create deal activity."

In a summary of key transaction trends expected in 2016, EY reports that more deals will be completed by private capital, but only the best assets will attract their focus, and pricing will remain disciplined. Due to the limited number of buyers and extreme price uncertainty deferred, deal consideration will grow.

Project spin-offs as a means to package and divest assets have increasingly been featured in boardroom discussions, but again, the level of working capital will be a strong constraint on the number of deals actually completed. Hostile takeover bids could come from better capitalized entities where the target operates desirable, low-cost assets in stable jurisdictions. De-risking and preserving capita will motivate and drive mergers and JVs.

In another report published during the annual Investing in African Mining Indaba conference in Cape Town included the results of a survey from KPMG (Amstelveen, Netherlands). The risk survey, "Settling the dust in South African Mining," reported that an uncertain regulatory framework, increased working costs, constrained infrastructure and high labor costs, coupled with poor levels of productivity and strained labor-management relations, are some of the challenges which have placed South Africa's mining industry in dire straits. This was gleaned from KPMG's first South African mining forum in 2015, which was attended by over 80 C-suite delegates.

Despite the fact that currently South Africa is not at its best from an economic perspective and is fraught with political issues and industrial challenges, there is still room for optimism about the future and opportunities in the country's mining sector, said Jacques Erasmus, KPMG's head of mining in the country. He added that the long-term economic fundamentals of the industry are still strong in the technically advanced global community.

A comparison between KPMG's South African and North American survey results show how perceptions differ between regions in a global industry and how much the stability of the local economy impacts the risks which executives focus on. While six of the top ten risks overlapped between the two regions, they appeared in a very different order. Results from both regions reinforce the importance of having a robust risk management process that identifies emerging risks in order to deal with a complex web of issues at the company level.

"The fact that African executives are still facing challenges linked to emerging economies is not surprising and it is something we expect to see for several years. It does, however, illustrate the importance of collaborative engagement between mining companies, the government and labor," Erasmus concluded.

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