For many of us, the New Year means high street sales – and in mining it seems everything is for sale at bargain basement prices. 2015 saw unexpected falls in metal prices and continual bad news from China. To make matters worse, the industry was caught out with high debt levels. According to recent EY research, mining industry net debt was a staggering $350 billion at the end of 2014, compared to $100 billion in 2006. With EBITDA falling, the industry liquidity ratios look the worst on record, with net debt averaging well over 2x EBITDA. Once great names – for example Cliffs, Peabody and Anglo American – are under huge pressure and Moody’s announced before Christmas that it was reviewing BHP Billiton for a possible downgrade.
There is gloom everywhere – analysts are competing with each other as to how low they can make their forecasts. Everywhere, the headlines are negative. Bloomberg is suggesting we ‘Let Coal Die a Natural Death,’ notes ‘Iron Ore Rout Deepens’ and comments that ‘Gold to Copper Bulls Left Heartbroken as Price Collapse Deepens’.
At the Mine Insider, we think this means one thing: time to buy. For astute investors, 2016 is shaping up as something really special, with once in a lifetime deals on offer. For example, Cliffs announced the sale of Bloom Lake to Champion Iron for C$52 million including obligations or C$10.5 million cash. That’s a pretty good discount of 99.8% on the original C$4.9 billion acquisition cost paid by Cliffs.
Investors have lots of choice. Just about everyone has asset sales at various stages – including Anglo, Glencore, Barrick, Rio Tinto, BHP Billiton and Vale. And you can buy entire companies for the price of a small mine – to quote just two, Peabody has a market cap of less than $150M, and Cliffs is trading at less than $300M.
Investor guru Howard Marks (Uncommon Sense for the Thoughtful Investor) suggests cyclicality is inevitable and linked to great bargains: “Rule number one: most things will prove to be cyclical. Rule number two: Some of the greatest opportunities for gain and loss come when other people forgot rule number one.”
Time to fill your boots? Not so fast. Trading these kind of assets is a risky game. Distressed assets or companies typically result from high purchase prices for lesser quality assets often using significant debt. If you buy the company or shares, you are still exposed to the debt, so buying the assets makes more sense. But these distressed assets are generally Tier 2 or 3 assets, mines which struggle to generate positive cash flows at the bottom of the price cycle (in contrast to Tier 1 assets which are defined as assets that remain cash positive at all points of the commodity cycle). And these assets often come with big liabilities. Stanmore bought the Isaac Plains coal mine in Queensland for just $1 last year, pretty good compared to the $430M Sumitomo paid for 50% in 2011 (we tried to calculate the discount, but our calculator does not have enough decimal places). The catch is that Stanmore has taken on significant obligations, so time will tell if it is a good deal. Timis Corp bought the former London Mining assets in Sierra Leone in late 2014, but had to promptly shut in the face of lower iron ore prices, so that doesn’t seem such a bargain now.
You need real nerve and discipline to trade these assets successfully – and as John Maynard Keynes found, more than a little luck because ‘the market can stay irrational longer than you can stay solvent’. At the Mine Insider, we say that it is possible to make money by trading Tier 2 and 3 assets providing some or all of the following conditions are met:
- The price paid for the asset reflects the asset value over the full commodity cycle;
- The asset must be shut and opened as market conditions warrant (mining a diminishing resource to lose cash really hurts);
- There should be no rush to get a closed asset into production until the market window is obvious;
- The buyer must have the resources to cover long term holding costs; and
- The asset owner must be ready to sell if others see more value, i.e. buy low sell high as opposed to buy high sell low.
But how many mining executives have the judgement and discipline to successfully execute this strategy, either as sellers or buyers? At the Mine Insider, we see many behaviours that we question:
- Too many companies continue to run mines at a loss – we expect to see many examples of this as the December half reporting season gets under way. Our advice: stop digging and leave the ore in the ground (BCI’s Nullagine decision is a good example).
- We think major companies selling expensive assets for nominal prices at the bottom of the cycle to pay off trivial amounts of debt is insanity (we’ve mentioned Cliffs with Bloom Lake, Rio’s Mozambique coal sale is another, but we fear there are lot’s more deals like this on the way). Our advice: be patient and sell high.
- For buyers, a cheap upfront deal with a good story is not enough: you need to pick a quality asset, you need the resources to hang in for the long haul, you need to limit obligations, you need the finance eventually to get into production, you need a flexible development approach and you need patient investors with indefinite exit plans. Our advice: you need a unique angle as cheap assets are cheap for a reason,
The conditions outlined are highly subjective requiring very astute decision-making capability. The mining industry has a habit of breaking these simple rules, but at the Mine Insider, we think a well managed Tier 3 asset is the mining industry equivalent of a Silicon Valley unicorn and may provide better returns for investors than conventional Tier 1 assets.