Tracking the 2016 Trends – Part 9: The merger and acquisition cycle

The ninth of a ten part series examining the trends that are leading the mining industry in 2016.

9. To buy or not to buy; that is the question

The first half of 2016 has seen a number of major divestments, particularly by Anglo American which has sought to emulate BHP in offloading its non-core assets, albeit in a much more piecemeal fashion than the South32 demerger process.

But why is this?

According to Ernst & Young, the aforementioned tighter capital investment market is forcing many miners’ hands.

“Divestments are increasingly being pursued across the sector,” it stated, “as capital remains constrained and corporates look to rationalise portfolios to achieve maximum return to shareholders.”

Deloitte added: “Diversified miners seeking to reduce their debt loads, simplify portfolios, and generate additional cash to offset underperforming investments are selling and spinning off a range of non-core assets.”

If there is all this divestment, will there be buyers?

According to JP Morgan, the M&A market is likely to heat up, because it has little further to drop after the hammering commodities have endured.

“In price relative terms, mining is back to its levels from ten years ago, when the Chinese commodity super cycle was just starting,” it said.

The World Bank is also predicting a new round of M&A, seeing mid-sized operators as the main targets.

These companies “may take the lead in mergers and acquisitions or become interesting targets for the more capitalised companies of the sector that are looking for growth that isn’t more exploration or greenfield projects,” World Bank practice manager for energy and extractive industries Paulo de Sa said.

E&Y agreed, stating, “We expect deal activity to pick up over the course of the year, particularly asset sales driven by the need to reduce leverage, and possible acquisitions of distressed companies by their debt holders.”

“Core, low-quartiles assets are likely to be retained, unless there is a commodity or regional restructure. We may also start seeing companies looking outside their existing commodity focus or leveraging existing operations to explore other opportunities.”

But this may become difficult due to the weaker capital markets, which will make it difficult to raise funding for larger acquisitions unless cash balances or scrip offers are used, and while there have been large purchases such as China Molybdenum Co.’s US$2.65 billion purchase of Freeport-McMoRan’s stake in the Tenke Fungurume cobalt mine and Anglo American’s Brazilian niobium and phosphate assets for US$1.5 billion (both in cash), overall deal values are expected to drop.

This has been supported by E&Y data which shows deal values have nearly halved year on year for the first quarter of 2016, falling 45 per cent to US$3 billion, while volume dropped 17 per cent to just 72 deals – although the top three deals were all divestments.

Further difficultly will be added by the fact divestment in mining differs in one major way from other sectors.

“The obvious exception is that opportunistic approaches are less likely to be a key driver in the mining and metal sector as many of the portfolio decisions are drive by concerns over capital preservation,” it said.

However, Deloitte believes the irony of the situation is despite these issues, “this is probably an ideal time for miners to be making acquisitions.”

“With a plethora of distressed assets hitting the market, coupled with divestments from the majors, buyers that strike whilst the iron is hot could acquire uncontested assets.”

Deloitte UK’s African services leader Debbie Thomas summed it up: “The scarcity of funds and a fear of investing are driving many potential buyers to stay their hands; with asset values being tested, however, there are currently compelling reasons to buy.”

“Whilst M&A will not be right for every company, counter-cyclical opportunities exist and companies that choose not to explore them may not be coming to the right conclusion.”

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