Resource Companies Will Focus on Capital Efficiencies

M&A Trends 2014

The downward trend in the commodity cycle for mining companies and sustained low natural gas prices have created acquisition opportunities for firms with access to capital. Major corporations in the resource sector are looking at divestitures and other opportunities to achieve efficiencies, strengthen core operations and position themselves for profitability. Both their continued focus on capital efficiencies and the favourable investment prospects for other market players are major trends that we expect to see in the resource sector in 2014.

In the mining sector, lower commodity prices, uncertain demand growth from China, high operating costs and the need to reduce debt are ongoing challenges that have prompted significant divestitures by the larger global mining companies. These divestitures are likely to continue as major players prioritize profitability over resource growth. Prominent examples include Rio Tinto’s proposed or completed pruning of aluminum, copper, iron ore and diamond assets around the world and Barrick Gold’s disposal of its energy business and gold mines in Australia.

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Disposals by the major miners have created opportunities for mid-tier companies to acquire ‎strategic assets – Capstone Mining’s US$650 million purchase of the Pinto Valley copper mine from BHP is one example. Attractive assets have drawn large-scale interest in the mining sector from private equity players and certain Canadian pension plans, with their presence seen in various sale processes of the major miners.

A similar phenomenon is occurring in the oil and gas sector. Continued weak natural gas prices and relatively stable oil prices have been catalysts for M&A activity for many Canadian oil and gas players, with deals directed at raising capital to strengthen balance sheets and focus on long-term strategic assets. Many of these deals have been conducted in tandem with shake-ups in executive groups and under the banner of new leadership. The junior oil and gas sector, in particular, has been hit hard by the lack of capital, deeply discounted stock prices and expensive debt, preventing properties from proving up and generating cash flow.

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Higher well costs and more technical drilling programs have seen the capital needed for many of the new plays increase from tens of millions to hundreds of millions of dollars. Oil and gas players have turned to Canadian and U.S.-based private equity firms that have (or are developing) deep industry specialization to gain a competitive advantage as buyers of these assets – a trend we discuss in article 5, Buyers Will Find New Ways to Gain an Edge in Private Company Auctions. While capital is available for recognized management teams with the right assets, completing transactions remains challenging as prospective buyers scrutinize deal metrics and the ability of assets to deliver value. For those without the luxury of time in this buyer’s market, persistent low gas prices and a lack of capital have led to discounted asset sales.

The need for capital wil‎l continue to drive alternative financing, such as joint ventures and streaming and royalty transactions. Although joint ventures offer an innovative way to bridge large valuation gaps in the oil and gas sector (e.g., the joint venture by Bellatrix in 2013; also see article 7, Acquisition Financing in Canada Will Take Cues From the United States), recent Canadian tax changes may lead to sellers incurring greater tax charges (see article 10, Foreign Buyers Beware: The Taxman Cometh). Mining companies will seek joint venture arrangements to raise capital and share costs and risk on major development projects. Recent examples are Arcelor’s restructuring of its interest in the Mary River Project and its sale of a 15% interest in ArcelorMittal Mines Canada for US$1.1 billion to a consortium led by Korea’s POSCO and China Steel Corporation. We also expect continued use of precious metals streaming and royalty transactions to finance development projects.

A key obstacle to completing deals has been the pricing gap between value-driven purchasers/private equity players and vendor corporations. We expect that this gap will close as pressure builds on resource companies to complete divestitures, more alternative financing structures become available and private equity players build further expertise and confidence in the resource sector. Although 2‎014 is likely to be another challenging year, companies that focus on profitability in core operations and others who capitalize on acquisition opportunities at attractive valuations will be better positioned to perform and grow over the longer term.

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