At the beginning of 2019, conditions seemed right for a significant new wave of M&A activity in the mining sector, with high expectations focused in particular on gold, copper and battery metals. However, in the nine months ending September 30, 2019, global transaction activity by value is down approximately 40% from the same period in 2018. By way of contrast, deal value during the comparable period in 2011 being the most recent peak period for M&A in the sector, was approximately four times higher.1
A cautious M&A environment
M&A enthusiasm has been dampened by growing concerns around the US-China trade dispute, Brexit and the overall health of the global economy. The price of copper, often seen as leading indicator of global economic activity, has declined from a high of US$2.97 per lb in April 2019 to US$2.56 per lb in October 2019, despite the widely expected medium-term supply side shortage. In the gold space, the wave of consolidation that was expected to be triggered by the Barrick/Randgold and Newmont/Goldcorp mergers, their stated intention to divest significant non-core assets and the industry-wide need to replenish resources and reserves, has resulted in only limited increased M&A activity.
The much-lauded battery metals space (encompassing cobalt, lithium and more recently nickel) has been characterized by volatile swings in metals prices and perceptions of future demand and supply. At the same time, activity involving Chinese acquirors has slowed as concerns have increased over the political effects of the US-China trade tensions and the increasingly challenging nature of foreign investment approvals. We expect that many of these headwinds will continue into 2020.
Overlaying these developments has been greater shareholder sensitivity and activism focused on the impact of transactions on shareholder value, both on the acquiror and target side. In this environment, M&A transactions have generally been disciplined, carefully structured and driven largely by key strategic imperatives and opportunities arising from market dislocations in certain sectors.
The recently completed C$515 million acquisition of Cobalt 27 by Pala Investments exemplifies many of these themes. By June 2019, when the transaction was entered into, cobalt prices had fallen 66% from their 2018 peak. Cobalt 27’s share price performance had fully matched the decline. These factors and their adverse impact on the outlook for Cobalt 27’s business in the short and medium term opened a unique strategic opportunity for an acquiror who believed in the strength of demand for cobalt over the longer term.
The transaction was creatively structured to provide for a spin-out to Cobalt 27 shareholders of the company’s assets, other than its physical cobalt inventory and its stream on Vale’s Voisey’s Bay nickel project. Conic Metals, the new listed company spun out to shareholders, holds a minority joint venture interest in the Ramu nickel project in Papua New Guinea and more than 10 royalties on earlier-stage nickel and cobalt projects. This structure was designed to allow Pala to focus on the key strategic assets of interest to it while giving shareholders continued exposure to other nickel and cobalt interests.
However, following announcement, the transaction became subject to criticism from some shareholders on value and governance grounds, culminating in a public campaign led by an activist shareholder opposing the transaction. An interloper also made a competing proposal for a transaction, although the interest of that party ultimately fell away. The leading independent proxy advisory firms issued contradictory recommendations, with ISS recommending in favour of the deal and Glass Lewis against. Shareholder activism of this type in the mining sector has increased in recent years as reflected in the high-profile campaigns involving HudBay and Detour Gold.
The Cobalt 27 transaction was ultimately approved by shareholders (and recommended by both proxy advisory firms) following a significant cash price increase and a sustained process of committed engagement with the company’s shareholder base. We believe that this type of sustained and committed shareholder engagement will become increasingly important to the success of public M&A deals in the mining sector—focused on both shareholders of the target company and shareholders of the acquiror. Shareholders have become increasingly skeptical of M&A transactions and therefore often require an enhanced level of engagement to allow them to understand the merits and strategic rationale.2
Challenging public markets—and success with creative alternatives
The first three quarters of 2019 saw a continued positive trend for gold and precious metals, and a corresponding positive trend for gold equities on the TSX: the S&P TSX Global Gold Index was up almost 15% in Q3 2019 and approximately 33% over the first three quarters of 2019. In contrast, public financing activity on the TSX has remained difficult. In the first three quarters of 2019, the TSX and TSX Venture Exchange have seen drops in new issuer listings and capital raising in the sector compared with the same period in 2018.
Financing activity has remained constrained as institutional and generalist investors have been slow to come back into the sector notwithstanding positive future supply and demand dynamics and some ongoing capital markets challenges arising for issuers in the cannabis and technology sectors. While some mining issuers have successfully accessed the markets through public equity offerings, those transactions have generally been difficult to complete. A significant portion of equity financing by Canadian mining companies has been conducted through private placements, strategic or otherwise.
The result has been a continued emphasis on creative dealmaking in the capital markets sector. One example was the successful bought deal secondary offering by Osisko Gold Royalties of shares owned by Orion Mine Finance. As consideration for the sale of Orion’s initial stream and royalty portfolio to Osisko, an affiliate of Orion’s initial fund, received cash and a significant equity stake in Osisko. Orion wished to monetize this equity position at an opportune time and Osisko was interested in ways to structure such a sale in a manner that would benefit Osisko.
The result was a creative transaction for Orion and Osisko. Osisko successfully completed a secondary offering of approximately 9 million shares held by the Orion affiliate for proceeds of approximately C$110 million.3 At the same time, Osisko repurchased just over 12 million of its shares from the Orion affiliate at the same price as the secondary offering for aggregate proceeds equal to approximately C$175 million payable in cash and the exchange of certain of the equity interests held by Osisko in other mining companies. The cash portion was funded by the sale by Osisko of its remaining interest in Dalradian Resources and its significant interest in Victoria Gold to another investment fund managed by Orion which had existing investments in Dalradian and Victoria. The result of the transaction was a reduction of Orion’s interest in Osisko from 19.5% to 6.2% and a rationalization of both parties’ equity investment portfolios.
The extent to which royalty and streaming companies continue to play a leading role in the sector is another result of the continuation of difficult public capital markets in the face of stronger precious metal prices. Their business model provides investors with access and exposure to precious metals (and in some cases other minerals and oil and gas) prices and production increases through a portfolio of investments, without the operating and capital costs risks faced by miners. In contrast to the mining sector in general, this approach has remained popular with many large institutional and other generalist investors.
Franco-Nevada, the largest royalty and streaming company by market capitalization, in July 2019 announced the implementation of a US$200 million “At-the-Market” (ATM) equity offering.4 An ATM is a low cost, flexible equity offering structure that permits equity to be sold directly into the market over a stock exchange at prevailing market prices. Sales occur at the issuer’s discretion periodically over the life of the program. While these structures have been a longstanding feature of the US capital markets, they have more recently become adopted in Canada, primarily for cross listed issuers such as Franco-Nevada. We expect that the ATM structure will be increasingly employed by mining companies while the environment for traditional public equity offerings remains challenged.
Alternative finance, and royalty and streaming finance in particular, continues to play a key role as a critical component for the funding of project development. A recent example was Triple Flag Mining’s US$100 million stream investment in Continental Gold to support the construction of the Buritica project in Colombia.5 The lack of large, new development projects in recent years has resulted in fewer large financing opportunities for royalty and streaming companies. As a result of the inevitable need to move new projects toward development to satisfy growing demand and declining output from existing mines, we expect that royalty and streaming financing will continue its key position in the overall mining finance toolkit.
1 Source: Mergermarket
2 Torys advised Pala Investments on the transaction.
3 Torys advised Osisko on the transaction.
4 Torys advised Franco-Nevada on the equity offering.
5 Torys advised Triple Flag Mining on the investment.