Waiting for the light

By almost every financial measure, the mining sector started 2014 in a dark place. Great assets, strong planning and good timing have sheltered some companies. The rest—the majority—are getting by on guts, cuts and creativity
By Jim Middlemiss

Daycon Minerals Corp. president David Poynton is hoping that 2014 is the year that his mining company strikes gold with investors. “I’m betting that this year Daycon will go public,” says Poynton, who is also a director at Marathon Gold Corp. (TSX:MOZ) and a former mining lawyer at Cassels Brock & Blackwell.

David Poynton, president and CEO Daycon Minerals: "I'm betting that this year Daycon will go public"

Daycon, a privately held copper and silver exploration firm, has assembled seven properties covering 2,500 hectares in the vicinity of the Idaho-Montana border, in an area known as the western basin. These includes the Snowstorm Project, a former producing Idaho mine, which sits near the Lucky Friday Mine, operated by Hecla Mining Co. (NYSE:HL). Hecla is also a Daycon shareholder.

Hecla is also a Daycon shareholder.

Daycon acquired the properties from Timberline Resources Corp. (TSX-V:TBR) in June 2012, which had determined they were “non-core projects.”

Poynton says Daycon was eyeing a public listing last year around the time of the Prospectors and Developers Association of Canada (PDAC) annual conference, but those plans got waylaid when the “market just went flat.”

Cratered would be a better description. According to a CIBC report, mining issuance hit an eight-year low in 2013 at $4.8 billion. Factor out Barrick Gold Corp.’s (TSX:ABX) end of the year $3-billion bought deal and total issuance was $1.8 billion, a 75% drop over 2012. For the past 10 years, mining issuance has averaged $7.7 billion annually. The past year figure is the lowest since 2000 and 2001, when miners raised a mere $200 million.

It was a brutal year overall. Mining deals were down and stock prices fell as much as 50% for some companies. Senior producers started shedding over-valued assets purchased in the recent 2010-2011 heyday and began rebuilding their balance sheets; stories appeared in the press about the expected demise of hundreds of junior mining stocks (which fortunately has yet to materialize). Commodity prices plummeted, led by gold, which fell almost 30% and retail investors fled the mining sector. New York hedge funds shorted mining stocks and CEOs got whacked.

Daycon, for its part, shelved its IPO plans and shifted gears, looking at joint ventures and alternative financing. “It’s very hard when the seniors are suffering to get anyone to talk to you about a junior,” says Poynton. When they do, he says, “the people with money are demanding outrageous terms.”

Daycon decided to ride out the storm. “Our strategy is to stay low, cut costs and wait until the market turns. It’s time for perseverance and focus and for remembering that out of adversity comes opportunity,” Poynton says. “I’m not pessimistic. Things will change, they always do.”

Whether that change comes anytime soon remains to be seen. “I think for 2014, we’re going to be seeing much of the same,” predicts Stephen Mullowney, the deals mining leader at PwC.

That means tough slogging for those seeking money. “In order to obtain financing the traditional way, it’s going to have to be a clean company with not a lot of debt, a reasonable position on the cost curve and a good property,” he says. “Unless you have that you are going to struggle raising capital the traditional way.”

REGULATORY RELIEF

Even regulators and exchanges realize the difficulty facing miners when it comes to raising money and are chipping in to do their part to ease the pain. John McCoach, president of the TSX Venture Exchange, says “there is no question this is a tough cycle. It always feels worse when you are in the middle of it.” He notes that the mining industry peaked in the spring of 2011. “We’re now two-and-a-half years into this cycle and that’s taking its toll.”

However, McCoach says, Canada still has 59% of the public mining companies listed here and 70% of the capital raised globally last year involved Canadian-listed miners. “Canadians are still very much holding their own.”

McCoach says the TSX is working to make it easier for miners to raise much-needed capital. Last year, for example, the Venture Exchange extended temporary relief provisions regarding pricing for private placements, which it first introduced in 2012.

Next up is a proposal that will make it easier for Venture-listed companies to tap existing shareholders. Under Multilateral Instrument 45-312, issued for review and comment in November, issuers will be allowed to distribute securities to existing shareholders without having to prepare a more costly prospectus or rights offering circular, provided the company meets the exemption’s requirements, which includes being current on their filings. Individual investors are limited to acquiring $15,000 worth of stock, unless they get advice as to the suitability of the investments from a registered investment dealer. “If the proposed prospectus exemption goes through, mining companies…will be able to access capital from existing shareholders much easier than they can today,” says McCoach. “It allows companies to keep existing shareholders engaged.” The commentary period closed in late January, which means the exemption could be in place later this year.

While that will provide the beleaguered junior mining sector some help, intermediates and seniors, which trade on the TSX, will still need to find financing for their projects, many of which are escalating in cost. Those who are adventurous and looking to expand will also have to win over the capital markets.

GETTING CREATIVE

Some companies are well positioned to take advantage of the opportunities presented by the current buyer’s market, as seniors shed assets.

Take Capstone Mining Corp. (TSX:CS). In the fall of 2013, it closed a US$650-million purchase of the Pinto Valley copper mine and related railway in Arizona from a subsidiary of BHP Billiton Ltd. Capstone financed it using existing cash and credit facilities.

Cindy Burnett, vice-president of investor relations and communications, says bluntly: “We didn’t contemplate doing equity.” The company tapped the markets back in 2011 and had been sitting on a pile of cash earmarked for a Chilean project that got delayed. It paid $375 million in cash and used credit lines for the rest at LIBOR plus 2.5%, which she says is “really low-cost financing.”

However, not every miner is in Capstone’s shoes. So what are the rest of the companies in the field doing to get financed and get by?

PwC’s Mullowney says companies are getting “creative with regards to financing.” It’s a trend he expects will grow as miners look for ways to sort out issues that can’t wait for a rebound in traditional financing.

Poynton, likewise, expects to see juniors continuing to do what he calls “bits and pieces financing” and limp along doing what they can to bring in money using non-brokered deals where they can to cut costs.

Mullowney says he expects more senior producers will raise capital to expand or clean up their balance sheets. “They have stable and valuable operations. Even in this market they will still be able to raise money. It’s a matter of what price will they be able to raise it at?”

PROXY AND HOSTILE ACTIVITY

The experts also think we’ll see more hostile transactions and proxy fights in 2014, as companies with heft look to throw their weight around and grumpy shareholders get antsy. Take Goldcorp Inc.’s (TSX:G) hostile $2.6-billion offer for Osisko Mining Corp. (TSX:OSK) in January. Osisko’s board called the 15% premium offered “very low and price opportunistic,” and later rejected it for being “financially inadequate.” The company won a further victory when it sued Goldcorp for misuse of confidential information and a Quebec court agreed to hear its suit in early March.

Paul Stein, a mining lawyer at Cassels Brock & Blackwell in Toronto, says the Goldcorp-Osisko situation—the sector’s first major hostile offer in some time—is a signal to expect further consolidation among producers. “Mining M&A activity will pick up out of necessity because there isn’t capital available,” says Stein.

Future financings will also depend heavily on the stability of commodity prices and the grade of the deposits, says Kevin Thomson, a mining lawyer at Davies Ward Phillips & Vineberg. Commodity prices have been bouncing around the past year, making it difficult to value and close deals. “You don’t want to get caught out.” What is clear, he says, is miners with “low-grade deposits are in very serious trouble.”

DISTRESS AND INSOLVENCY

If you hear the word “trouble,” can distress be far behind? As such, you should expect to see more distress M&A in the coming year, as companies run out of cash and seek creditor protection.

“We will certainly see some distress M&A in 2014,” says John Turner, leader of the global mining group at Fasken Martineau DuMoulin in Toronto. “We will see some intermediate companies acquire some juniors and see some merger of equals at the intermediate level.”

Insolvency and defaults are increasing, notes Andrew Kent, a lawyer at McMillan LLP in Toronto. “There seems to be a lot of asset transfers going on, some voluntary and some involuntary.”

Two examples: Last September Donner Metals Ltd. (TSX-V:DON) forfeited its interest in the Bracemac-McLeod mine to Sandstorm Metals & Energy Ltd. (TSX-V:SND) after missing a payment under a metals purchase agreement; in January, the Ontario Supreme Court granted Jaguar Mining Inc. (TSX:JAG) an extension of creditor protection to pursue its recapitalization plan.

Kent says what’s happening is that if cash-strapped juniors can’t meet their obligations or push projects forward “senior creditors are taking control or third parties with financing or access to financing are taking control.”

Poynton adds that mining exploration firms will jettison some of their claims because they can’t afford the annual fees needed to keep them. “Everybody is hurting down the chain…except of course governments who want their fees.”

PRIVATE EQUITY

The current environment has many wondering if one key area of alternative financing—private equity—will be mining’s salvation. Brian Graves, co-leader of the mining group at law firm McCarthy Tétrault thinks the stars are aligning for private equity.

“There are a number of funds that have been around either in the U.S. or Australia that tend to be the centre of gravity for a lot of mining,” he says. It includes funds like Resource Capital Funds, Arias Resource Capital Management LP, Pacific Road Capital Management and the Sentient Group, which all specialize in mining and have strong teams in place. “They have been active in the junior and mid-market providing financing.”

“What they tend to do is travel the globe looking for undervalued opportunities,” Graves explains. “That’s been a difficult game in the last couple of years because high commodity prices have resulted in some pretty cash-rich producing companies competing with private equity buyers.” With the drop in commodity prices, the decline in mining company shares and larger companies seeking to sell assets, it’s created a perfect environment for private equity. “This is not a favourable environment to be selling assets wholesale,” says Graves.

However, not everyone is convinced private equity is a salve for the wound. “We see them looking at transactions, but we don’t see them pulling the trigger,” says Mullowney. The Venture Exchange’s McCoach adds “there’s really no [private equity] capital deployed to date,” compared to the size of the public markets.

But to another group sitting in the wings—recently deposed mining CEOs—this situation spells opportunity. A number of those CEOs, who either left their recent jobs because of mergers or were dumped in corporate bloodlettings, are lining up funds and colleagues to get back in the game.

For example, former Xstrata plc executives Mick Davis and Trevor Reid, have raised $1 billion for their venture X2 Resources, and are seeking $2 billion more to begin scouting for acquisitions. Meanwhile, former Barrick CEO Aaron Regent has formed Magris Resources to acquire, develop and operate mining resources.

Graves says that people who are well known in the industry are able to attract financing and quality management. “They could take pretty large bites and acquire pretty large producing assets that are non-core to a seller.”

Canada’s pension funds are another potential form of private equity still largely on the sidelines but with the potential to act. To wit, in 2013, Ontario Teachers’ Pension Plan announced the creation of its Natural Resources Group, with a goal to provide the pension fund with “exposure to commodities with direct physical investments in producing natural resource assets,” including mining. The $129.5-billion fund made its first investment in some producing oil and gas fields in 2013 and it is hunting for opportunities. It’s likely Canada’s other large pension plans will look to follow.

ROYALTY AND STREAMING TRANSACTIONS

On the tactical side, producing miners that can’t get traditional funding having also been getting creative with competitors, vendors and suppliers in order to push their projects forward.

Graves says streaming and royalty transactions “have really become vogue,” led by companies like Silver Wheaton Corp. (TSX:SLW) and Franco-Nevada Corp. (TSX:FNV). In a typical streaming deal, a company will sell off by-product that a mine produces. For example, HudBay Minerals Inc. (TSX:HBM) sold its silver and part of its gold output from its Constancia copper mine to Silver Wheaton for a total of US$850 million to help defray the costs to build the Peruvian mine.

Graves says mining firms that are close to production “may find a royalty player who might be prepared to [invest.]” However, he notes, “most streaming deals are better left to companies closer to production and tend to be highly tailored to the circumstances.” Joint ventures between companies to produce their properties are also an option.

The longer times are tight, the more commodity buyers can also expect to be called on to help prop up ailing firms by doing off-take or products-supply agreements. So, for example, a steel company that needs a steady supply of iron ore may be investing in a project. Mullowney says those types of deals are project-specific. “You need to know where you are going to be on the cost curve.”

Vendors will also be called on for financing, says Mullowney. He cites the recent instance of a drilling firm that took back a convertible note for its services from an exploration firm. “A driller is only going to do that if they think it’s a decent property. Those are the sorts of things you can do to move things along.”

Of course, there is always high-yield debt. “It’s a bit of a volatile market,” Graves says, adding “it tends to be high cost and something of a last resort.”

RESILIENCE WILL PAY OFF

Which companies are most vulnerable right now? That’s easy: juniors that are low on cash. According to Graves, “There are a limited number of funds out there…prepared to invest in early-stage entities and they are very much aware that the market is a tough one.”

However, he says, the death of the junior mining market has been overpredicted. “Junior mining companies have a fairly remarkable ability to reduce their costs and reduce their operations to a bare essential so they can ride out the market,” says Graves.

Whether Daycon hits pay dirt this year and goes public only time will tell. But Poynton isn’t worried. “We can hold out forever as a private company.”

Like a true mining optimist, Poynton sees the blue skies amid the clouds. While companies like Barrick and Goldcorp have seen their shares decimated he doesn’t worry. “These are all good companies. They will come back.”

Sidebar:

Once bitcoin, twice shy

Alix Resources’ novel plan to use bitcoin digital currency to fund work and gain revenue died a quick death

If the current mantra for junior and mid-cap miners seeking financing is to“get creative,” Vancouver-based Alix Resources Corp. (TSX-V:AIX) gets credit for trying to be the most creative of all.

Last November, company CEO Michael England announced that Alix, which at the time had early-stage properties in B.C., Alaska and Arizona, was going to use bitcoins to pay service providers for exploration work at its Windy tungsten property in B.C. and also launch its own bitcoin exchange to provide a stream of revenue for the business.

Bitcoin, an innovative peer-to-peer digital currency, has been making plenty of headlines and modest inroads in commercial transactions of late. It appeals to users because it lets them avoid banking fees when paying for services or transferring money overseas. Thus far, while extremely volatile, bitcoins have appreciated significantly in value over time, also leading some to buy them as an investment. Bitcoin exchange operators, meanwhile, can make money charging modest transaction fees—and that aim was at the heart of Alix’s plan when first announced.

Alas, it seems the mining market—or perhaps regulators or the company itself—isn’t quite ready for bitcoin. A week after Alix’s initial announcement, it said it was postponing its plans to launch a bitcoin exchange pending further research, but that it would still use bitcoins to pay service providers on its Windy project. Then, in mid-January, Alix announced the sale of its stake in its Golden Zone Alaska project to “have a more directed focus” on its Windy tungsten project in B.C. In other words, it was employing a more common industry tactic to finance work on its core property.

Lest anyone not understand the significance and implications of the move, in the same news release, in a single sentence, the company said it “has determined to not proceed with its bitcoin initiatives.”

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