Mine Africa - Surviving the Global Financial Crisis in the Mining Sector

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Surviving the Global Financial Crisis in the
Mining Sector Strategies for Junior and
Mid-Market Companies
Daryl J. Hodges Senior Managing
Director Investment Banking
28 February 2009
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Monday September 29th, 2008
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and More Recent Headlines (Feb 27th, 2009)
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Credit Freeze Financial Crisis Markets
Reaction
Apr-July 2008 Certain Markets and Commodities
Make New Highs Small Caps Left out of the Rally
Jan 2008 The First Major Sell-Off in the Eq.
Markets Fed Slashes Rates in Emergency Meeting
Sept Oct 2008 Lehman Fails, AIG Bailed Out/
TARP Passes After First Being Rejected, Panic
Takes Over
Feb 2009 Nov 2008 Lows Retested
Aug 2007 Credit Crunch News Hits the Eq. Markets
Mar 2008 Bear Stearns Fed Brokered Deal
Aug 2008 A slew of Negative News Hits the
Markets Freddie Fannie
Source Bloomberg Financial Markets
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Liquidity Crisis Different Toll on Different
Metals
Source Metalprices.com
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Light Crude Oil (CL, NYMEX)

• After an all-time high of US 147.27 in July
  2008, oil has fallen under US 40.00 by January
  2009 prolonged recession expectations coupled
  with US appreciation fuelled the dramatic fall
  in crude prices
• If and when the global economy starts to recover,
  too many dollars chasing too few barrels will
  only lead to much higher oil prices

Source NYMEX
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Equity Capital Markets 3 Year Review

• Over the last 3 years, Global, Mining and
  Canadian Equity Issuance very strong
  exception 2008
• While the overall global equity sales dropped
  significantly in 2008, it seems Mining issues,
  while lower, held better than the overall markets
• 1st half of 2008 saw decent volumes on Iron Ore,
  Potash and Coal financings
• 2nd Half of 2008 NO IPOs on the TSX

Global Equity Markets
Equity Markets - Mining
622.8B raised 3,283 Issues
209.7B raised 365 Issues
556.6B raised 3,095 Issues
194.9B raised 232 Issues
377.9B raised 1,325 Issues
118.4B raised 312 Issues
21.5B raised 44 Issues
19.3B raised 184 Issues
14.7B raised 74 Issues
Source Bloomberg Financial Markets
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High-Yield Debt Markets 3 Year Review

• High-Yield Global Debt Markets saw a sharp drop
  in 2008 from 2006, 2007 levels
• Canadian and Mining specific deal were somewhat
  more resistant to the downturn

Source Bloomberg Financial Markets
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Equity Capital Markets 2009 YTD

• Over the past few months - global mining stock
  raised more than US 34B in fresh non-bank cash
• Largest chunk of that US 19.5B
  RioTinto-Chinalco deal (US 7.2B convertibles,
  plus US 12.3B in assets/ equity stakes)
• Gold and Silver stocks very well received
• Capital raising by Gold stocks mainly by way of
  bought deals almost US 4.0B
• CURRENT PRODUCERS
• Newmont Mining Corp US 1.7B public offerings of
  34,500,000 shares and US 517.5M principal amount
  of 3.00 convertible senior notes due 2012
• Kinross Gold Corp US414M
• Silver Wheaton Corp C287.5M
• (ADVANCED) DEVELOPERS
• Osisko Mining Corp C402M
• Great Basin Gold Ltd C125M
• Uranium
• Cameco Corp C400M
• First Uranium Corp C61.5M

Deals not closed as at Feb 27th, 2009 Source
Bloomberg Financial Markets
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Liquidity Crisis Different Toll on Different
Securities
Recently Filed for Bankruptcy
Recently Announced Very Dilutive Equity Financing
Ongoing Sale of Noncore Assets, Re-negotiating
Debt Covenants, Layoffs
Performed Rather Well, Recently Announced Equity
Financing
Source Bloomberg Financial Markets
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Junior Natural Resources The 2008 Meltdown

• First half of 2008 tough credit, softening
  commodities
• Volatility and liquidity trading volumes
  declining and share prices falling
• Deal flow showed a sharp decline, transactions
  were closing under issue price
• Second half of 2008 financial collapse, plunging
  oil and copper
• Trading volumes dried up, sellers wanted out -
  immediately
• Selling down on positive news as increased
  volumes provided a liquidity window
• Traditional investors, retail and institutional,
  fled the market to cash
• Resource equity financings become nearly
  impossible
• Debt market activity shrinks to lowest level in
  over a decade
• Result share price collapse, severe treasury
  drain on junior companies
• First 2 months of 2009
• Gold is in favour
• Base metals still struggling

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Where Are We Now?

• Dont get a false sense of security from the
  recent uptick - the panic may be over (Recall
  98-03)
• Treasuries are drained, money is scarce
• Shares trading at rock bottom prices, they have
  rebounded slightly
• Industrial commodities at low prices again
• Precious metals weak, but gold and silver is
  starting to look attractive as the US dollar caps
• Producers balance sheets under increasing
  strain start-ups struggling
• Risk re-pricing analysts and investors
  re-rating companies target prices dropping
• Bankruptcy protection for some, extreme dilution
  for others
• Risk re-rating caused perceived risk to move up
  market
• Bank stocks and insurance companies are
  considered risky credit ratings are dropping
• Juniors resource developers are excluded from
  many portfolios
• RESULT For many, the cost of capital is the
  highest we have seen it
• Given the chaos in global markets, and the
  ongoing freeze in debt markets, mining companies
  are deploying conventional and unconventional
  ways of raising fresh capital

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And the Casualties are Starting to Pile Up

• First Metals Inc. Files Notice of Intention to
  Make a Proposal Under the Bankruptcy and
  Insolvency Act (January 2009)
• Adanac Molybdenum Corporation to Evaluate
  Strategic Alternatives Under CCAA Protection
  (December 2008)
• Giant metals miner Teck Cominco cuts 1,400 jobs
  A big concern surrounding Teck is its ability
  to pay off nearly 10 billion in debt it incurred
  with the purchase of Fording last fall. This
  includes a 4-billion term loan and a
  5.8-billion bridge loan. (Globe and Mail,
  January 9, 2009)
• Rio Tinto commits to reduce net debt by 10
  billion in 2009 Reduces workforce by 14,000
  (company press release, December 10, 2008)
• Boart Longyear misses earnings, reduced workforce
  by 20
• Anglo American scraps its dividend and cuts
  19,000 jobs worldwide
• Xstratas shareholders to vote its proposed
  4.1bn rights issue next week (Mon) might not
  pass

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The New Cost of Capital Yield and Dilution

• Recent High Yield Debt Issues
• Petaquilla Minerals USD 60 million (October 3,
  2008)
• (initial YTM, not including the warrant sweeter
  17.8)
• Northern Star Mining Corp USD42 million
  (September 11, 2008)
• (initial YTM, not including the warrant sweeter
  22.4)
• Farallon Resources Ltd 25 million (September 3,
  2008)
• (initial YTM, not including the common shares
  attached 15.0)
• Recent Equity Financings
• Yamana Gold Inc 100 million _at_ 6.00/ sh. (3.00
  dilution)
• (52-week range 4.29 to 19.79)
• Semafo Inc. 23 million _at_ 1.20/ sh. (10.00
  dilution)
• (52-week range 0.75 to 1.72)
• Kinross Corp US414 million _at_ US17.25/ share
  (5.00 dilution)
• (52-week range US7.77 to US27.00)
• Osisko Mining Corp C402 million _at_ 4.55/ share
  (54.00 dilution)
• (52-week range 1.40 to 6.29)
• Farallon Resources Ltd 10 million _at_ 0.20/ sh.
  (14.00 dilution)
• (52-week range 0.10 to 0.84)

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Surviving the Downturn

• Two choices
• Hunker down slash spending, husband cash, and
  weather the storm
• Seek creative, or non-traditional, financing
  strategies in the secondary market to continue
  advancing the company, and prepare for the next
  upturn
• Actually, there is only one choice do both!
• High Yield Debt Financing
• Convertible Debentures
• Flow-through Shares
• Off-take Agreements, Strategic Investors
• Royalty Agreements
• Forward Sales
• MA
• Where to Seek the Funds (Who is Providing Funds)
• Requirements
• Deal Structures
• Recent Examples

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Alternative Sources High Yield Debt

• Most commonly issued for project financing,
  situations in which banks not willing to lend,
  or conditions too onerous and time is of essence
• Broad distribution multiple buyers/ lenders,
  can be issued as a private placement or more
  broadly under a prospectus
• Market to a wide cross section of equity, debt,
  and high yield portfolios
• Retail demand strong
• Domestic and international exposure
• Customize to the majority of lenders, no single
  party drives the process
• Debt instrument is secured (commonly) or
  unsecured (rarely), provides a high priced
  coupon, offered at a discount, and often
  accompanied by an equity kicker
• Typically less onerous covenants compared to a
  classic project financing or bank debt
• Full bankable feasibility study not necessary,
  but assurances of success need demonstration
• Metal hedging can take place at a future date, at
  the Companys discretion
• Less onerous reporting requirements reasonable
  financial stress tests
• The high coupon and wide distribution can make
  the situation stressful, if deadlines are
  difficult to meet or the issuer needs to
  negotiate changes to the original deal
• Current conditions leading to extremely costly
  financings difficulty in meeting debt
  obligations
• ALL lenders have become extremely nervous
• Use as a bridge loan until other forms of
  financing are available

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Alternative Sources Convertible Debentures

• Similar application as High Yield Debt,
  Convertible Debentures a hybrid debt equity
  instrument
• Debenture secured and pays a coupon over its
  term
• Conversion feature can convert into shares of
  the company at a future date, usually at a higher
  price
• Distribution investors view convertible
  debentures as a trade off between perpetual,
  low-cost capital (equity) and time-limited,
  costly (high yield) form of capital
• In the current market it reflects both yield and
  dilution components of financing and can reduce
  both slightly
• Terms of coupon and conversion tradeoff between
  expected equity return, liquidity of underlying
  shares, stability of cash flow (if any), and
  security of underlying assets
• In many deals, the short-sellers/ arbs gets
  involved
• Sell short the underlying shares and buy/ go long
  on the convertible security (if the stock rises,
  they convert the bond to cover the short. If not,
  they continue to earn coupon rate)
• As with debt the current market conditions are
  making these products very expensive for issuers
  and the providers are very nervous

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Alternative Sources Gold-Linked Convertible Debs

• Attractive especially to gold companies on the
  cusp of production
• Similar application as High Yield Debt,
  Convertible Debentures a hybrid debt equity
  instrument
• Debenture secured and pays a coupon over its
  term
• Conversion privilege Common Shares or physical
  Gold
• Upon Conversion or Maturity - transfers the
  leverage of increasing gold prices to the
  investor
• With (higher) expected gold conversion, the
  actual coupon might be lower, helping companies
  manage the overall cost, particularly so in the
  pre-commercial production stage
• Also the choice of conversion between shares or
  gold, puts less pressure on a balance sheet,
  therefore reducing the risk of bankruptcy if
  depressed commodity prices continue

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Alternative Sources Flow-Through Shares

• Canadian exploration and certain development
  projects can be funded by FT shares that flow
  the exploration tax deductions, normally claimed
  by corporations, through to investors
• Funds must be spent on specific allowable tasks
  (drilling, surveying, etc) and are thus
  restricted
• Flow through funds, and retail investors main
  purchasers
• Issuer must be a Canadian company, and
• Projects must be in Canada
• Additional provincial tax credits can be
  available
• Not really a new alternative, since these have
  been available off and on for twenty years, but
  traditionally confined to exploration Cos and
  strictly to the ones having Canadian properties/
  assets
• More midcap companies may need to explore this
  avenue for exploration financing
• Deals typically done around year-end but also
  whenever a fund raises capital (which is becoming
  more difficult)
• Pricing is market dependant many companies
  expect premiums, given the tax advantage inherent
• For exploration companies this is often the only
  method of financing
• Many investors buy flow through for the tax
  advantage with no concern for the underlying
  issuer or its project
• The shares often re-enter the market as soon as
  the investor can sell

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Alternative Sources Off-Take / Strategic
Investors

• Mostly done by European, Asian smelter companies/
  or metal trading houses
• The company must have a mining project with
  measurable production expected
• Usually companies get an up-front cash payment,
  plus fixed price on the metals/minerals
• Overseas strong financial partner providing both
  equity/ debt financing, combined with an off-take
  contract, represents pure relationship business
  (essentially important in bear markets)
• Mitsubishi Materials Corp. purchased 25 equity
  interest in Copper Mountain Project (CUM TSX)
  for 28.75m, arranged a 250m project loan, and
  contract to purchase all the copper con from the
  mine for 10 yrs
• Korea Resource Corp (KORES) 30 acq. of Baja
  Mining Corp. (BAJ TSX) for US435m of project
  funding and 30 Off-Take Rights on Commercial
  Terms 30 Completion Guarantee on Project Debt
• Tata Steel Global Minerals purchased 19.9 of New
  Millennium Capital Corp. for 23.5 million and an
  option to acquire 80 equity interest in the DSO
  project, by paying 80 of cost, investing a
  further 300 million in exchange for 100 off
  take
• Trafigura Beheer BV Amsterdam, off-take agreement
  with Farallon Resources Ltd. (FAN TSX)
• Chinalco, Jinchuan and Glencore AG are cashed up
  and currently making strategic investments in
  base metals producers

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Alternative Sources Royalty Sales

• Company gives up a portion of future income or
  revenue stream exchange for current financing
• Usually completed just in front of production,
  but are not unusual on exploration projects
• Often used in early prospector transactions, so
  very important to search for lingering or
  multiple royalties on title, since a royalty is
  most commonly recorded as a lien against a
  property
• Typical royalty Net Smelter Royalty (NSR) of
  2 of the proceeds net of smelting and refining
  charges
• Net Profits Interest (NPI) of 10 to 15 is
  paid after all expenses from operations are
  deducted
• Generally royalties are considered non-dilutive,
  but equity investors are not keen on them, and
  often they do not raise that much money relative
  to the payout stream
• Typical NSR deals would have been struck at
  anywhere between 1.25 to 2.00, recent
  negotiations have started _at_ 2.00, with a
  sliding-scale NSR, that could reach as much as
  3.25-3.50
• Royalty Companies are not very fond on NPIs, even
  though mining companies were willing/ ready to do
  deals in the range of 10-15 NPI participation/
  profit interest
• Recent Transactions
• International Royalty Corp. (IRC TSX) 2.85m
  acq. of additional gold royalties from Barrick/
  Atna Resources
• Franco-Nevada Corp. (TSX FNV) 103.5 m acq. of
  7.29 NSR on the Gold Quarry Royalty Property/
  Nevada
• International Royalty Corp. (IRC TSX) 2.6m acq.
  of additional Skyline Coal Mine royalties located
  in Carbon and Emery Counties, Utah

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Alternative Sources Forward Sales

• Company sells forward portion of future revenue
  stream, usually by-product at a pre-determined
  price, in exchange for current financing
• An excellent way to monetize future minor revenue
  from a project
• Can be made to downstream consumers (i.e.
  smelters), but more recently specific gold and
  silver companies have been purchasers of metal
  from wouldbe or existing producers Silver
  Wheaton, and Gold Wheaton
• Usually completed just in front of production,
  usually done on by product precious metals
• Generally forward sales considered
  non-dilutive equity investors and analysts
  satisfied with them, provided negotiated metal
  prices not too deeply discounted
• Typical gold or silver deals would involve a
  substantial pre-payment in exchange for most of
  metal revenue, with residual revenue stream
• Recent examples include
• Silver Wheaton purchase of Mercator Minerals
  silver stream at Mineral Park US42m
• Gold Wheaton purchase of 50 of FNXs gold,
  platinum and palladium C175m in cash, 350m Gold
  Wheaton shares C50m in Gold Wheaton warrants
• Gold Wheaton purchase of 25 First Uraniums
  2.1m Ozs gold stream C125m in 2 tranches, C75m
  due Feb 27/ 09
• Silver Wheaton purchase of 75 of Farallons
  silver stream from Campo C80m in several
  tranches

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Alternative Sources Mergers and Acquisitions

• Many companies shrunk to puny market caps, well
  below many institutional investors thresholds
• Risk re-rating has resulted in funds drying up
  and a reluctance to finance juniors
• The current order of least to most likely to get
  financed is
• Early stage exploration pre drilling pass the
  hat!
• Pre resource drilling difficult and only
  superb results attracting attention (area where
  good news has caused sales on liquidity)
• Resource drilling and pre production equity
  very difficult, pro-forma economics must be
  robust, must be in safe jurisdiction, will be
  financed by existing investors or value
  investors, debt very difficult, expensive and
  typical plant and equipment are being marked down
  extensively as collateral
• Production can get financed, especially to take
  advantage of vulture opportunities, but capital
  IS expensive (excluding dealer commissions!)
• This is the time for companies to look at
  preparing for next recovery and metal cycle
• Create critical mass that investors will want to
  own
• Those with cash and healthy balance sheets to
  look for opportunities
• Those with weakened balance sheets to face
  reality

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Alternative Sources Mergers and Acquisitions

• What the market wants to see, and how to position
  for that
• Cash on balance sheet find a partner with a
  healthy balance sheet, and be extremely stingy
  with that cash,
• Explorers with good projects should seek those
  trading below cash value
• Limited debt on balance sheet beware of
  leverage, unless its manageable
• Stable cash flow find a partner with robust
  operations, and a track record
• Reduce operating risk make multiple, quality,
  producing assets a priority
• CRITICAL MASS annual production and market caps
• 100,000 oz gold, 5 10 mm oz silver
• 50,000 tonnes copper, zinc, 10,000 tonnes nickel
• 50 million market caps as a minimum
• Growth opportunities find assets that have
  upside, not retreads
• Growth opportunities find quality exploration
  properties
• Strong management find management teams with
  proven success
• Strong board find board members with depth and
  success
• Sell your assets (projects, or future
  revenue/income)
• Sell your company give your investors
  flexibility

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Conclusions

• Funds are scarce and expensive
• Budget with care watch every non-essential
  expenditure, and at a last resort, wind down or
  temporarily close production/ operations
• Consider the financing alternatives suggested,
  how does your Companys profile fit?
• Consider strategic partnerships either with
  private pools of capital (NovaGold) or state
  backed enterprises (Chinalco)
• Merge with or acquire cashed up shells or other
  cash rich(er) companies
• It may be necessary to sell assets, or all of the
  business
• Even with all these different options, some of
  the current juniors will be extinct by the time
  the bottom in equity and commodity markets is over

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