jeremy beer, ernst & young:alternative strategies to finance projects in the current economic...

Alternative strategies to finance projects in the current economic climate Jeremy Beer

Mining South Australia – November 2013

Macro and micro factors united against the sector in 2012 ...

Impact

► Squeezed margins

► Share price volatility

► Sub-optimal returns

Macro

► Economic uncertainty

► Volatile markets

► Resource nationalism

Micro

► Weaker metals prices

► Labor unrest

► Cost inflation/overruns

A “risk-off” capital strike

► Slowdown/Cutbacks in capex

► Smaller, “safer” M&A

► Focus on capital optimization

► Capital recycling through divestitures

Companies: slower spending

► Risk aversion

► Retreat of traditional capital providers

► Emergence of private and strategic investors

► Increased funding innovation

Investors: selective investing

... perpetuating a two-tier capital environment ...

Record bond proceeds as % of capital

raised

Tightened equity on highly dilutive terms

Bank debt reserved for quality

names/refinancing

▼

▼

▲

Capital raising by asset class: proceeds (2007–1H 2013)

► Constrained capital for junior and mid-tier companies

► Unique opportunities for the investment grade producers

0

50

100

150

200

250

300

350

2007 2008 2009 2010 2011 2012 1H 2012 1H 2013

Pro

ceeds $

b

IPOs Follow-ons Convertible bonds Bonds Loans

Source: EY, ThomsonONE

- 100 200 300

2008

2009

2010

2011

2012

1H 2013

Other Asian debt Bonds - Top 6 Loans - Top 6

A new capital era

T6/majors = top six global diversified miners. Source: Ernst & Young, ThomsonONE

Challenging funding conditions for all but the investment grade majors

Capital raising: majors’ proportion of total Debt and equity raising ($b)

Deb

t E

qu

ity

- 100 200 300

2008

2009

2010

2011

2012

1H 2013

Other Top 6 IPOs Top 6 Follow ons Top 6 convertibles

0

50

100

150

200

250

300

350

400

2008 2009 2010 2011 2012 1H 2013

Pro

ceeds $

b

IPOs Follow ons Convertibles

Bonds Loans T6 (all classes)

Unique opportunities

The largest miners borrowing large

Glencore

$19bn of syndicated loans in 2012

Largest ever single tranche A$ bond

(non financial)

Long dated tenors (30 years)

Bonds

Unprecedented investor demand for

high grade issuers

Banks

Maintaining strong relationships with

highest grade borrowers and national

champions

Institutional

Rise of the term loan B market

Second largest covenant-lite loan

Investment grade and larger miners

Sentiment-driven high-yield market — all about timing

► Volatile high-yield markets,

heavily influenced by economic

news flow and sentiment

► Widening divergence between

coupons on high-yield and high-

grade bonds in 2012

► On the cusp of an apparent turn

in the interest rate cycle, fear of

rising interest rates may drive a

change in investor preferences

US$ bond issues by month (proceeds, 2012–1H 2013)

Coupon ranges on US dollar and Euro bonds, by tenor (2012)

0

20

40

60

80

100

-

5

10

15Ja

n-1

2

Feb-1

2

Ma

r-12

Apr-

12

Ma

y-1

2

Ju

n-1

2

Ju

l-1

2

Aug

-12

Sep

-12

Oct-

12

Nov-1

2

Dec-1

2

Ja

n-1

3

Feb-1

3

Ma

r-13

Apr-

13

Ma

y-1

3

Ju

n-1

3

MO

VE

ind

ex

Bo

nd

pro

ce

ed

s $

b

Proceeds MOVE*

Source: EY, ThomsonONE, Thomson Datastream

*MOVE: Merrill Option Volatility Estimate index

Emergence of non-traditional investors

► Retreat of traditional capital providers from higher risk growth projects

► Funding gap that is increasingly being filled by strategic, long-term investors

Project funding options typically utilized in current environment

Development stage Exploration Development Construction Mid-tier producer Major producer

Credit quality Unrated Unrated Unrated/High yield High yield Investment grade

Investor perspective Highest risk,

zero/negative yield

High risk,

uncertain yield

High risk,

high yield

Medium risk,

high yield

Lowest risk,

low yield

Public equity

Farm-ins

Standby equity

Strategic equity

Convertible bonds

US PPM

Streaming

Royalties

Offtake

Development finance

Project finance

Equipment finance

Pre-export finance

Fixed income

Commercial loans

Refinancing

Financing Considerations

Equity Convertible Royalty

Finance

Off-take

Finance

Structured

Loan

Project

Finance

ECA Finance Corporate

Bonds

Corporate

Loan

Summary

IPO, Private

placement etc

Hybrid debt

instrument with

equity component

Financing

provided as

consideration for

the right to a

percentage of

future project

revenues

A form of debtor

financing secured

by an off-take

agreement

Non bank loan

secured against

company’s

assets

Bank loan

secured against

project assets

Debt provided by

export credit

agencies

Non bank debt

security, private

placement,

USPP (144A)

Bank debt

Min Transaction

Size

Transaction

specific

Public US$25m

Private none

Transaction

specific

Transaction

specific

Transaction

specific

US$10-15m US$20m US public bond

US$250m

USPP US$25m

None

Timing

IPO 3 months,

placement 2

weeks

Public 4 weeks

Private 8 weeks

4-10 weeks 8-12 weeks 6-12 weeks 3-6 months 6-12 months 3-6 months 4-10 weeks

Advantages

Flexible

structure

Short prep

periods

Lower interest

coupon than

vanilla debt

No covenants

Less dilutive

than equity

Negotiated

bilaterally

Flexibility

Limited

refinance risk

Off balance

sheet financing

Long term

demand

secured

Leverage off-

takers’ credit

profile

Straight

forward

process

Structural

flexibility

No dilution

Non recourse

Relatively

cheap

Easy to

restructure

Relatively

cheap

Long tenor

Provides

liquidity

Depth of

market can

fund large

transactions

Majority of

deals

unsecured

Non amortising

Relatively

cheap

Straight

forward

process

Long term

financing

relationship

Considerations

Potential

dilution

Deep discounts

given weak

market

conditions

Cashflow

required to

service coupon

Public bond

requires min

market cap of

$250m

Can prove to

be costly

In effect

increases

project costs

Financiers

require “hell or

high water” off-

take

Risk premium

payable to off-

taker/discount

pricing

Complex

financial

structures

Can include

warrants

Strict covenants

Lengthy DD

and docs

process

Commodity

hedging

Long time to

execution

Not flexible

once

established

Availability

linked to

exports

Credit rating

preferable

More

expensive than

bank debt

Lengthy DD

and docs

process

More

covenants than

bonds

Amortisation

required

Alternative Funding Examples

Glencore Offtaker Finance

• Precious and base metals junior

miner (mkt cap ~A$70m)

• Financing package (Nov-12)

• A$3m Equity Placement

• A$70m Converting Notes

• A$85 Debt Facilities

• Life of mine base metals offtake

with Glencore

• Glencore as project partner

(technical committee & board)

• DFS completed on the Hera project

• Structural highlights

• No hedging requirements

• Financial flexibility (YTC

conversion option)

US Term Loan B Financing

• Australia iron ore producer (mkt cap

~A$1.2bn)

• Financing package (Dec-12)

• US$275m term loan

• A$50m RCF

• First debt facility Atlas has raised,

historically funding operations with

equity and cash flow


• “Covenant lite” (no earnings

based maintenance

covenants)

Sandstorm Royalty Finance

• Junior gold miner (mkt cap

~CAD$18m)

• Financing package (May-12)

• US$7.5m upfront cash

payment for granting of

royalty

• US$0.5m share subscription

• Pre-feasibility study completed on

the Coringa project


• 2.5% royalty on the Coringa

gold project

• 1% royalty on the Cuiu Cuiu

gold project

Moving up the curve

Value

A

B

Stage of Development

Exploration Scoping Pre-feasibility Feasibility Development Operational

Cost of Funding Equity dilution

20-25%

Likely to include equity component

15-25%

May include equity component

15-20%

May include equity component

Base rate +

300-800bpsVarious

Direct comparison of funding structures is often complex across equity, royalty and hybrid and fixed

interest instruments

Pricing feedback from investors compared to stage of development

Instrument Comparison

Current

Share Price

(A$[])

Equity A$[] VWAP +

[]% Premium

Convertible Note (A$[]m) Evaluation

Upside Price

Scenario

>A$[] p/s

► New shares as % of prior

shares outstanding: []%

► No. shares Issued @

A$[] placement price: []m

A$[] VWAP

Inc. Premium



► No. shares issued on

conversion : []m

In an increasing share price scenario,

the CN is more dilutive despite

exercise price > equity raise price.

This is driven by the fees and interest

which results in an increased CN

facility size to achieve net A$[]m

funding

Downside

Price

Scenario

A$[] p/s





A$[] VWAP

Inc. Premium



► No. shares issued @ A$[]

equity raise given no

conversion: []m

In a decreasing share price scenario,

the CN is more dilutive given the

requirement to raise equity to repay

the CN at the decreased price

Flat price

scenario

A$[] p/s





A$[] VWAP

Inc. Premium



► No. shares issued on A$[]

equity raise given no

conversion: []m

Where the share price at conversion is

between the equity raise price and the

CN exercise price, the relative

attractiveness is determined by the

scale of the CN fees and interest vs.

the premium to VWAP at which the

exercise price is set

Convertible note vs. equity raising example

► Retrospective analysis of the shareholding that is required to be sold to achieve net funding in each option

► Interestingly, the equity raising was likely to result in lower relative dilution in all share price scenarios

In focus: Alternative sources of finance

Royalty agreements

The provision of an upfront payment to the mining

company in return for future payment, typically based

on either a) a percentage of the value of the product

produced or b) the profits or revenues generated from

the mine. Royalties are most frequently granted over

precious metals, but there are no limitations.

KEY PROVIDERS

► Royal Gold (Nasdaq/TSX) – one of the oldest royalty companies,

also becoming active in streams (e.g., Thomson Creek); 83% of

2013–15 revenues precious metals, 17% base metals; 76% from

royalties, 24% from streams; 36 producing and 22 development

stage assets

► Franco-Nevada (TSX) – 2012 revenues: royalties – revenue-based

45%, profit-based 10%, 45% streams; 75% gold, 14% PGMs, 10%

O&G, 1% base

► Premier Royalty – newest royalty company to emerge; 60% owned

by Sandstorm Gold; NSRs on operating and exploration assets

(gold)

► Anglo Pacific (LSE) – established royalty provider with 21-strong

portfolio of producing, development and early stage royalties;

diversified exposure to coal (53%), iron ore (21%), gold (11%),

chromite (4%), uranium, copper, nickel, PGMs and others

► Callinan Royalties (TSX-V) – 1 producing (Hudbay), 2

development and 14 exploration assets

► Americas Bullion Royalty (TSX) – precious metal royalties and

streams; 32 agreements, including Barrick Gold; able to receive

payments-in-kind (bullion instead of cash)

► Royalco Resources (ASX) – ASX’s only royalty company; nine

royalties in Aus and NZ (petroleum, silver and gold); and royalties

on exploration projects in the Philippines (gold/copper) and Uganda

(gold)

► Gold Royalties Corp (TSX-V) – relatively new entrant; NSR

structures on early stage and producing mines in Canada; royalties

on nine mines (as at June 2013)

Royalties typically take the following forms:

► Gross revenue – right to a fixed percentage of gross revenue

on metals sales

► Net smelter return – right to a fixed percentage of net revenues

(gross revenues less treatment, refining and freight charges –

i.e., cash flow that is free from any operating and capital costs

or environmental liabilities)

► Net profit interest – right to a fixed percentage of the profits

from an underlying asset. Terms vary but royalties are

commonly payable after the recovery of certain pre-production

costs and typically deduct mine site operating and

administrative costs plus tax.

► Typically registered to the underlying property title, giving

priority over creditors in financial distress

► Long-term, passive investments – no commitment to fund

capital or operating costs

► A large degree of flexibility can usually be built into contracts

► Normally limited to between 2% and 5% of a project’s net

revenue after certain charges

► Costs are usually limited to legal fees in drawing up contract

terms; no hedging requirement.

► Royalties can change hands among (be acquired by other)

royalty providers.

Mid producer Maj. producer

Construction Advanced

Early

Standby equity

Key providers to mining industry:

► YA Global (Yorkville Advisors)

► Darwin Strategic (Henderson Global Investors)

► Dutchess Opportunity Cayman Fund (Dutchess Capital Management)

Example:

Company X agrees a $5m SEDA facility with Provider Y. CX may draw down these

funds over a period of up to three years, in exchange for the issue of shares to PY

at a discounted price (5% to market price during a 10-day drawdown period), with

the maximum advance by PY linked to share trading volumes. A fee of $150,000,

payable to PY on first drawdown, secures the facility.

Benefits for the company:

► Is in control of the timing – funding can be drawn when needed

► Provides level of comfort over availability of near-term funding

► Eliminates the need for roadshows to bankers and investors

► Allows companies to set a price floor to each tranche

Drawbacks:

► Can be lengthy and expensive to set up, depending on

regulatory environment (structures differ according to market)

► Setup costs

► Drawdown can negatively impact share price – dilution of

existing shareholdings usually includes a purchaser discount

Recent deals:

Standby equity (a.k.a. equity line, equity-linked) facilities provide

companies with an option to issue shares to a facility provider over

a multi-year time period, giving companies assurance of a future

buyer of shares and the flexibility to choose the timing of the

issuance. There is no upfront capital injection but there may be an

arrangement/security fee.

The equity provider commits to purchase a pre-established dollar

amount of a company’s shares in a series of drawdown at the

option of the issuer. The purchaser is committed for a fixed period

to buy the securities. The issuer has the ability, but not the

obligation, to sell the shares. There are normally no penalties for

inactivity or termination of the agreement.

There are also SEDA-backed loan facilities whereby the borrowing

company has the option to convert outstanding loan amounts into

ordinary shares for the SEDA loan provider. Some providers also

offer equity-linked promissory notes – short-term upfront capital

injection (usually 90-180 days), repaid with cash from operations or

funds drawn from the associated equity agreement.

Provider Company Value Type

Dutchess Baobab Resources

Sunkar Resources

£17m

£10m

Equity line facility

Equity line facility

YA

Global

Red Rock Resources

ECR Minerals

Kibo Mining

Conroy Gold

Strategic Minerals

Shanta Gold

£3m

£2.75m

£3m + $1.5m

$5m

Financing package

Financing package

Stock purchase agreement

SEDA

SEDA+ Loan

Loan

Darwin Horizonte Minerals

Altona Energy

Noventa

Orogen Gold

Sunrise Resources

DiamondCorp

Ortac Resources

£8m

£2m

£5m

£5m

£3m

£10m

£20m

Equity finance facility









Early

Offtake agreements/ pre-export finance

Offtake agreements typically comprise payment for a determined

volume or percentage of production over a determined time span,

often with exclusivity attached. Typically provided by customers,

traders and specialist finance providers.

Terms vary significantly from deal to deal. Some offtake

agreements are required components of funding facilities (debt or

equity), securing advance payments or used toward repayment or

arrangement of the financing. Offtake-linked loans typically require

some form of security over the assets or company.

Pre-export financing is secured against determined production

volumes, though additional security may be required to account for

production/supply risks.

Offtake prices are usually market-linked, and sometimes

discounted. Offtakes provide a guaranteed source of revenue for

the project, which can help secure other sources of finance.

Type Offtaker Company Advance Type

State-

backed

buyers

►Tongling

►Sinosteel

►Yunnan TCT

►Nautilus Minerals

►Kaboko Mining

►Sirius Minerals

-

-

-

►Take or pay

►Exclusive take

►Fixed tonnage

Private

capital

►Red Kite

►Allied Gold

►Nevada Copper

►EMED Mining

►Augusta Res.

►$80m

►$200m

►$80m

►$83m

►Loan repayment

►Loan

►Equity + loan

►Loan

Banks ►Stand. Chart. ►Archipelago Res. - ►Exclusive take

Customers ►Tiffany’s

►Wolfram Bergbau

►Tata Steel

►DuPont

►Sinosteel

►Yara Int’l

►Toshiba

►DiamondCorp

►Wolf Minerals

►Northern Iron

►Base Resources

►Kaboko Mining

►IC Potash

►GoviEx Uranium

►$6m

►$75m

-

-

-

►$40m

►$40m

►Term loan

►Loan

►Long-term offtake

►Purchase

►Take or pay

►Equity

►Convertible

Commodity

traders

►Noble

►Glencore

►Trafigura

►JP Morgan

►Samsung

►Kaboko Mining

►Bellzone

►OceanaGold

►Straits Resources

►Amara Mining

►$10m

►$15m

-

►$98m

►$20m

►Loan

►Early payment

►Purchase

►Upfront payment

►Loan

Typically comprise any of the following:

► Pre-production advances in return for future offtake in form of:

► Equity stakes

► Loans (interest- and non-interest-bearing)

► Convertible bonds

► Exclusive right to purchase production at a determined price

(which is usually index/market linked)

► Built-in options to extend – based on mutual consent

► Take or pay agreements (purchase product or pay a penalty)

► Additional marketing/distribution terms

► Some minimum stipulations are common:

► Minimum volume of offtake over agreed period of time

► Minimum price in volume-based offtake contracts

► Hedging to protect against volatility

Recent deals:



Early

Development finance

Development Finance Institutions (DFIs) (or multi-lateral

development banks) provide credit in the form of higher

risk loans, equity stakes and risk guarantee instruments

to companies investing in developing countries.

In principle, DFIs can accept higher project and country

risk than commercial banks, but borrowers must

demonstrate their commitment to benefitting the host

nation, and compliance with high environmental, social

and transparency standards.

Typical funding structures

► Provide a variety of investment instruments – e.g., senior

debt, subordinated debt, equity and convertibles

► Usually invest at BFS (post-DFS) stage

► Usually invest in base, precious or industrial minerals, but

recent investments also seen in diamonds

► Follow stringent environmental and social standards –

and under public scrutiny over their mining investments

► Frequently come with ancillary value-add services, such

as environment and social (E&S) risk management

advice, community engagement strategies

► Can be a more costly source of funding than other

alternatives

► Represents vote of confidence/recommendation, which

lends support to future financing opportunities

Key recent investments by DFIs in the mining sector:

DFI Company Project Value Type

IFC ►Oyu Tolgoi

►Unigold

►Finsch Diamond Mine

►Hummingbird Resources

►Sama Resources

►Guyana Goldfields

►Copper, Mongolia

►Gold, Dom. Rep.

►Diamonds, S. Africa

►Gold, Liberia

►Nickel, Cote d’Ivoire

►Gold, Guyana

►$400m

►$12m

►$25m

►$9m

►$1m

►$10m

►Loan

►Equity

►Loan

►Equity

►Equity

►Equity

China

Dev’t

Bank

►MMG/China Minmetals

►Gindalbie Metals

►Generaly Moly

►Zijin Mining

►SLZ, Australia

►Iron ore, Australia

►Molybdenum, US

►Investm’t/acq’n

►<$1b

►$250m

►$665m

►$4.9b

►Loan

►Loan

►Loan

►Loan

EBRD ►Dundee Precious Metals

►Coal Energy

►Oyu Tolgoi

►Lydian International

►Hambledon Mining

►Gold, Bulgaria

►Coal, Ukraine

►Copper, Mongolia

►Gold, Armenia

►Gold, Kazakhstan

►$67m

►$70m

►$400m

►$45m

►$30m

►Loan

►Loan

►Loan

►Equity

►Loan +

equity

IDCSA ►Scaw Metals

►Sedibelo Platinum

►DiamondCorp

►Village Main Reef

►Metals, South Africa

►PGMs, South Africa

►Diamonds, S Africa

►PGMs, South Africa

►$340m

►$328m

►$28m

►$15m

►Equity

►Equity

►Loan

►Loan



Early

EY Capital & Debt Advisory

The Capital and Debt Advisory Group advises clients across the capital spectrum in a broad range of debt

transactions

► We provide objective and independent advice to our clients who are typically pursuing

► We are a core part of Ernst & Young’s broader corporate finance business. Our product excellence is supported

by exceptionally strong sector coverage capability and where it adds value, we are able to bring the wider service

offerings of Ernst & Young to the situation, including transaction tax, specialist modelling and due diligence teams

► Our approach is flexible, from leading a debt raising to advising from the sidelines. Typically we undertake a two

phase approach to ensure the debt structure and funding sources match your needs, as follows:

► Transaction financing / acquisition financing

► Refinancing

► Debt capital markets issues

► Structured financings

► Growth capital

► Debt restructuring

► Credit ratings advisory

► Cross border financing

Assessment of

Objectives Options Appraisal

Process

Preparation and

Market Sounding

Formal Process &

Execution

“Objective and independent funding advice, excellence in executing transactions and

access to a local and global network of banks, financiers and investors”

Contacts

Jason Lowe

Executive Director, Joint National Head of Capital & Debt Advisory

Tel: +61 3 8650 7600

Mobile: +61 412 699 778

E-mail: [email protected]

Jeremy Beer

Associate Director, Capital & Debt Advisory

Tel: +61 3 9288 8717

Mobile: +61 413 976 634

E-mail: [email protected]

Thank you

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About EY’s Global Mining & Metals Center

With a strong but volatile outlook for the sector, the global mining and

metals sector is focused on future growth through expanded

production, without losing sight of operational efficiency and cost

optimization. The sector is also faced with the increased challenges of

changing expectations in the maintenance of its social license to

operate, skills shortages, effectively executing capital projects and

meeting government revenue expectations. EY’s Global Mining &

Metals Center brings together a worldwide team of professionals to

help you succeed — a team with deep technical experience in

providing assurance, tax, transactions and advisory services to the

mining and metals sector. The Center is where people and ideas come

together to help mining and metals companies meet the issues of today

and anticipate those of tomorrow. Ultimately it enables us to help you

meet your goals and compete more effectively.

© 2013 EYGM Limited.

All Rights Reserved.

EYG no. ER0107

ED None

This material has been prepared for general informational purposes only and is not intended to

be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for

specific advice.

jeremy beer, ernst & young:alternative strategies to finance projects in the current economic...

Economy & Finance

constrained capital

capital raised100

high yieldmedium risk

high yieldlowest risk

tightened equity

twotier capital environment

zeronegative yieldhigh

uncertain yieldhigh