objective capital global mining investment conference - closing keynote: michael lynch-bell

London Global Mining Investment Conference

Stationers Hall, London

Wednesday 30th September 2009

www.ObjectiveCapitalConferences.com

16.50 Closing Keynote“Impact that borrowing during the latest cycle has had on the mining & metals sectors”

Michael Lynch-Bell

Head of Mining

Ernst & Young

http://www.objectivecapitalconferences.com/

It’s the fundamentals……Global Mining Investment Conference

30 September 2009 Michael D Lynch-BellGlobal Transaction Leader

Mining & Metals Ernst & Young LLP

+44 (0)20 7951 [email protected]

mailto:[email protected]

The wall of debt

Global Mining Investment Conference3

► The events of the second half of 2008 were sudden, severe and unexpected. The mining sector was hit hard. 2009 has seen some recovery, particularly in commodity prices, but valuations remain a long way from peak levels.

► Increasingly there appears to be light at the end of the tunnel. Fear for survival has largely eased, giving way to a desire to control costs and become ‘fitter’ for a challenging period of global recovery.

► But what damage has been caused by the over-borrowing ahead of the most recent commodity collapse?► How many years of supply growth have been lost through development cuts?► Will the ‘borrowers’ ever catch up with those now sitting on cash?► How long before the return of mega-mergers, or indeed mass-scale M&A?

The wall of debt


► Ernst & Young has completed research to understand how borrowing in the sector has changed over the last 30 years:► How has the absolute level of debt changed?► What is the relative level of gearing now compared with 30 years ago?► What proportion of financing has been raised through debt rather than equity?

► We took a sample of 63 listed mining and metals companies:► Covering the period 1980 through to 31 December 2008► In any given year the sample provides at least 35 data points ► The sample represents companies from across the globe with particular focus on

UK, US, Canada, South Africa and Australia

► All data has been adjusted to real terms using the US CPI index

EBITDA – 1980 to 2011F


► Total EBITDA for our sample topped $124bn in 2007, as the most recent commodity cycle hit its peak

► Since this peak, EBITDA fell to $111bn in 2008 following lower commodity prices in Q408. The full year effect of the downturn is predicted to drive EBITDA down to $80bn in 2009F per consensus forecasts

Source: Ernst & Young, Worldscope via Thomson Datastream. Forecasts are Reuters consensus estimates, via Reuters Knowledge

Net debt in real terms – 1980 to 2011F


► Net debt for the sample was $182bn in 2008, an increase of $75bn (70%) over net debt in 2007 ($107bn) and equivalent to 1.47x Prior Year EBITDA

► In real terms, net debt rose at an annual rate of 5.2% between 1980 and 2003, compared with 25.0% for the period 2003-2008


YoY movement in net debt – 1980 to 2008


► This trend is even more apparent when the data is shown as year-on-year movements► In real terms, total increase in net debt was $22.4bn from 1980 to 2007► During 2007 and 2008, the increase was over $150bn

► BUT equity was not raised to anywhere near the same level as debt


Funding the future: Capex


Dividend and Capex as % of EBITDA

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

19

80

19

81

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

► Dividends paid during the period 1980-2008 have been relatively stable for our sample at around 20% of EBITDA. This is expected to tail off significantly in 2009 with many companies already reporting a dividend freeze

► Capex varies significantly, being the first cost to be cut during difficult times but invested heavily during periods of economic growth. Interestingly, the relative level of capex spend to EBITDA was lower during the most recent cycle than previously

Capex

Dividends

Source: Ernst & Young, Worldscope via Thomson Datastream

Funding the future: Acquisitions


► But what about acquisitions?► In the three years 2006-2008, the cash consideration for acquisitions was very similar

to capex spend for our sample at around $160bn► However, our research suggests that during this period there has been a strong trend

to finance acquisitions through debt rather than equity.

Aqcuisition finance - consideration split

50.0%

79.0%

96.0%

50.0%

21.0%

4.0%

0%

20%

40%

60%

80%

100%

2006 2007 2008

Equity

Cash

Source: Ernst & Young

The US$ and LME metals index, 2003-2009


►The US$ abruptly changed direction in July 2008

►The metal prices then fell disproportionately

Source: Ernst & Young, Thomson Datastream

The slow rise and fast fall


►Over H2 2008, the major mining indices plummeted to 2005 levels.

►Since January 2009, the LME metals index has recovered by over 60%


Copper – LME stocks and prices since 1994


►LME copper stocks being drawn down by Chinese buying


Copper supply and demand in recessions


Recessionary periods

Source: ICSG, Ernst & Young

FTSE sector price/earnings ratios

At 31 January 2009:

FTSE Industrial Metals

9.19

FTSE All Share 8.70

FTSE 100 8.51

FTSE Mining 3.85


At 25 September 2009:

FTSE All Share 17.44

FTSE 100 16.36

FTSE Industrial Metals

16.02

FTSE Mining 9.87


Key mining indices in 2009



Conclusions – Supply/demand imbalance


► Repaying the significant level of debt currently held will curtail production growth and supply in the short to medium term:

► Capex has been cut significantly – the first casualty of reduced profitability► Exploration spend has been drastically reduced both by majors and juniors► Rising cost of debt and increased volatility of metals prices has resulted in a higher hurdle

rate for new projects► Even if approved, financing new development is a major obstacle

Supply will be constrained and unable to meet demand in the medium to long term, resulting in a significant increase in commodity prices during the next upturn

Conclusions – A return to equity finance


► Debt, rather than equity has been the foundation of both M&A and project finance during the most recent cycle

► There have been a number of equity raisings over the last 6 months, but management are reluctant to issue new shares at significant discounts

► Whilst the corporate bond market has been tapped, it is proving expensive and, ultimately is only deferring the problem to a later period

Equity raisings will become more prevalent, with a particular emphasis on strategic investments and financing of individual projects via IPO or partnership

If not, a divide will quickly emerge between those with leveraged balance sheets and those with financing capacity

Conclusions – Smarter M&A


► Just under 2,000 transactions were completed in ‘07/08, totalling over $338bn despite a number of ‘mega’ deals being abandoned

► Going forward the key drivers for transactions still exist:► Unlocking of synergies even more relevant given recent margin squeeze► Long term demand fundamentals are strong, with supply increasingly being curtailed ► Portfolio of undeveloped assets can often be better unlocked on a combined basis

► Clearly those with strong balance sheets will be at an advantage, but so too will the sophisticated acquirers:► Increased number of paper transactions► Sovereign Wealth and Private Capital► Strategic partnerships► Initial Public Offerings► Asset swaps

But doing deals will be harder given reduced availability of debt and a reluctance to sell

Things are never as bad as they seem(ed)

30 September 2009 Michael D Lynch-BellGlobal Transaction Leader

Mining & Metals Ernst & Young LLP

+44 (0)20 7951 [email protected]

Harper Lee inTo Kill a Mockingbird

mailto:[email protected]

Our views and opinions


Disclaimer

This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research, or the exercise of professional judgement. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor.


London Global Mining Investment Conference

Stationers Hall, London

Wednesday 30th September 2009

www.ObjectiveCapitalConferences.com

Michael Lynch-Bell

Head of Mining

Ernst & Young

Michael Lynch-Bell is responsible for leading both Ernst & young’s Mining & Metals team across EMEIA and its global Mining & Metals transaction advisory services team. Mr Lynch-Bell has spent over thirty four years in the firm specialising in the provision of services to the extractive industries sectors and has worked with most of the firm’s extractive industry sector clients in many different parts of the world.

He is Chairman of the ad hoc group of experts to the United Nations Framework Classification Committee on Reserves and Resources and is on the advisory panel to the IASB’s Extractive Industries Project.

http://www.objectivecapitalconferences.com/

objective capital global mining investment conference - closing keynote: michael lynch-bell

Economy & Finance

mining sector

debt source

listed mining

major mining indices

thomson datastream

consensus forecasts

absolute level of debt

capex dividends source