Some $2 trillion is being invested worldwide by private equity funds every
year with a chunk of that destined for junior mining companies. Demand is as
strong as or stronger than ever as investors see a shopping opportunity. Who
is deciding where it goes and based on what criteria? At the annual Fall
Mining Showcase event in Toronto, Red Cloud Mining Capital enlisted the help
of three private equity panelists to answer those burning questions. Cheryl
Brandon, a partner at Waterton Global Resource Management; Dan Wilton, a
partner at Pacific Road Capital Management; and David Thomas, managing
director of Resource Capital Funds, brought their insight. Anthony Vaccaro,
publisher of The Northern Miner, moderated the spirited discussion that shed
light on how private equity investments in junior mining work, the widely
held fear of private equity among CEOs and a surprising level of interest in
junior mining equities by private equity fund investors. What follows is an
edited version of that panel discussion.
Anthony Vaccaro: A few years ago, there was a perception that
private equity was going to come in and wash away the junior sector's worries
about insufficient capital. Was that perception misplaced?
Dan Wilton: The perception was somewhat misplaced. I think people
saw big numbers being raised, $2, $3, $4 billion ($2, $3, $4B) by people like
Mick Davis, but that's very different from what we do. You need to understand
our investors to understand how we invest. It's a different investor base
than you would find in a traditional mining resource fund. Our investors tend
to be big U.S. pension funds or university endowments—not retail investors.
They commit money to us for 10 years, and they're patient. Unless the fund
has a specific mandate to go out and fund exploration—and few of the private
equity funds do—there tends to be a bias toward later-stage asset
development.
Funds like ours are not investing in a portfolio, they're looking to buy
an asset and grow a company. The pool of traditional mining-focused private
equity is smaller than people know. It tends to be focused more on
later-stage opportunities because that's where you can deploy larger amounts
of capital. It's difficult for us to put money out in $1, $2, and $3 million
($1, $2, $3M) increments when you have a $475M fund to invest. When you're
looking to put it into six or seven assets, those numbers get fairly large.
And if you're a $6 or $7M market-cap company and someone offers you $20M,
you'd be amazed at the resistance. People don't want to take the dilution at
these levels, but at some point you have to have a supportive partner. It's a
viable strategy, but most companies don't want to sacrifice the option value.
AV: There is also a perception that private equity firms can
sometimes be ruthless. Is that fair?
David Thomas: It's important to make the distinction between what
Cheryl's, Dan's and our funds do versus the big private equity generalists,
like KKR & Co., The Carlisle Group, and The Blackstone Group. We're a
sector fund, with a "niche-y" investor base, which happens to be
the same as Dan and Cheryl's investor base. Sector funds would be more akin
to a venture capital fund. The bad guys, if you will, would be the bigger,
leveraged buyout funds. Because of the inherently risky nature of the mining
sector, you really don't want to multiply those risks by layering in
financial risk, so Resource Capital Funds (RCF) does not use any leverage
when it's making investments.
AV: What are some of the advantages that mining companies would
garner from working with a private equity firm?
Cheryl Brandon: The mining sector in general has been very retail
investor-based or institutional resource-focused investment funds, not
private equity. As a result, most of the projects are long-dated, meaning
long-term capital. That's one thing that our groups bring to the
table—long-term capital. Our fund lives are 10 years. All the funds here have
large technical groups internally, so we really understand the risks
associated with the underlying projects, and we underwrite as such. When we
are putting an investment into a company we say, "OK, if the company
needs X and they want to do Y, let's come up with a fully financed plan to
create value, so that when the market turns, not only will the company have a
strong, supportive partner, it will also have a project that's much more
advanced." That's the way we look at it.
Back to Dan's point about dilution, a lot of the companies we speak with
don't want to take the dilution at these levels. However, when the commodity
cycle turns, having a strong partner and a project that's further along the
development curve will benefit shareholders.
We all do different types of structures and financings—joint ventures,
asset purchases, equity investments and structured financing. The advantages
are different for each structure.
AV: Dan, what kind of risk profiles are you looking at? How do you
distinguish between later-stage projects?
DW: There's no shortage of risk in this business, so a big part of
our due diligence process is about understanding those geological,
metallurgical, operating, jurisdictional and financial risks. It's a
risk/return business. When we see a risk that we can mitigate, that becomes
part of the funding plan. But our return expectations are higher for
something that has risks we can't control. For example, we have an investment
in Kenya, which is a challenging place to do business, so our return
expectations are higher than they would be for a gold project outside of
Val-d'Or, Quebec, where you don't have the same inherent risks. Private
equity groups have a pretty high tolerance for risk. We're in a risk-seeking
business. We have to take risks to earn upside returns, but I think we have a
better understanding of a lot of the risks that mining companies face. We
have a portfolio of 12 or 15 investments right now and we would tell you that
a lot of people running companies don't have the full appreciation of (the
risks) because they don't necessarily have the benefit of the experience of a
diversified view on a whole range of projects.
DT: An example of this partnership is RCF's history with TMAC Resources
Inc. (TMR:TSE), a junior building the Hope Bay gold mine in Nunavut. TMAC
is one of RCF's larger investments in Canada. BHP Billiton Ltd. (BHP:NYSE;
BHPLF:OTCPK) discovered Hope Bay in the early 1990s and it passed through
different hands before it was acquired by Newmont Mining Corp. (NEM:NYSE) in
2007. TMAC management, the core of the former FNX Mining team (Terry
MacGibbon and his crew), approached Newmont about Hope Bay after the senior
producer put Hope Bay on care and maintenance in 2012. Newmont sold Hope Bay
in exchange for an equity stake in TMAC, which at that point was privately
held.
TMAC raised funds through a couple of different private rounds before
going public. RCF got involved in the later rounds and put a reasonable
amount of cash into TMAC to help it derisk Hope Bay, primarily through
drilling. Hope Bay is a high-grade but "nuggety" gold deposit, so a
lot of drilling was needed to establish confidence in the resource. A lot of
private equity funds will often try to sell down on an IPO, but RCF bought
more stock. The TMAC management team attracted a debt component to the
financing package to build a gold mine in a tough market. Having RCF there as
a strong partner gave the lenders greater confidence.
CB: With a structured-lending investment, we typically don't take
board seats. Essentially, we get an operating report from the company every
quarter that says how the company is advancing the project.
Most of the joint ventures we've done haven't been as the operator, so we
allow the company to operate the asset and have a management committee, of
which we make up a portion and the public company makes up a portion. The
annual budget determined at the beginning of the year says: "This is
what we're going to accomplish and this is what we're going to spend."
We fund a pro rata portion of that budget.
As an equity investor, we recently made a 19.99% equity investment in a
public junior with a project in Nevada. We have one board seat on a six-seat
board and another on the three-member technical committee. As it relates to
corporate decisions, it's ultimately what's best for shareholders. All the
private equity funds here invest using different structures, which I think is
an advantage because we can help shape the investment for what the company
needs.
AV: Tell us about accountability and how that works.
DW: In situations where we're a 25%, 35%, 40% shareholder, a lot of
management teams find it quite different managing a company where you have
one shareholder who really cares. We like to think that we can bring
something to the table, whether it's best practice, free advice or getting
some good technical people in our network to help. One of the single biggest
differences between having a diversified shareholder registry and one large
shareholder that is really vested in your success, is that with that large
shareholder comes a significant degree of accountability.
The reality is management teams should always be accountable to the
smallest shareholder, that's their fiduciary duty. But it takes on a
different meaning when that shareholder or a couple of shareholders are 80%
of your shareholders. The people who really prosper with private equity see
it as positive. It removes a lot of the uncertainty because we generally
don't care about week-to-week. We care about getting good technical work
done, de-risking a project and unlocking the fundamental value of those
resources. If that means shutting down an operating mine for a period of time
if that is the right thing to do, it doesn't bother us. We like to think it's
a real positive, but there is only a limited subset of people running public
companies who see it that way.
AV: How does your group deal with tension when it happens?
DW: It depends on the situation. We have a number of investments
where we're 20% shareholders with a board seat. Frankly, we have found that
to be pretty ineffective because you don't have sufficient influence to
execute change. It comes down to boardroom dynamics.
When you're a majority shareholder, you can speak with a more direct
voice. We had one investment where the management team told us they were
interested in having a supportive, long-term investor, but the reality was
that they weren't. The choice was to sell the stock or change the management
team. It can go in either direction. Generally, if we're not happy, most of
the other shareholders aren't happy either.
AV: A lot of people here are familiar with Pretium
Resources Inc.'s (PVG:TSX; PVG:NYSE) deal with Blackstone Tactical
Opportunities and Orion Mine Finance Group. It's interesting because there's
a debt component, an equity component and a streaming component. Is this an
evolution of the private equity investment model?
DT: Private equity funds pride themselves on being flexible in the
financing solutions that they offer mining companies. This is a perfect
example. These private equity firms worked with Pretium to come up with a
comprehensive financing package. Brucejack is still not fully funded, but to
attract $540M from two investors in this market is extraordinary. Orion has
been doing streaming deals for quite some time but the number of ounces that
are covered under this streaming deal is capped. Royalty and streaming
companies typically want life-of-mine exposure to give them that optionality.
So if you're Pretium management, that's pretty attractive because Brucejack
contains a lot of ounces. You're going to see more of these hybrid deals.
One of the things that I will point out, though, is that these deals
require a certain level of financial sophistication. If you're a CEO of a
mining company and you are considering doing business with a private equity
fund, it's pretty important that your finance team is the "A" team
because there are fairly demanding reporting requirements, and the term
sheets can be complex.
AV: Has RCF done any streaming deals?
DT: We have negotiated some royalties as part of bigger financing
packages, but we have yet to do a stream. There is nothing that would stop us
from doing one, if it made sense. The issue is that streams in the eyes of
some of the ratings agencies are treated as debt and that can be problematic
for insurers.
AV: Cheryl, let's look at the investments that Waterton makes. How
many companies are you looking at? And what are the metrics that Waterton
uses to evaluate companies?
CB: We have a narrow focus. We look primarily at copper or gold
projects in stable jurisdictions, and most of those projects have had capital
invested previously so they have drilling databases. We know all the
projects, whether we've looked at them on a desktop due diligence basis or
done a deep dive (signed nondisclosure agreements and got material nonpublic
information). But for every investment we've made—and we've made about 14
investments in the past 12 months in our second fund—we've looked at about
300. Not all of those didn't move forward because the project didn't check
out—they often didn't move forward because a lot of publicly traded mining
management teams and boards are still getting comfortable with private equity
investors, which is dissimilar to oil and gas. Private equity is in roughly
50% of the oil and gas deals; in mining, that's not the case.
As it relates to metrics, the way retail and standard institutional
investors look at projects is P:NAV or EV:balance or P:cash flow or EV:pound
or EV:resource. Everyone values an asset (net asset value), using the
underlying metal price. We don't. We have a downside scenario where we ask
what happens if gold goes to $900 per ounce ($900/oz) and how are we going to
ensure that our investment is still there at the end of four or five years,
so that we can benefit from the next cycle? We also know that gold could get
to $1,600/oz. It might not happen tomorrow, but it may happen in 2020, so we
ask, what does our investment look like in that time horizon? We actually
underwrite with higher commodity prices. We're OK taking on those risks; we
just need to underwrite them appropriately and make sure that there are no
fatal flaws.
DT: Years ago RCF hired a corporate social responsibility (CSR)
officer to work with its deal teams during due diligence and throughout
investment ownership. Our investment in Noront Resources
Ltd. (NOT:TSX.V), which is in northern Ontario's Ring of Fire district,
is a good example of where the fund spent a lot of time on sustainability
issues, such as project permitting, engagement with First Nations and other
stakeholders including environmental non-government organizations,
communities and various levels of government.
CB: You would never imagine that the mining industry is as
distressed as it is when you meet with investors who allocate to private
equity in mining. We raised our fund in early 2014 and had 10 investors who
had allocated a total of just over $1B. We had no plans to raise another fund
until those investors told us they wanted to double their exposure. So we're
closing another $1.1B next month.
The appetite for exposure to the sector is very high. When investors find
the right team they just want to keep writing checks. They don't want that
money back; they want the money out the door. They understand that now is a
good time to have exposure to the sector. We've had an unbelievable amount of
demand from pension funds and endowment funds that are just cold calling us
to ask, do you have room in your fund? It's a completely different
environment (versus what is happening in the public markets). There's no
shortage of capital available to us. We just need to be able to successfully
allocate that capital to management teams.
AV: Thank you all for your insights.