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May 25, 2016
Mining: The consolidation opportunity
By: Segran Pillay

For some time now, market conditions in the mining industry have been changing, and not for the better. Subsequently mining companies have been forced to explore new business strategies.  For many, mergers and acquisitions (M&A) may be key to surviving, and even thriving, in this difficult environment—leading to a wave of consolidation.

Today’s lackluster market performance is not likely to improve anytime soon. Demand outlook for commodities remains weak. That is largely due to China, which has seen slowing infrastructure investment, and which reported a lower-than-expected Purchaser Manufacturing Index for April1. More broadly, the significant expansion of mining activity over the past decade has created an oversupply in base metals and bulk commodities, which is expected to continue through 2017. At the same time, the US dollar is predicted to remain relatively strong for the rest of the year, making metals more expensive for many commodity consumers. All these factors point to the continuation of weak demand and low prices.

Cost reduction: Required, but insufficient
Faced with that reality, many miners have proactively reduced costs in an attempt to protect profits. However, cost-reduction strategies do not help them cope with the credit-ratings downgrades and reduced ability to generate sustainable cash flows that stem from weak pricing. As a result, miners continue to simplify their assets portfolios and recalibrate their business models through productivity drives, organizational change2, 3 and asset impairments. In an attempt to shore up their balance sheets, many have now acknowledged the harsh new reality of “lower for longer” commodity prices by slashing dividend payments4—and, significantly, selling assets5, 6.

Asset sales are expected to increase in the face of sustained low prices. An analysis of announced and closed M&A deals from 2012 to the present shows that on average, about 23% were corporate divestitures. The share of these type of deals peaked in 2013, accounting for 25.7 percent of the deals (29.0 percent of total value in US dollars). So far in 2016, about 20.5 percent of the deals have been corporate divestitures, accounting for 10.9 percent of total value in US dollars (see Figure 1). Overall, asset sales through divestitures have been consistent, and this trend is likely to continue.

Figure 1: Accenture analysis of corporate divestitures in the mining industry

The appeal of Australia
More divestitures could mean opportunity for miners that have strong cash flows and are in position to capitalize on low valuations of mining projects to acquire lossmaking assets. Australia offers these miners some especially attractive options. The country accounts for about 38 percent of global saleable iron ore, and it is expected to contribute 66.1 percent of new supply through 2020, due to 33 financed projects. Seven of these projects are at risk of being cancelled, delayed, suspended or even divested7 because each has cash costs ($/mt) that are higher than the consensus iron ore price of $45/mt8, 9. What’s more, the three lowest-cost iron ore miners in the world are located in the country’s Pilbara region. The Pilbara's high-grade ore, good port access, strong rail system and relative proximity to China have enabled these low-cost, and high-margin, operations10.

Meanwhile, the volatile conditions arising from the speculative trading occurring on the Dalian futures contract as led to spike of iron-ore future prices and as also artificially pushed up prices of physical iron ore prices.11 Rallying commodity markets are likely to spur bargain hunters to act now on deals rather than wait. Those bargain hunters would do well to consider acquiring assets from junior miners, because the majors that are divesting assets are not afraid to wait for a seller's market to reappear12.

Bargain hunters that are interested in acquiring iron-ore assets in Australia may consider the following actions:

  • Increase pressure on the Australian government to allow closer ties among major mining companies in order to help them stay competitive.

  • Reduce risk through partnerships. Junior miners can seek non-traditional financing or collaborate with majors to help secure financing.

  • Leverage digital technology to increase visibility into operations and, ultimately, identify and realize synergy opportunities from consolidation.

All in all, mining companies would be required to draw on a variety of strategies in today’s difficult markets, including continued operational improvements and cost-cutting. For many, consolidation can be an important, and valuable, addition to those strategies—and the time appears right to be planning and pursuing deals.

Footnotes:
1Mark Magnier, China's Factories Lose Some Momentum, Wall Street Journal, 2 May 2016. Factiva, Inc. All Rights Reserved. (accessed April 5, 2016).
2Barry FitzGerald, Mackenzie prepares BHP to face new era, The Australian, 9 April 2016. Factiva, Inc. All Rights Reserved. (accessed April 5, 2016).
3Rio Tinto Shakes Up Management, Dow Jones Wire, 18 March 2016. Factiva, Inc. All Rights Reserved. (accessed April 5, 2016).
4Robert Guy, Rio Tinto Ditches Dividend Policy: More Iron Ore Pain?, Dow Jones Newswire, 11 February 2016. Factiva, Inc. All Rights Reserved. (accessed April 5, 2016).
5Rhiannon Hoyle, BHP Has Renewed Appetite For Deals, The Wall Street Journal, 17 March 2016. Factiva, Inc. All Rights Reserved. (accessed April 5, 2016).
6Anglo American to Slash Assets, Cut 85,000 Jobs, Dow Jones Wire, 8 December 2015. Factiva, Inc. All Rights Reserved. (accessed April 5, 2016).
7Fawad Mir, BC Iron mulls sale of 75% stake in mothballed Nullagine iron ore mine, SNL Metals & Mining Daily: East Edition. Factiva, Inc. All Rights Reserved. (accessed April 5, 2016).
8http://www.cnbc.com/2016/04/07/australia-lifts-2016-iron-ore-price-forecast-by-11-to-45-a-tonne.html (accessed April 5, 2016).
9Vesna Poljak, Iron ore will not remain at $US70 a tonne, The Australian Financial Review, 23 April 2016. Factiva, Inc. All Rights Reserved. (accessed April 5, 2016).
10Bloomberg Intelligence, Australia's Pilbara Is Home to Lowest-Cost Iron Ore Globally, Bloomberg, 13 January 2016. (accessed April 5, 2016).
11Rhiannon Hoyle, China Gets a New Casino --- Speculative bets on iron ore transform a market. Wall Street Journal, 02 May 2016. Factiva, Inc. All Rights Reserved. (accessed April 5, 2016).
12Amanda Saunders, Rio ices coal asset sale in full market, The Australian Financial Review, 18 April 2016. (accessed April 5, 2016).

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