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27 February 2013

Equity Market Comment

Global accountancy and consulting group Ernst & Young recently published a review of the global mining sector, which concluded that the industry, generally, is facing a capital strike, and that the effects were most pronounced amongst the junior miners (i.e., explorers). The drop off in activity was apparently most acute during the second half of 2012. On a positive note they do anticipate that capital markets’ appetite for the industry could begin to improve toward the end of the current calendar year. Table: Volume & Value of Deals (2003 – 2012)
Volume Value ($m) Average value ($m) Median value ($m) 2003 475 46,182 97 4.4 2004 596 26,350 44 3.1 2005 564 65,430 116 4.8 2006 701 175,713 251 6.2 2007 903 210,848 233 7.2 2008 919 126,884 138 6.0 2009 1,047 60,035 57 3.2 2010 1,123 113,706 101 5.2 2011 1,008 162,439 161 5.6 2012 941 104,014 111 5.0

Source: Ernst & Young (Mergers, acquisitions and capital raising in mining and metals)

There appear to be several general reasons for the slowdown in corporate activity that can be briefly summarised as: • • • • Global economy remaining weak Softening commodity prices and rising operating costs Increasing demand for improved equity returns and Sharply reduced bank lending partially offset by increased bond market activity.

None of the general conclusions arising from the report come as any great surprise to us because we had previously expressed concern about commodity prices and the sector’s disconnect from the real economy i.e. commodity prices had continued to rise while economic demand was slumping. In our view, reality has finally caught up with the industry and it is belatedly responding to the changed demands of equity and debt capital markets. Unlike Ernst & Young, Intellisys does not anticipate that capital markets’ conditions will ease much before 2014 at the earliest. We anticipate that global economic growth will remain subdued and will remain at sub-historic trend growth rates until the leading industrialised economies overcome the drag created by rebalancing their economies and eliminating and/or reducing their structural deficits; a process that takes many years to fully and successfully implement: Table: GDP forecasts
GDP % YoY UK Germany France Eurozone (15 countries) USA World
Source: Intellisys, IMF and OECD.

2007A 3.6 3.4 2.2 3.0 1.9 5.4

2008A -1.0 0.8 -0.2 0.3 -0.3 2.8

2009A -4.0 -5.0 -3.1 -4.3 -3.1 -0.6

2010A 1.8 6.3 1.6 1.9 2.4 5.1

2011A 0.9 3.9 1.7 1.4 1.8 3.8

2012E 0.1 0.4 0.2 -0.6 1.5 2.0

2013E 0.5 0.7 0.4 0.0 1.7 2.5

2014E 1.2 1.0 0.7 0.6 1.9 2.8

2015E 1.6 1.4 1.1 1.0 2.3 3.4

Philip Morrish +44 (0) 20 3239 8994

Market Comment

Although a recovery is under way, the ongoing weaker demand would suggest further dampened appetite for hard commodities resulting in persistently softer prices. Commodity Prices
Gold Silver



Source: and

Over at least the past 6 years, the sector has very actively capitalised upon the well documented price rises of hard commodities to fund volume growth. However, the more detailed findings of the Ernst & Young report indicate some fundamental changes about how the industry is being financed and the corporate responses to those changes. Table: Capital Raising by Asset Class – Proceeds (2007 – 2012)
$m IPOs Follow-ons Convertible Bonds Bonds Loans Total
Source: Ernst & Young

2007 21,400 66,802 12,865 36,358 110,787 248,212

2008 12,406 48,751 12,238 38,146 171,691 283,232

2009 2,987 73,806 14,431 61,016 62,420 214,660

2010 17,948 49,705 5,477 72,502 183,875 329,507

2011 17,449 49,745 2,365 83,804 187,059 340,422

2012 1,388 25,950 3,537 112,539 105,981 249,394


27 February 2013

Philip Morrish


Market Comment

Charts: Capital Raising by Asset Class 2007 and 2012
2007 2012

Source: Ernst & Young; Intellisys

In general, the industry is composed of three segments – Major Producers, Advanced Juniors and Explorers – and each is responding differently to the changed capital markets climate. The Majors, in direct response to their equity investors’ concerns about falling share prices and declining profitability ahead of massive planned capital spending, are concentrating upon maximising returns on capital and capital recycling. This capital allocation rethink has manifested itself in thorough and on-going reviews of corporate portfolios, the redistribution and diversion of capital from high cost to high return projects and the divesting of noncore assets. In addition, the Majors are using the corporate bond markets to refinance their balance sheets on favourable long-term rates. The successful implementation of these new strategic plans should result in progressively widening profit margins, sustainably improving capital returns and higher dividend distributions, which should encourage equity investors to rebuild exposure. The Advanced Juniors are similarly re-addressing their capital allocation plans but they have to be somewhat more creative in securing their long-term capital requirements because they are unable to readily access the investment grade bond markets like the Majors. They have successfully accessed the high yield and US private placement markets as well as encouraged long-term investors to take strategic equity stakes and/or provide off-take financing. However, most Advanced Juniors are reluctant to dilute existing shareholders through equity placements although some have benefited from a ‘stock selective’ mood swing by institutional investors in favour of quality, de-risked investment opportunities with reasonable visibility and near-term returns. However, given the limited availability of broadly distributed quality company research, many of the Advanced Juniors already fail to register on the Institutional Investor radar screen. Moreover, many of the resultant ‘individually creative’ but complex capital funding solutions for the Advanced Juniors will tend to discourage an early ‘en masse’ return by equity investors because each of the companies will have to demonstrably prove its particular business and financial model. Finally, the capital strike by risk adverse equity investors has pushed the Explorers back into survival mode. With more and more of these companies showing signs of financial distress, this group either has to accept last resort funding proposals that often result in loss of control over projects or onerous terms, or brutally pare back activity and costs in the hope that they can survive until a more favourable funding climate emerges. Generally, these companies’ shares will only appeal to those equity investors with an ultra-high risk appetite.

27 February 2013

Philip Morrish


Market Comment

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27 February 2013

Philip Morrish