AMONG the mining companies that lined up to bid for Atlantic Nickel, a company that owns the Santa Rita mine in Brazil’s Bahia state, were two carmakers. Not normally in the mix when it comes to direct, large-scale mining sector merger and acquisition (M&A) activity, their presence speaks volumes about metals scarcity, especially in a world of strangled supply chains.
As it turned out, South Africa’s Sibanye-Stillwater placed the winning bid for Atlantic Nickel. It offered $1bn in cash to Appian Advisory Capital, a UK-based private equity fund that had picked up Atlantic Nickel and another – Mineração Vale Verde (MVV) – out of bankruptcy in 2018. MVV owns the Serrote copper project, also situated in Brazil, which Appian Advisory re-developed and will become Sibanye-Stillwater’s first copper dedicated producing asset.
For Sibanye-Stillwater, buying Santa Rita and Serrote was the company’s fourth major transaction of 2021 – a $2bn augmentation of its fast-paced growth strategy. Previously centered on the production of gold and platinum group metals (PGMs), the group’s CEO, Neal Froneman, estimates that a third of the company’s future earnings will come from battery metals – a broad church that includes lithium as well as copper and nickel which also have established industrial markets.
Taken as a whole, these metals are critical to building the batteries for power electric cars as well as renewable power storage applications that may play a role in baseload power supply. Other metals, such as PGMs, will also play a part in the green hydrogen revolution.
Whilst it’s now a mainstream thought that base metals such as copper and nickel are heading for enormous supply deficits as politicians globally implement policy aimed at decarbonisation, a more recent feature has been how the JSE’s established mining sector names are taking riskier bets to participate in the metals rush.
To an extent some have no choice. Exxaro Resources, one of South Africa’s largest thermal coal producers, faces a loss of investment relevance if it doesn’t wean itself off the fuel in the next ten years. During September, it announced a new strategy in which it will target copper, manganese and bauxite production – metals that require an aggressive M&A strategy.
South32 is another. Although its interest in diversifying into base metals was already made plain by dint of its past investments in North American copper and nickel exploration prospects, it broke its normally conservative mould last month by announcing a A$2.05bn deal for a 45% stake in the Sierra Gorda copper mine in Chile.
Meanwhile, the jury is out on Impala Platinum (Implats). Its CEO, Nico Muller, has cautiously noted the importance of metals other than PGMs in the future drive-train. Stopping well short of an outright declaration to diversify, however, Muller has said the company wants to get battery metals “on to its radar”. It remains to be seen how the PGM producer will play its cards.
One reason why M&A is so firmly back on the agenda is down to the shortage of new projects. Following the mining sector over-spend of the last cycle, firms have focused on dividends rather than on building new projects. The exploration pipeline has been largely ignored with the focus falling on resources replacement through organic growth. As a result very little thought has been given to supply expansion.
Danielle Chigumira, a global metals and mineral analyst at Bernstein, a banking group, said at the Financial Times Mining Summit in October that while mining sector capex was expected to grow at a rate of 15% a year in the next five years, it was insufficient to keep pace with the rate of demand growth.
Global copper demand is forecast to grow by 11 million tons (Mt) in the next ten years, according to Goldman Sachs. “The forward deficits this market is facing are the largest ever,” said the bank’s analyst, Nicholas Snowden. “The long-term supply gap is about 8.5Mt against a 20 year historical average of four million tons.
“That figure just gets larger and larger through time due to the combination of EV demand growth and the limited level of investment in new supply,” he said. The scale of demand is expected to far outgrow the demand triggered by China urbanisation at the turn of the century. It’s that big.
However, the mining sector is not geared for the heightened demand, not currently. Firstly, inflation will eat away at the capex notwithstanding its growth, whilst the demands related to ESG are changing the way mines are built. In short, it’s becoming increasingly expensive to bring new production. Whilst the market will incentivise new production with higher prices (more of this later) the lead times from discovery to commissioning are becoming increasingly longer.
Of expected industry capex, Bernstein’s Chigumira said: “It’s nothing near the speed we need to avoid a supply crunch similar to the energy crunch we’re seeing now”.
According to Michael Scherb, the founder and chairman of Appian Advisory, there’s a fundamental disconnect in the mining sector which dictates its fate. “You are matching up investors who have a quarterly or even monthly mark to market in an industry where you take a five to 10 years view. So that fundamental disconnect between short term capital chasing a long lead time capital intensive business actually creates the cyclicality of our space,” he said in an interview.
Auditing firm, PwC said its annual industry report ‘Mine’ that M&A in the South African resources sector may be limited for the current time owing to shareholder pressure for sustained economic returns in the form of dividends. Shareholders fear the possible value destruction of M&A without synergy. Yet it recognised that these were unusual times: “During times of transition, as it experienced at present, there are bound to be interesting portfolio reassessments with opportunities up and down the value chain”.
Here’s now four of South Africa’s largest mining firms are considering their portfolio options.
Group CEO, Nico Muller has been somewhat cryptic regarding his firm’s intentions in respect of diversification. Drawn on the topic at the firm’s full-year results presentation, he said: “We don’t have a rich pipeline of projects, but we do recognise the global demand patterns are shifting over the next decade to 15 years.
“We do recognise it, and to that extent we are developing a radar screen to educate ourselves in terms of how these commodity demand patterns are going to shift. We want to be in a position to tap into that.”
That was in September. Less than two months later Implats said it was in takeover talks with Royal Bafokeng Platinum (RBPlat) – a development that suggested the company was focusing its efforts on PGM industry consolidation. Two weeks later, on November 9, Implats had the rug pulled from under its feet after rival Northam Platinum gazumped it by taking a stake in RBPlats for itself and triggering a takeover battle the outcome of which is yet to be settled.
Embarking on PGM industry consolidation is the opposite of diversification but with RBPlat potentially off the table, the prospect of diversification might be back on.
Ultimately, Implats decision to diversify will turn on its interpretation of future pricing of battery metals compared to the outlook for PGMs. There’s a debate as to penetration rates of EVs in future society. Unathi Loos and Daniel Sacks at asset manager, Ninety One, said in June the adoption of battery EVs would be a gradual process. Science is also finding ways to accommodate PGMs in other ways; specifically in hydrogen-powered fuel cells which needs PGMs to work.
An aspiration to move into the production of copper, manganese and bauxite was met cautiously by the market. Two days after the strategy announcement – which also includes building Exxaro’s independent power production expertise – shares in the company retreated 12%.
Ironically, the company’s valuation had been on the rise since the middle of the year as a result of improved thermal coal pricing. Exxaro receives a dividend from Kumba Iron Ore through its 20% shareholding in the joint venture company, Sishen Iron Ore, but coal is Exxaro’s bread and butter as evidenced by share price behaviour.
Analysts asked at the time of the diversification strategy announcement whether shareholders might be better served by Exxaro sticking to its core principles. “In the past, whenever Exxaro’s management has spoken about diversification into other minerals, they’ve received robust resistance from investors, and we’d expect to see the same this time,” said RMB Morgan Stanley analysts at the time.
One of the concerns regarding Exxaro’s diversification plans is that it has had little deal-making success previously. Two major transactions, the purchase of Total Group’s Total Coal South Africa (TCSA) in 2014 for about $382m, and Moyoko – a Republic of Congo iron ore prospect – resoundingly failed. The company impaired Moyoko for R5.3bn. As for the former TCSA assets, they were sold this year to Overlooked Collieries for an undisclosed cash sum.
In addition, it’s worth noting that Exxaro is matching itself against rival and much larger mining groups generating hard currency in a highly competitive sector. All of the major miners including BHP and Rio Tinto are on the lookout for new assets such is the frenzy for sources of new supply.
Anglo American is one of the major mining diversified companies not on an acquisition spree (Glencore is another). In fact, it is one of the few major miners that has a copper equivalent production growth locked in, partly by dint of its $5.3bn Quellaveco project in Peru which commissions next year.
But highlighting the state of the metals sector, Duncan Wanblad, Anglo’s CEO-in-waiting, said at the FT Mining Summit that no mining company could sleep easily knowing a supply squeeze could be on the horizon. Metal prices will vault, certainly, but in a disorderly way. Mining companies don’t prefer that.
Wanblad said that even with circular economy contributions in the form of metal scrap supply, the world would still need around 30 new Quellaveco-sized mines for primary supply to meet demand. “There’s an enormous amount of primary copper that needs to come to the market in pursuit of the low carbon economy,” Wanblad said.
For this amount of new material – which extends to elements such as lithium and nickel as well as the lesser known rare earths, and vanadium and manganese – the market will invariably display its efficient characteristics by incentivising production with higher pricing.
Ivan Glasenberg, the former CEO of Glencore, suggested last year that the copper price could move to $15,000 per ton. Having already eased past $10,000/t this year – a decade high – expectation of a yet higher copper price isn’t fanciful anymore.
“We forecast copper up to $15,000/t by the middle of decade,” said Goldman Sachs’ Snowdon. “The longer we stay down here with a lack of investment, the higher the risk of a more disorderly surge higher in price and that $15,000 might prove conservative.” He couldn’t discount a $20,000/t copper price: “Commodity prices will go to where you can’t believe when faced with scarcity.”
It’s perhaps with this in mind that South32 departed from its normal conservative curation of its balance sheet by offering A$2.05bn for Sierra Gorda. Having already sold its South African coal assets to Seriti Resources this year, the company has now completely transformed its portfolio in a way that perhaps Exxaro is seeking to do.
According to JP Morgan Cazenove, the stake in Sierra Gorda lifts South32’s earnings before interest, tax, depreciation and amortisation margin to 36% compared to an EBITDA margin of 32% in the 2020/21 financial year. But it’s the portfolio mix where South32’s acquisition has the most current resonance.
Copper would have been the joint largest contributor to EBITDA assuming the performance of other metals as per South32’s 2020/21 financial year, joint with earnings from aluminium, and followed by alumina, aluminium’s input ore.
If copper follows the price trajectory hinted at by Goldman Sachs, South32’s commodity profile could be significantly transformed proving that carefully judged M&A, notwithstanding lofty equity prices, can make money and sense.
According to Avior analyst, Wade Napier the calculus for South African PGM companies was to build, consolidate or diversify. Sibanye-Stillwater is probably best known for the latter, seeking to add battery metals including lithium, nickel and copper to its portfolio despite having recently consolidated a substantial portion of South Africa’s PGM business.
Last year alone, the company has conducted no less than $2bn worth of corporate deals including buying two lithium projects, one in Finland and another in the US, as well as the nickel processing facilities in France. These amounted to $1bn in cash outlay and commitments with another $1bn pledged for the Santa Rita and Serrote mines.
And no clearer signal was provided that Sibanye-Stillwater planned to continue its transaction odyssey in 2022 than a $1.2bn corporate bond announced in early November. After allowing for the redemption of a $370m bond due to mature in 2025, the company will have $830m for deals and corporate expenses (bearing in mind that the $1bn it owes to Appian has not yet been paid).
It’s a high risk strategy however. According to Napier, Sibanye-Stillwater has past experience integrating assets, as evidenced by its purchase of PGM mines into its existing gold business. Nonetheless, investors are taking a cautious view of the company. Its dividend yield of about 8.1% will lag competitors, Napier said.
This speaks to the tension between pleasing shareholders and taking a view on future supply deficits. Unlike its PGM acquisition strategy – in which Sibanye-Stillwater conducted four consolidatory deals between 2016 and 2018 – the group is not buying battery metals assets at the bottom of the market; far from it.
“However, Sibanye-Stillwater believes the similarity between the battery metals entry and the PGMs entry is that they are done on the respective attractiveness of each market’s supply-demand fundamentals,” said Napier in a report earlier this month.
The market isn’t convinced. How is it possible that Anglo American Platinum, the 80%-owned listed subisdiary of Anglo American, was worth two Sibanye-Stillwaters, said Laurent Charbonnier, the group’s chief commercial and development officer in October.
“It’s tough now to persuade capital to invest in medium to long-term investment,” said Snowden. “It really is a job to bring investors to medium-term growth. The dominant investor base are enjoying returns so it will need a persuasive nattative to look at growth,” he added.
Chigumira doesn’t believe shareholder returns ought to be paid at the expense of the strategic importance of recognising future demand growth. “This is often conceptualised as and either/or; as dividends or growth. But those two things have to be mutually exclusive,” she said.
Appian Advisory’s Scherb says the difficult for mining companies is trying to anticipate where metal prices will land. His company is setting about its third fund having exited most of its current investments (of which Atlantic Nickel and MVV were one).
“We see a lot of investors spending hours and hours in investment committees debating commodity prices and it’s just a waste of time and air because you’re never going to get it right,” said Scherb. “Why waste trying to get a commodity price right which is the beta (which is a measure of volatility in valuations) when you should be focusing on the alpha which is the value creation itself of buying assets and developing them outright. And then delivering production.”