Private equity will be nimble in tweaking investment strategy in the mining sector should funding options expand for mine developers in an improving market.
A veteran of the space, who preferred not to be named, recently shared this view as he discussed broader private equity themes with S&P Global Market Intelligence.
In recent years, private equity emerged as a greater force in the mining sector while equity financing on leading exchanges dried up and stagnated. Yet the market may become frothy again, the expert acknowledged, and that could squeeze private equity if investor appetite for public offerings grows. But even if the boom times return, private equity has at least two options, he said.
"One is we will adapt our models and maybe invest in more equity," the expert said. "The second possibility is that if we continue to want high returns, we might consider moving into riskier countries or changing our commodity focus."
If the health of the mining market improves, albeit more slowly, it may remain business as usual for private equity. "Most of these funds have a seven- or a 10-year life," he said. "You typically only have four or five years to invest and then you're supposed to harvest. So if it's a longer recovery than normal, we'll be fine. We'll have plenty of product to invest in."
Joe Mazumdar with Exploration Insights agreed private equity is unlikely to suffer too much even in a healthier market. "Private equity definitely is here," he said. "And as long as they make returns, they'll get funded."
Private equity firms have gone through a recent winnowing process, and that may improve prospects for remaining and more-established players. For example, X2 Resources LLP, headed up by Mick Davis, raised US$5.6 billion in 2015 but went on to free backers from commitments in 2017.
"Last year we saw a bit of a culling period, where the weak investment models fell and the strong models got stronger," the private equity veteran noted.
There is also the question of whether cash will flood back to the mining sector even if mining stocks strengthen. Both retail and institutional investors were burned on many mining equities during the last upcycle after high-priced acquisitions soured on miners, leading to write-downs, and as some mine developments proved to be losers. Meanwhile a drop in metal prices caught some investors off guard as it punished stocks.
"Why is it that the equity markets are doing so poorly at financing new mines? It's because the investor base isn't there," the private equity expert said.
Investors may have become gun-shy and continue to avoid backing managed funds focused on the mining sector even in a rising market. "These people have given them money and they've lost it," Mazumdar said. "They're not inclined to give them more, and they don't want to pay the fee anymore."
Another source of competition could come from the banks, which can offer lower interest rates than private lenders.
"If the big banks ever got back into the game and started putting up money, their money's a lot cheaper than ours," said the private equity expert. "But they're covenant-heavy." For some mine developers, the covenants can look restrictive, especially when facing bumpy mine ramp-ups where secure cash flows are uncertain.
Mazumdar said private equity funding — in its various forms — will always be more flexible, if typically more expensive in terms of cost of capital. It can seek returns through equity, metal streaming and royalties, among other things.
"Banks don't have that flexibility," he said.
Private equity, on the other hand, can eke out returns in myriad ways. "If they don't get you with the interest rates on the debt, they'll get you on the gold stream, or they'll take a royalty," Mazumdar said.