Mergers, acquisitions and capital raising in the mining and metals sector 1H 2012

BHP Billiton quarterly briefing

Mergers, acquisitions and capital raising in the mining and metals sector 1H 2012
Escalating capital costs and softening prices are forcing mining and metals companies to rethink investment decisions. This may herald a shift in focus from build to buy. However, resource nationalism and macroeconomic issues are making decisions difficult. This is reflected by the steady decline in deal volume since 2010. Synergistic and one chance deals continue to be undertaken, while more speculative deals are being deferred. The majors are able to access capital, but remain focused on maintaining investment grade credit ratings, driving efficiency and reducing financing costs. This suggests that there is capacity in the market to support activity that best demonstrates attractive returns including M&A and return of capital to shareholders. Equity is tightening amid widespread volatility and risk aversion, impeding the timing and pricing of IPOs. Early stage juniors face particular challenges, with widespread implications for exploration activity. Majors themselves are becoming an increasingly important source of capital, as they look to invest in future growth through minority holdings and joint venture positions.

Note: The data is primarily sourced from ThomsonONE. $ refers to US dollars.

Mergers, acquisitions and capital raising in the mining and metals sector 1H 2012

Value and volume of deals by size

2010 Volume Value ($m) Average value ($m) Cross border (% share) 1,047 113,706 2011 1,008 162,439 Y-o-Y change -4% 43% 1H 2011 580 89,746 1H 2012 470 55,679 Y-o-Y change -19% -38%

M&A activity
Global economic uncertainty and market volatility have subdued deal value and volume in 1H 2012, but strong balance sheets among producing companies, favorable long-term fundamentals and lower valuations are creating an attractive environment for M&A. There were 20 megadeals (>$1b) completed in this half, up from 15 in the same period last year reflective of opportunistic and synergistic M&A. Activity in June suggests a pick up in momentum, with deals totaling $10b completed (up 88% month on month), and an increase in 1H 2012 volumes on 2H 2011 (although volumes are down year on year). Higher cross border deal share is being seen, despite a consolidation drive in commodities such as coal and steel. Developed market assets were increasingly targeted by BRIC1 and emerging market players seeking to secure resources. The Asia-Pacific region was both the preferred destination and the most active acquirer, with China dominating deal activity. Chinese mining companies acquired domestic and cross border targets in equal measure, completing deals worth a combined $17b. Australia closely followed, largely driven by domestic consolidation among coal companies. North American deal activity more than halved in comparison with 1H 2011, primarily due to reduced domestic consolidation activity within the region. This may change in light of the current shake up of the US coal market. Major European players continued to be acquisitive, seeking to achieve growth through outbound M&A. The largest of these deals was KGHM Polska Miedz acquisition of Canadas Quadra FNX Mining for $3.3b. In Africa, the Democratic Republic of Congo and Sierra Leone were the most-targeted, for copper and iron ore assets, despite the higher risks associated with these nations. This highlights the strategic importance of mineral supply.

101

161

59%

155

118

-24%

64%

62%

-2%

60%

63%

3%

Value of deals by target region ($b)

Asia Pacic North America Africa Latin America Europe CIS 3.2 5.9 9.0 8.1 10.4 19.1

Value of deals by acquiring region ($b)

Asia Pacic North America Europe Latin America CIS Africa 0.6 5.0 3.5 9.3 12.1 25.2

1 Brazil, Russia, India and China

Mergers, acquisitions and capital raising in the mining and metals sector 1H 2012

M&A outflows for key nations

Deal values in $b

1.3 1.4

6.1 1.1 0.6

1.5

2.0

UK 3.0
1.1 0.2 Germany 0.7 Kazakstan Belgium 1.4 Switzerland 2.3 Greece

Russia
Mongolia 0.2 0.2 8.5 8.7 1.0

Canada
0.2 3.3 1.6

US
Mexico 1.9

0.5

China

Japan

Colombia 0.4

1.5 Sierra Leone 1.3 Democratic Republic of Congo 1.3 0.5 Namibia 2.3 1.8 3.6 1.0

Chile 0.8 0.4 Argentina

Australia
1.5

0.9 South Africa 0.3

0.7

Domestic (bubble size = deal value)

Outbound (bubble size = deal value)

Commodities coal remains top target

Coal remains the most targeted commodity in 1H 2012 in value terms at $12.4b, despite a year-on-year decline in activity as lower shale gas prices weakened coal demand. Coal acquisitions were driven by: Power utilities and trading companies buying assets to secure supply Consolidation in order to achieve synergies and economies of scale, particularly in Australia due to the inflationary cost environment Large players looking to boost production capacity Copper was the second most sought-after commodity in 1H 2012, with $9.2b of deals completed. Activity was driven by strong long-term demand fundamentals and competition for scarce, quality assets. Steel deals took the third largest share of deal value, reflecting consolidation among Chinas fragmented steel sector in an effort to remove excess capacity, reduce costs and improve margins. Gold deals took the highest share of deal volume at 160 in 1H 2012. However, there have been fewer sizeable deals compared with the same period in 2011, resulting in a relatively low average deal value of $40m (down from $62m during 1H 2011). Expectations of a demand rebound in uranium is triggering acquisitions to secure future supply in the current depressed pricing environment deal value and volume has increased year on year.
4

M&A outlook
We expect to see continued uncertainty and volatility in the market throughout 2012. Those companies with a bullish outlook on China, and that can work with volatility, will be the dealmakers this year. The following factors are likely to drive future deal flow: Lower valuations, which may drive opportunistic deal activity A prevailing focus on M&A in familiar territory during volatile times; this may take the form of domestic consolidation or companies seeking to build on their minority holdings and JV positions. Synergistic, one chance deals if valuation metrics permit Increasing costs of organic projects driving a greater focus on M&A by the producers Greater scrutiny on investment returns will force management to adopt more sophisticated bid tactics and focus on synergies and unique competitive advantages. We expect to see more divestment activity, and an increased focus on portfolio management, in the face of rising costs. Nearly 70% of mining and metals respondents in Ernst & Youngs Capital Confidence Barometer (April 2012) confirmed they are planning divestments in the next 12 months to focus on core assets.

Mergers, acquisitions and capital raising in the mining and metals sector 1H 2012

Capital raising trends

Capital raising by asset class proceeds raised (20071H 2012)
400 350 300 250 Proceeds $b 200 150 100 50 0 2007 2008 2009 2010 2011 1H 2011 1H 2012

Challenging markets contributed to a decrease in capital raising activity in 1H 2012, compared with the same period a year ago. Total proceeds fell 35% to $123b, with a 16% decline in volume of issues. There has been almost a 50% reduction in the number of companies raising capital, and a marked decline in equity raising due to market volatility. However, corporate bond activity continues to break records, following on from a strong 2011.

IPOs

Follow-ons

Convertibles

Bonds

Loans

Capital raising by month proceeds raised (2012)

25

20

Proceeds $b

15

10

Jan Equity

Feb Bonds

Mar Loans

Apr

May

Jun

Mergers, acquisitions and capital raising in the mining and metals sector 1H 2012

IPOs a dramatic drop-off

Market volatility has had a profound impact on 2012 IPOs across all sectors. The mining and metals sector has been particularly impacted due to a decline in investors appetite for risk, and lower valuations, which have resulted in issues being too dilutive for foundation shareholders. IPO volume fell 37% to 47 IPOs in 1H 2012. Proceeds decreased by a significant 80% (excluding Glencore) to $0.9b, from $4.3b in 1H 2011. All major mining capital markets were impacted, with lower volumes, reduced prices and deferrals experienced on the Hong Kong, London, Australian and Toronto exchanges. The largest share of proceeds were raised in Hong Kong ($644m), with the TSXVenture exchange attracting the highest share of junior IPOs at 22 still a 53% year-on-year decline. The largest crossborder IPO was that of Chinas Rare Earths Global, which closed the half with a market value of $322m, listing on AIM to capitalize on demand outside of China. IPOs remain on the corporate agenda but in such a volatile market, only the ASX and TSX-V are seeing real volumes. A relatively small number of explorers are raising minimal funds through IPO in order to gain a market presence for future raisings. Short term financing solutions (including private placements and debt facilities) are being sought as an interim solution for those in need of immediate capital.

Follow-on equity in free-fall

Proceeds raised from follow-on issues of equity are also down significantly year on year, following a particularly volatile 2Q 2012. Volume declined by 18%, while proceeds dropped 69% to $10b, from $32b in 1H 2011. This was the result of fewer large issuers and a reduction in funding to the juniors. Mid-tiers and advanced juniors attracted equity investment to fund the development of quality projects and acquisitions. However, early stage explorers are faced with fewer options and challenging market conditions, with average proceeds by this group falling to $3m in 2Q 2012.

Convertible bonds projectbased funding

Convertible bonds showed a year-on-year increase in volume and proceeds in 1H 2012, largely driven by small-scale project-based funding for advanced juniors/mid-tiers unable to access straight bonds. Over $2.1b of proceeds were raised, compared with $2.0b in the same period a year ago. Convertibles can be an attractive investment option in periods of volatility, offering investors some downside protection. Australian issuers took the highest share of proceeds, offering opportunities for investors to participate in the growth potential of Australias mining industry. We have also witnessed a number of strategic investors taking cornerstone positions in convertible bonds during the first half of the year, including Mount Kellett Capital Management in Lynas Corps $225m issue, and China Railway Materials in African Minerals 8.5% notes due 2017.

Mergers, acquisitions and capital raising in the mining and metals sector 1H 2012

Corporate bonds continued demand drives record proceeds

The popularity of corporate bonds continued during 1H 2012, with a 29% increase in proceeds to $59b from $46b year on year. Corporate bonds remained an attractive funding option for the majors looking to refinance, push out maturities and lock-in favorable long-term yields. The first half of 2012 was about windows of opportunity, reflecting fluctuating market confidence. There was a slow start and end to the first six months, with a clear preference for quality compared with 1H 2011. But mid-tier companies found pockets of demand in March and May for high yield issues and we expect that sustained (albeit volatile) demand for yield should provide valuable support for mid-tier producers and advanced juniors in the second half. The first half of 2012 witnessed a greater share of volume by emerging market issuers accessing US dollar investors, looking to secure rates ahead of an expected increase in US treasury yields. Nearly $9b of investment grade Euro bonds were raised, despite challenging market conditions in the Eurozone, reflecting investor demand for quality investment opportunities. Record low coupons were again achieved by investment grade majors. Conversely, yields remained relatively high for subinvestment grade mid-tier companies, driving demand among yield-seeking investors.

Syndicated loans major refinancing, but little project financing

Syndicated loan proceeds declined 46% in 1H 2012, to $51b from $95b in 1H 2011. Large deals have been reserved for A-rated borrowers with strong banking relationships for example, Glencores $12.8b refinancing with a 91-strong syndicate of lenders. However, with over half of this years loan proceeds used to refinance existing agreements, very little new money is flowing in, particularly for project finance. During 1H 2012, $2.9b worth of project finance was closed, the largest deal being a $1b facility for First Quantum Minerals Kansanshi copper mine. A mandated pipeline of $10.8b in 2012 is still to be financed. With Basel III making it increasingly difficult for Western banks to provide anything other than short-term loans at competitive prices, we will continue to see a significant shift away from traditional long-term, project-based bank lending in the sector, and an increased role for alternative lenders and funding structures.

Capital raising outlook

We expect the corporate bond market to remain strong in 2012 for investment grade issuers, with sustained but volatile demand for higher-yielding sub-investment grade issues by mid-tier companies for project development. With funding options (both equity and debt) tightening for juniors, we may see bond investors with higher risk appetites (such as hedge funds) willing to fund quality projects in smaller companies. The IPO markets are expected to remain difficult, with companies unlikely to pursue large issues in the very short term, at such dilutive levels. Signs of recovery in global equity market conditions over the second half of 2012 could lead to an increase in IPO activity in Q1/Q2 2013. Markets are volatile and sentiment-driven: pockets of confidence will drive investor demand, but companies may increasingly look to strategic investors willing to invest for the long-term. Funding may come from Asian lenders, made via co-investments in overseas projects with local state partners such as infrastructure developers. Such investment often comes with additional ties, however, such as a share of future offtake. Multiple options need to be pursued to raise finance at the right price, in order to create competitive tension and ensure that reliance is not placed on just one source of finance.

Mergers, acquisitions and capital raising in the mining and metals sector 1H 2012

Ernst & Youngs Global Mining & Metals Center

With a strong but volatile outlook for the sector, the global mining and metals industry is focused on future growth through expanded production, without losing sight of operational efficiency and cost optimization. The sector is also faced with the increased challenges of changing expectations in the maintenance of its social license to operate, skills shortages, effectively executing capital projects and meeting government revenue expectations. Ernst & Youngs Global Mining & Metals Center brings together a worldwide team of professionals to help you achieve your potential a team with deep technical experience in providing assurance, tax, transactions and advisory services to the mining and metals sector. The Center is where people and ideas come together to help mining and metals companies meet the issues of today and anticipate those of tomorrow. Ultimately it enables us to help you meet your goals and compete more effectively. Its how Ernst & Young makes a difference.

Ernst & Young Assurance | Tax | Transactions | Advisory

About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 152,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit www.ey.com.

Area contacts
Global Mining & Metals Leader Mike Elliott Tel: +61 2 9248 4588 michael.elliott@au.ey.com Oceania Scott Grimley Tel: +61 3 9655 2509 scott.grimley@au.ey.com China and Mongolia Peter Markey Tel: +86 21 2228 2616 peter.markey@cn.ey.com Japan Andrew Cowell Tel: +81 3 3503 3435 cowell-ndrw@shinnihon.or.jp Europe, Middle East, India and Africa Leader Mick Bardella Tel: +44 20 795 16486 mbardella@uk.ey.com Africa Wickus Botha Tel: +27 11 772 3386 wickus.botha@za.ey.com Commonwealth of Independent States Evgeni Khrustalev Tel: +7 495 648 9624 evgeni.khrustalev@ru.ey.com France and Luxemburg Christian Mion Tel: +33 1 46 93 65 47 christian.mion@fr.ey.com India Anjani Agrawal Tel: +91 982 061 4141 anjani.agrawal@in.ey.com United Kingdom & Ireland Lee Downham Tel: +44 20 7951 2178 ldownham@uk.ey.com Americas and United States Leader Andy Miller Tel: +1 314 290 1205 andy.miller@ey.com Canada Tom Whelan Tel: +1 604 891 8381 tom.s.whelan@ca.ey.com South America and Brazil Leader Carlos Assis Tel: +55 21 2109 1606 carlos.assis@br.ey.com

Service line contacts

Global Advisory Leader Paul Mitchell Tel: +86 21 2228 2300 paul.mitchell@cn.ey.com Global Assurance Leader Tom Whelan Tel: +1 604 891 8381 tom.s.whelan@ca.ey.com Global IFRS Leader Tracey Waring Tel: +44 20 7980 0646 tracey.waring@uk.ey.com Global Tax Leader Andy Miller Tel: +1 314 290 1205 andy.miller@ey.com Global Transactions Leader Lee Downham Tel: +44 20 7951 2178 ldownham@uk.ey.com
2012 EYGM Limited. All Rights Reserved. SCORE Retrieval File OC00000205
This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor. www.ey.com/miningmetals ED 0113