Miners slash costs but shakeout looms

NEW YORK (Reuters) - Some small and medium-sized miners could see their ranks thinned as a free-fall in commodity prices and tight credit markets threaten to reshape the entire mining sector.

Mining companies have been shelving projects, restructuring debt and adjusting M&A strategies as declining industry fundamentals hit the sector from top to bottom.

The environment is forcing even cash-producing majors to examine their balance sheets, as evidenced by Freeport-McMoRan Copper & Gold's (FCX.N) decision to suspend its dividend and slash capital spending on Wednesday and BHP Billiton Ltd/Plc's (BLT.L) (BHP.AX) cancellation of its planned $66 billion takeover of Rio Tinto (RIO.L) (RIO.AX) last week.

It is pushing small players to focus on survival and if commodity prices continue to decline, it could mean an increase in bankruptcy filings starting about six months from now, bankers and lawyers said.

Metals prices have soared in the last three years on demand from China and other developing countries building up their infrastructure. But prices have dropped sharply this fall amid weakening demand in the global credit crunch. Copper, which is used in wiring for new construction, was selling for more than $4 a pound in July, but was going for less than $1.60 on Wednesday.

Meanwhile, the broad economic downturn has made it tougher for companies to restructure existing loans or borrow more money, experts say.

"If you are looking in the crystal ball for where real trouble will be, it might be in that middle tier of companies that have debt and might have gotten themselves a little overextended," said Kevin Shaw, a partner in law firm Mayer Brown's Houston office.

"If they were not hedged properly then they are going to have to go back and restructure that debt and if they can't, then they will be in bankruptcy," Shaw said.

DARWINIAN CULLING

Analyst Michael Gray of Genuity Capital Markets in Toronto predicted a "Darwinian culling" of junior exploration companies, with 50 to 75 percent of the world's more than 2,000 so-called junior companies unlikely to last the next 12 months. In better times, they usually survived on credit until a larger player came in to fund their projects.

But with metals prices low and even top miners cutting capital spending and stopping production at high-cost mines, only the best projects will get funded, he said.

"It's going to take a while to really see it, because companies will do whatever's necessary to sell assets and generate cash," Gray said.

Distressed assets will come onto the market as companies that have spent money on early stage development realize they will not be able to deliver the project, said Peter Gray, managing director of the energy and natural resources group at KPMG Corporate Finance LLC.

"There is going to be a lot of distress in the middle market and junior mining groups -- companies that have a concentration on one commodity or one geographic jurisdiction," he said.

Buyers of these distressed assets could include the major metals companies such as BHP, Xstrata (XTA.L) and Companhia Vale do Rio Doce (VALE5.SA), he said. Given the difficulty in borrowing money from banks right now, those are the companies that have the necessary cash on hand, KPMG's Gray said.

Some private money such as hedge funds or private equity firms may also come forward, one banker said.

"There can be very creative solutions to solving whatever balance sheet issues these producers are facing," said Perk Hixon, a managing director at Lazard. "That's primarily due to outside capital that is looking to help out and play in this industry going forward. This was not on the radar screen of big-time private money five years ago."

CUTTING PROJECTS

Among companies that have said they are reviewing projects or cutting back projections are the large miners such as Xstrata, Teck Cominco (TCKb.TO) and Rio Tinto.

Even some once-strong players are now facing tough choices to stay solvent.

Canada's NovaGold (NG.TO), once the subject of a failed $1.7 billion bid by Barrick Gold (ABX.TO), warned last week it had shut its only producing mine and would be unable to repay a $20 million bridge loan in December, meaning it will have to sell assets or issue shares to avoid default.

Frontera Copper FCC.TO, once worth $500 million, has seen its stock drop 93 percent from its all-time high in October 2007, and said this week it had hired a financial adviser to examine strategic alternatives. It was forced to shut its mine in Mexico last month due to lower copper prices, and must find a way to repay debentures that will begin coming due in 2010.

"If we don't have the opportunity to restart our mining operations by the time those debentures come due, it's going to be difficult for us to meet our obligations there," said Rod Prokop, Frontera's vice-president of investor relations.

Large companies that have been able to stockpile cash during the run-up in prices that began five years ago will likely weather the storm better than their smaller counterparts, according to one investment banker who works in the industry.

It could be six months before any distressed companies reach the point where they decide they have to sell themselves, two other sector bankers said.

Companies in the middle of development projects, particularly those that have raised debt, are most at risk, one of the bankers said.

"They haven't delivered the cash flows yet and the cash flows they are going to deliver if they finish building are probably lower than they thought they were going to be," the banker said.

(Reporting by Caroline Humer, additional reporting by Michael Erman in New York and Cameron French in Toronto; editing by Matthew Lewis)