LONDON (Reuters) - Private equity firms are stepping in to fill a funding gap in the resource sector as companies struggle to get bank loans to build new mines or drill wells.
Much of the activity is venture capital by boutique houses backing entrepreneurs with new mineral deposits, but some mainstream buyout firms are considering entering a sector they previously largely ignored due to its cyclical nature and its relative lack of control over pricing.
Since the credit crunch, the amount of debt available for mine projects has been scaled back dramatically and hedge funds have also largely withdrawn from backing unlisted firms.
“The fact that many people find it difficult to successfully raise funds at the moment works to our advantage,” said Bert Koth, partner at private equity firm Denham Capital Management, which has $4.3 billion in mostly energy and commodities assets.
“It’s very, very clear that there are many fewer doors for companies to knock on... you probably see four to five times the deal flow than before the crisis.” Last year the value of borrowing in the mining sector tumbled by 64 percent to $62.4 billion, accountancy group Ernst & Young said in a recent report.
“Despite massive de-leveraging across the sector and a return to a strong earnings outlook, project finance still appears to be almost impossible to secure,” the report said.
Denham makes investments of about $20 million to $150 million and prefers to invest after a deposit has been targeted and ride the increase in value as its size and mine potential is proven.
One recent investment was in Trans-Tasman Resources, which is hoping to exploit iron sands deposits in the seabed off New Zealand.
Private equity firms that specialize in resources are well placed to deal with the cyclical nature of the sector, said Carmel Daniele, chief executive of London-based CD Capital.
“A lot of the hedge funds that used to play in the private equity space no longer can, which is probably a good thing because they need to meet liquidity requirements,” she said.
“We’re longer-term capital, we’re very patient, as long as the long-term trend is up, we can ride all the swings up and down and none of us will blow up a company by selling it when it’s the worst time to sell it.”
CD Capital was an initial investor in Brazilian iron ore company Ferrous Resources, which said last week it plans to raise up to $400 million by listing in London.
Another CD Capital investment was in Brazil’s HRT Petroleum, which planned to list in Sao Paulo later this year, she added.
Firms scrambling for funds to develop a mine, coal field or oil well also can turn to China, keen to lock in supply of resources for its ambitious infrastructure building program.
In the early stages of a mining firm’s development, however, private equity has an advantage, Koth said.
“We thought we would find it difficult to compete with Chinese capital for making investments in the metals and mining industry, but we actually found it fairly easy,” he said.
“You cannot really maximize value if you give a significant equity stake in your company at an early stage to a party who is there primarily for the offtake.”
The rise in activity by private equity in mining ranges from new firms emerging and big buyout firms taking another look at a sector they had largely ignored due to its volatility.
In February, Ambrian Capital AMBN.L set up a private equity business with a team of three former executives from commodities trading group Glencore GLEN.UL.
Tim Williams, director of mining and metals at Ernst & Young, said some big private equity groups were taking a hard look at the mining industry.
“They have felt that it is a sector that has sort of left them behind — historically they haven’t been particularly interested because it’s cyclical,” he said.
They were looking for retired mining executives to restructure and manage assets they buy, he added.
“I think they’re looking for suitable targets. They’ve got to look at someone like Rio Tinto (RIO.L) (RIO.AX), BHP Billiton BLT.L (BHP.AX) or one of the other big diversified conglomerates and see what division in there they don’t want.”
A possible target may be Rio Tinto’s talc business, which, Rio told Reuters in March, was back on the market.
During the mining boom, big private equity houses flirted with the sector and several considered making bids for U.S. aluminum giant Alcan in 2007, near the top of the market.
In the end, Rio Tinto won a bidding battle for Alcan with a successful cash bid of $38 billion, but later acknowledged it paid too much and was left saddled with huge amounts of debt during the downturn.
Reporting by Eric Onstad, Editing by Sitaraman Shankar