Financier & Lawyer Discuss: 'Can M&A Solve the Broken Mining Finance Sector?'

• M&A in the resource sector is driven by synergies, cost savings, and access to capital markets
• Challenges include realizing promised synergies, post-deal integration, and aligning management incentives
• Debt financing for resource M&A is becoming more difficult, with banks withdrawing and covenants tightening
• Alternative financing options like credit funds and bonds are available but come with higher costs
• Government and industry support is needed to enable M&A and project development in the resource sector

M&A Remains Key to Unlocking Value in the Resource Sector

Mergers and acquisitions (M&A) play an important role in the resource sector, enabling companies to achieve synergies, access capital, and advance projects. However, M&A also presents challenges around realizing promised benefits, aligning incentives, and securing appropriate financing. In this article, we explore the key drivers, challenges and financing considerations impacting resource sector M&A.

The Basics of Resource Sector M&A

At its core, M&A is driven by the potential to create value by combining two entities. In the resource sector, this often involves consolidating nearby projects to share infrastructure, realize operational synergies, and reduce costs. As Brandon Munro, executive chair of Bannerman Energy explains, "The classical M&A deal is a couple of resources projects down the road from each other. They can either pull their resources for a common development...Where you're able to consolidate that big ore body and develop it as one rather than compete with each other for infrastructure and customers and so on.

M&A can also be motivated by a desire to access capital markets. Combining companies, especially in the gold sector, can create larger, more liquid entities that are included in ETFs and accessible to institutional investors. Todd Ross, CEO of Nordic Nickel, notes how hundreds of gold companies have pursued M&A because "Just by adding 1 plus 1, there's a big inflow of passive investor funds via ETFs. They become more accessible to institutional money." However, he cautions that scale alone doesn't guarantee success - the underlying assets and strategy must still make sense.

Challenges of Realizing M&A Benefits

While M&A is often justified based on potential synergies, cost savings and access to capital, realizing those benefits is far from certain.

Studies suggest only a small minority of deals ultimately achieve the synergies promised to shareholders. Munro elaborates, "The number that sticks in my head is circa 20%. So 80% of the time, the end result from the merger is not as good as what was predicated as part of the deal.

Post-deal integration is often more complex than anticipated. Reducing headcount and combining systems, processes and cultures is not as simple as "shooting every second body". It requires detailed organizational planning to capture synergies while maintaining key talent and capabilities. Deals justified mainly on synergies warrant caution compared to those based on more straightforward rationales like increased scale and access to capital.

Aligning Management Incentives

Management incentives also play a role in M&A. On one hand, overly generous change of control provisions could motivate executives to pursue deals primarily for personal gain. Conversely, having no protection could make them oppose even sensible deals out of fear of losing their livelihoods. As Munro explains, "The far bigger evil is executives who will refuse to do a deal because they're terrified of losing their job or not being able to support their family or pay their mortgage." Carefully structured incentives are needed to motivate value-creating M&A while avoiding misaligned enrichment of executives.

Financing Resource Sector M&A

Debt financing for single-asset resource projects is becoming increasingly scarce. Many banks have withdrawn from the sector in recent years. Those that remain have tightened lending requirements, shortened tenors, and imposed more restrictive covenants. As Ross describes, "It is getting more difficult. Banks are less and less willing to fund the resource sector...Single-asset project financings that were bread and butter for a lot of banks for a long time are very difficult to do these days.

Alternative Financing Options

With traditional debt less available, resource companies are turning to alternative financing options to enable M&A. These include credit funds, bonds, convertible notes, streaming and royalty deals. While providing capital that may not otherwise be accessible, these options typically come at a significantly higher cost.

As Ross elaborates:"There's always going to be a market to provide some level of financing for any particular projects... it just depends on what the cost is and what the challenges and the covenants are going to be. I would be very cautious about taking on corporate bonds or convertibles that are highly restrictive and highly expensive if you haven't exhausted all the other avenues of Cheaper debt financing.

Need for Government and Industry Support

Ultimately, the capital needed to drive resource sector M&A and project development exceeds what companies can access on their own - especially for critical minerals and the energy transition. Greater support is needed from both government and industry.

While initiatives like the Inflation Reduction Act and the European Critical Minerals Act are spurring huge investments in downstream processing, more focus is needed on securing the raw materials to feed those facilities. As Ross points out regarding Europe, "There's major challenges... Why was there only one nickel explorer with a project in Europe at a recent conference despite the EU target of sourcing 10% of raw materials domestically, up from less than 2% today?

Collaboration with larger industry players can also help de-risk and finance projects. For example, BHP's Xplor program provides mentoring and expertise to attractive junior companies. But as Munro cautions, "If government doesn't play a role in making the journey more viable for smaller players, then they're simply creating a concentration of power amongst the very large companies and that's not ideal for a resources sector that's going in many sectors to have to increase by an order of magnitude between now and 2050.

Conclusion

M&A remains a crucial tool for resource companies to unlock synergies, access capital and advance projects.

But realizing those benefits is not always straightforward. Careful deal structuring is needed to align incentives and integrate successfully. Scarce traditional financing is making M&A harder, forcing reliance on costlier alternative funding. Looking ahead, M&A alone won't be enough to drive the massive increase in resource production needed to power the energy transition and meet other demands. Greater government and industry support will be essential to de-risk and finance resource projects. By pursuing smart M&A and collaborating to solve key funding and permitting challenges, the resource sector can position itself to supply the materials the world needs.