Exploration and feasibility of alternative funding for distressed mining and resources projects
The last decade has seen an increase in the availability and diversity of funding options available to mining and resources projects. This trend is particularly apparent within restructuring with offtake, debt for equity and specialist mining funds homing in on the potential for significant returns which may arise from supporting distressed projects through a turnaround.
The primary financing options for mining and resource companies are equity, debt; royalty or offtake/ streaming finance. Each option varies in the complexity of documentation required, the degree of dilution of control and pricing. Unsurprisingly the different options attract different potential lenders, each of which may have differing primary interests (security of supply, profit or state interests).
The involvement of traditional bank lenders within this space is extremely limited and so to unlock access to the full range of potential funding sources mining and resources companies must engage with well-connected advisers.
Where raising funds for a distressed company, existing lenders and stakeholders must be carefully assessed and managed before new financing arrangements will be viable. Consideration must be given to how incoming capital will interact with existing and senior debt and granted security interests. Where existing lenders wish to continue to participate, but only give limited or no further funding (while retaining existing priority for repayment and security), deeds of priority and/ or side agreements must be negotiated before new alternative financing arrangements can be finalised.
Where alternative capital is deployed it can assist in creating improved valuations through stronger balance sheets due to the limited reliance on fixed repayment commitments.
Globally, approximately $15 billion of alternative finance is understood to be dedicated to mining. As this is a small fraction (~ 1%) of total funds under management within the alternative financing arena there is significant potential for growth and we expect to see this form of finance increasingly deployed to support restructuring efforts within the mining and resources sector.
Debt and equity-based financing are the traditional forms of financing in this sector. Below we unpack the key sources of alternative finance in Australian mining and set out the basic features, advantages and disadvantages of each.
Offtake/ streaming
A streaming agreement provides for the forward purchase of the metals or minerals produced. The offtaker will ordinarily pay a lump sum to the mining company, who in turn agrees to sell a certain amount of the relevant metal or mineral at an amount that is below the market price at the time of entry into the agreement. We have commonly seen this finance arrangement for by-products of the mining operation for example for gold, chromium, cobalt, copper, lead, molybdenum, palladium and lead. Recent figures predict global streaming revenues of up to $380 billion within the decade (led by gold, copper and silver). An example was the Orion financing stream inside Heron and the Trafigura and Mercantia streams inside Wiluna. Offtake arrangements can also be structured as streams, albeit these are more traditionally provided by commodities traders or principal refinery parties.
Pros
- Streaming agreements can usually be negotiated within short timeframes (4-6 weeks).
- Provides an almost immediate cashflow for a business undertaking a restructure.
- No dilution of control.
- The funds obtained are usually not restricted for certain uses.
- The lump sum is sometimes not repayable (instead representing consideration for the locking in of a lower than market price).
- Can support a sustainable leverage ratio.
Cons
- If significant production cost or market price increases occur, the company may be in a loss-making contract.
- As a royalty stream investment is long term, the investor would likely require a high level of detail on the restructuring plans.
- Unless secured, streams have subordinated priorities in a winding-up.
Royalty
A royalty is, in its simplest form, provision of lump sum payments to a mining company in return for periodic repayments based on the production of mined minerals. A number of parties such as Vox Royalty provide financial products relating to royalties. Royalty agreements tend to have lengthy terms and are quite flexible in how the initial payment is to be repaid. For instance the agreement may require repayment based on:
- price per unit;
- percentage of gross sales revenue; or
- net smelter return (where production costs are subtracted from gross sales revenue).
Royalties will often include terms such as reporting obligations, rights to visit or inspect the mining site, transfer provisions and the right of first refusal.
Pros
- No dilution of control.
- Flexible contractual agreement which can be cheap and fast to implement.
- Repayments are more often than not linked to actual production which can diminish risk for the company.
- A royalty holder will require less by ways of covenants and defaults compared to a bank or institutional debt financier.
- A royalty can easily sit alongside other forms of equity raising.
Cons
- Because of the long-term nature of the agreement, the pricing is typically more expensive than for ordinary debt finance.
- The existence of a royalty agreement will likely decrease net present value of a mine (which can be an issue if the mine is to be sold).
- Calculation and payment of the royalty may result in administrative burden.
- The pool of potential royalty funders is limited.
- Questionable priority in a failed company situation.
Key takeaways
As always, when considering foreign sources of funding it is important to consider whether the incoming funder might require FIRB approval.
Offtake, streaming and royalties provide a flexible and emerging source of capital which are increasingly deployed in supporting restructures and turnaround strategies within the Australian mining and resources sector.