Specialist PE funds offer hope to resources firms

In a changing M&A world, where buyers are now more interested in finding value than paying a high price for growth, Australian resources companies are hoping to attract a new breed of suitor.

Private equity firms are well placed to fill the gap left by strategic buyers, said Mark Pistilli, managing partner at Clifford Chance in Sydney, who has a long track record of advising on cross border M&A transactions between Australian sellers and Asian buyers.

Pistilli said the market for mining resources has been heading towards the bottom of the cycle since its peak in 2007. “At the top of the cycle the large mining companies like BHP, Rio Tinto, Vale and Glencore Xstrata wanted to add capacity by buying projects and assets,” he said. “Now the heat has come off commodity prices and these companies are focused on improving productivity by achieving operational efficiencies.”

Part of that process involves selling non-core assets at reduced rates, leaving the door open for global PE funds and specialist players that are looking for value. Funds such as Australia’s Gresham Partners and Resource Finance Corporation, and offshore players like the recently formed X2 — a buyout firm set up by former Xstrata chief executive Mick Davis, which is said to be eyeing assets in the coal industry.

PE funds haven’t always embraced the resources sector, with Clifford Chance estimating they traditionally account for less than 2% of global investment in mainstream mining. The biggest obstacle is the length of the commodities price cycle and the risk of being exposed to depressed prices at the same time as a fund wants to exit an investment.

“But prices have dropped far enough now for bargain-hunters to take a look,” said Pistilli.

The best bargains are those companies in the pre-production phase. “These companies are burning cash and need capital, and yet they have limited access to debt and the equity markets are only open to selected issuers,” said Pistilli, adding that PE buyers are most likely to take a minority stake in a company that already has a strong management team. “PE funds have a real opportunity to turn these companies into viable producers and then sell the assets to larger players.”

Deals might also be driven by a perception that the Australian dollar remains overvalued and may have further to fall. The currency has already dropped nearly 15% against the US dollar this year, from A$1.05 in mid-April to A$0.91 now. “Since most mining commodities are priced in US dollars, any further fall in the Australian dollar reduces the cost of local production and boosts profitability without any additional investment or significant management time,” explained Pistilli.

He said Clifford Chance is handling an increasing number of enquiries from PE buyers, but declined to comment on specifics. And despite speculation that X2 may be about to purchase some of Rio Tinto’s metallurgical coal assets, there hasn’t been any notable deals to illustrate the trend.

“There is still a certain amount of caution in the market, as buyers wait to see how the upcoming federal election in Australia will impact government policies on taxing carbon emissions and mining profits,” said Pistilli. “But there is plenty of evidence that PE firms are now more involved in the bidding process. I expect that once more funds take the view that we have actually hit the bottom of the market, deal flow will increase.”