M&A games

With M&A activity among metals producers reaching peak levels, banks are starting to look at new ways to create financing opportunities in the mining and metals sector. Erika Morphy takes a look at the consolidation trend and assesses where the market is heading.

ABN Amro, ever on the lookout to expand its repertoire of commodity finance products, has developed a new finance solution specifically for commodity companies that are in acquisition mode. “We call it acquisition pre-export finance,” Prabhat Vira, head of global commodity finance at ABN Amro, says. “Essentially what we do is use pre-export finance techniques in an M&A situation.”

Vira says the bank began discussing development of the product six to nine months back, and actively began working on it three months ago.

“Using our network we explored our ideas and solutions with a number of companies involved in potential M&A activity and we discovered there was a great deal of interest.”

He says the bank is currently working on a number of transactions and expects the first will likely close within the third quarter of 2005. And while eventually he expects to see deals to close in all of the major asset classes from orange juice to oil and gas, the honours of the first transaction will likely go to the base metals and/or mining industry, he says.

A starring role

ABN Amro is working on a score of new solutions for commodity finance, including a series of end-user financing solutions for the various commodity classes. Some of these have already gone to market.

But for various reasons, metals and mining has become the stage on which banks such as ABN Amro are likely to introduce new products under development.

Many of the trends that are manifesting themselves in the global commodity market, of course, are present in the metals and mining sub-sector. However, as ABN’s new foray illustrates, some of these trends are accelerating even faster in this particular space.

Consolidation of producers, namely, is happening at a rapid pace on a near unprecedented scale. To cite just a few examples, Russian iron ore producer Mikhailovsky GOK and Sokolovo-Sarbaisky GPO, one of the largest iron ore producers in Kazakhstan have agreed to merge, according to news accounts. Assuming the merger receives approval from Kazakh authorities, the deal would represent a 30% share of the iron ore market in Russia. Another Russian metal conglomerate, Norilsk Nickel, the world’s largest producer of nickel, copper and platinum, has been reported to be in negotiations with the Canadian corporation Kinross Gold to sell Polyus, which manages Norilsk Nickel’s gold mining assets.

Over the past few years several new producers have come to market in emerging countries such as the Ukraine and other states of the former Soviet Union. Other companies, many, again in these emerging markets, are modernising facilities and otherwise increasing capacity. At the same time, new supply alliances are forming that include many of these new players. India, for instance, has become a very important player in these alliances.

Indeed the commodity industry as a whole is globalising, Vira says. “Increasingly commodity producers are becoming more global – they are accessing new markets and buyers and sellers in different parts of the world. For us, what that means is that we have to be able to follow our clients in these markets.”

However the acquisition mode of the more established companies is no match for the new supply. “A lot of steel producers, for example, are buying iron ore producers or acquiring coal mines,” says John MacNamara, managing director, structured trade and export finance, Deutsche Bank in Amsterdam.

“They are trying to lock in their supply of raw materials as the commodity price upside potential steadily moves upstream.” On the other hand the thinking on the part of many of the producers making acquisitions of downstream production assets in developed markets, he speculates, is that if trade barriers later develop these acquisitions will serve as a hedge because they will be on the inside. “A good example in this regard is the Russian steel giant Severstal which has bought steel production assets inside both the United States and the European Union, typically producing steel products complimentary to rather than competing with the goods produced by the group’s main operations in Cherepovets.”

Nor is it just the producers that are snapping up related industries. Non-commodity companies in the metal space – automotive firms or soft drink-can manufacturers – are purchasing firms in order to ensure supply. No doubt these are exactly the firms ABN Amro expects to target with its new commodity merger and acquisition product.

“People have made a lot of money in the metal markets in such countries as Russia over the years,” says one banker who did not wish to be identified. “But the consolidation in the copper and aluminum markets in Russia has reduced the number of clients. This is not good for banks – we can’t keep making the same money from half as many clients.”

Lost in translation

But whether metals and mining proves to be a reliable testing ground for the next generation of structured commodity finance products remains to be seen. For various reasons, structures that work well in the metals and mining industry do not always duplicate well to other areas, or vice versa.

John Penn, head of structured commodity finance at Standard Bank, notes that Standard Bank maintains a separate team for mining finance that resides within the resource banking group. This team focuses on financing ‘green field’ medium-term mining projects. “Historically, we haven’t combined our metals and mining financing businesses in the same way that other banks have.” The reason, he says, is that green field financing is quite a different discipline from structured trade. For instance, a far greater degree of technical due diligence is required (eg, feasibility studies, specialist mining reports, etc) to be carried out on the mine and its ability to commence production. In structured trade one would normally only be providing finance to more mature operations that have a proven production record.

Indeed, some bankers contend that the metals and mining sector – among the world’s oldest industries – is so mature that most institutions intuitively concentrate on exporting structures to other asset classes from metals and mining, at least those structures that translate well into other areas.

One banker reports that a hedging product recently introduced in the oil and gas sector has been used frequently in the metals and mining industry for some time.

Conversely, another banker reports disappointment in the number of hedges used in mining transactions lately, given the slight drift back of prices in the space. “I would have thought people would have wanted to lock in prices,” the banker said. “But apparently there are some that still see an upside.” He admits urging clients in the oil and gas industry a year ago to do the same, to little affect then as well. “They thought prices would remain where they were, and they were proven right,” he says.

Different but the same

In other ways, the metals and mining space is mimicking the rest of the commodity market with perfect symmetry. Another reason for the wave of acquisitions in the metals and mining space, for instance, is that producers are loathe to invest too much of their profits in production – to do so would drive down profits. In Severstal’s case, it was rumoured throughout 2004 to be sitting on a cash pile of over $1bn, which for a producer in a relatively mature industry like steel is unprecedented.

Also, for various reasons (see cover story, page 20) institutions are ratcheting up their presence in the commodity area, giving those producers that are looking for financing even further options. GE Commercial Finance’s Energy Financial Services [see 60-second interview, page 10] recently announced two transactions, providing refinancing capital to Oxford Mining Company headquartered in Coshocton, Ohio and a $65m credit facility for CAM Holdings, LLC, based in Pikeville, Kentucky.

“Producers have enjoyed good prices on metals over the past 12 months,” Penn says, “so they are cash-rich and don’t need financing as much”. Those that are still tapping the market for funds are enjoying low financing rates and looser structures. This is largely because there are many banks chasing fewer assets, which in turn drives financing rates down, and country risk is not seen to be as risky as it was say, a year or two back.

Market conditions are tough at the moment for the traditional trade finance banks, but there is a feeling that the bottom of the rate cycle has been reached. So, now, the question is when will financing rates move up?