Shiny new people

Commodity finance in the metals industry is as strong as ever. But metals producers are turning to private equity and other capital sources to bridge gaps in their capital stocks. Amanda Greene reports.

Recently Metalux Limited, a specialist steel company, found itself in very predictable straits. High demand for its products, namely from ongoing development in China and India, had resulted in some difficulties in keeping up with orders.

It turned to its bank, Royal Bank of Scotland (RBS), for relief. And the bank, eager to keep a profitable client in a red-hot market, was happy to comply.

RBS was able to help it improve its cash flow by developing a bespoke facility that allowed Metalux to maximise its trading patterns.

Conventional means typically used to advance working capital were not possible, as they did not fit Metalux's modus operandi, explains Catherine Adair-Faulkner, director, international cash management sales at RBS. “We structured the deal in a unique way that allowed the company to maximise its working capital cycle.” By using a bespoke facility, RBS was able to advance funds significantly sooner in the process than it would have under a typical letter of credit (LC), she says.

In order to satisfy the banks’ credit team, warehouse warrants were also used to charge the steel to the bank while in a designated warehouse. This involved a great deal of due diligence of the type of steel, both current market conditions and conditions projected for the future and the warehouse issuing the warrants. The bank also needed to establish that the warrants could sit alongside an existing security package and if called upon would be enforceable.

“It was the first time we had ever structured a deal like this for a client,” Adair-Faulkner says.

Beyond trade finance

As RBS’ example makes clear, trade finance providers are ever more willing to stretch the envelope to keep their metals and mining producer clients happy.

But some in the industry are wondering if capital market financing in the metals sector will follow the same trends that have developed in other high-flying commodity areas, such as oil. In those sectors, some producers are reporting that banks have been unwilling or unable to accept changing price paradigms, making it difficult for producers to acquire new reserves or finance new acquisitions (see Trade & Forfaiting Review, ‘Shifting Dynamics’, February 2006, page 39) if they were to rely on debt alone. These firms have been forced to turn to private equity to bridge the gaps. This has been true in particular of junior companies.

Oversupply of capital

Fortunately, the metals and mining producers in the North American markets have been inundated with a wave of new capital. Institutional and individual investors are seeking returns outside of the stock markets and as a result are sinking cash into real estate and commodities – two areas that historically have little correlation to the stock market. Metals producers in particular have turned to private placements as a way to fund trade, to fund operations and even future acquisitions and other investments.

More capital is available for private placements in the metals industry because there is an oversupply of capital in the hands of private equity managers, says Brodie Cobb, CEO of Presidio Financial Partners, an investment bank in San Francisco.

"$100 billion was raised last year in private equity," Cobb says. There is no end in sight and the excess is seeping into every nook and cranny in the economy."

According to PrivateRaise, a financial content provider, energy, followed by metals, minerals and stones were the most active sectors for private equity last year. In the metals category, the company reported 113 transactions totaling close to $9bn, with each transaction averaging $7.9m.

“We are finding private equity to be very aggressive and very creative in terms of figuring out a way to get capital deployed and a transaction done,” Cobb says.

Complementary roles

In some cases the new equity is complementary, or to be more accurate, irrelevant to banks’ product lines. Many banks, for instance, offer acquisition financing for commodity producers to support these firms’ voracious appetite for new source materials. Last year, for example, ABN Amro rolled out a new service called acquisition pre-export finance, focusing first on the metals industry.

But not every company is large enough to take advantage. Nonetheless, they still seek out acquisitions. To name just one example hoping to capitalise on the recent run-up in the price of silver, Valencia Ventures, a Toronto-based Canadian resource company listed on the TSX Venture Exchange with a focus on the exploration and development of quality precious metal (gold/silver) opportunities worldwide, has been seeking out potential acquisitions in South and Central America. The company plans to raise up to $2m by way of a non-brokered private placement.

Cobb also notes private equity is shifting to encompass a broader spectrum than before. “Investors will dip down into earlier stage financing, go into industries or sub-sectors they haven’t been in before and take a minority position in a firm.”

A metals producer thinking of monetising its assets, “will find that it doesn’t get much better than this”, he says.

For banks as well, times are good for this niche. Despite the competitiveness, debt-to-equity ratios are remaining largely the same, with traditional capital structures still intact. Unlike other commodity sectors, such as oil, “Banks are not having to stretch as much,” Cobb says. At the most, he adds, there might be a little bit of a stretch at the upper end, where the banks become super competitive in levering these transactions. But that has traditionally been the case – even when commodity prices were not at the sky-high levels that they are today.

Factoring IP into a metals M&A

Patents, as most in the industry know, play an important role in metals manufacturing. In an acquisition they are considered a key asset that can be monetised. “Generally banks are pretty clued into the due diligence they must perform to value patents correctly,” says Joe Berghammer, a partner at the Chicago, Illinois office of Banner & Witcoff, a boutique intellectual property firm.

But as cross-border acquisitions of metals manufacturers and producers grow, bankers and acquiring companies need to be aware that there are tax ramifications to acquiring these assets, as well.

“Governments address the tax issues surrounding IP in different manners,” says Berghammer. “So a bank may not recognise there are potential landmines in an acquisition unless it is tying tax and IP issues together.”

One structure that has come under fire is investment holding companies, typically based in a low tax locale, which buy a patent and then license it back to the company. Many governments, including the United States, have begun questioning the validity of investment holding companies’ maintaining the license. They are demanding that the license revenue be subject to taxation under the previous regime, Berghammer says.

China in ten years

Another IP issue that could affect metals M&A – or rather, vice versa – is the investment flows into China and India. China, in particular, is not known for its rigorous IP protection regime. But Berghammer and others believe that will change as China’s economy becomes ever more incorporated into the global marketplace.

“Forward looking companies believe China will continue to grow – including its own manufacturing base – and within ten years will begin to see the value in strengthening its own IP laws.”

Acquiring a company for its patents, or taking out a patent in China now might be considered a waste of time and money. “But in ten years’ time, they will be valuable.”

Berghammer says this is a topic of interest in the steel industry in particular. “These companies are thinking more about China and how they would like to be positioned in the country in the coming decade.”