Mining in Africa Six keys to success

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1 Mining Insight Series Mining in Africa Six keys to success Edition 1 Mining in Africa Six keys to success The changing nature of operating models for mining in remote locations There s no doubt about it, Africa is hot as a mining destination for Australian companies looking for continued growth. The relatively untapped Continent is experiencing a renaissance and presents some of the best investment mining opportunities in the world over the years to come. Over the last six years (2005 to 2011) the number of Australian companies with projects in Africa has nearly tripled and almost one in five Australian resources companies now have their primary asset located in Africa. Australia is competing in a global stampede into the Continent 143 new African projects commenced in 2010 and many more (mostly exploration plays) have been added since the start of In the search for boosted returns and faster growth, Australian mining companies must enter this vast, diverse and exciting market with their eyes wide open. It is somewhat naïve to think of Africa as one investment destination. The Continent has 55 countries and there is enormous diversity between the political, legal and investment structures of these jurisdictions. As a result, investors need to appreciate that the risk is not equal across Africa it s vastly different between borders. Africa has woken to the fact that its abundant resources are key to its long-term growth and prosperity. African nations are keen to benefit from their resources and real rises in standards of living are taking place as a result of heightened mining activity, along with rapid changes in government policy and regulation. A deep and fundamental understanding of the jurisdiction in which you are operating, through on-the-ground knowledge, expertise, relationships and true collaboration is critical for mining success on the Continent. At a glance Africa is not one investment destination, but a Continent of 55 countries with vast differences in political, legal and investment structures. A deep and fundamental understanding of the jurisdiction in which you are operating is critical for success. Deep and broad community engagement is vital community groups may not necessarily agree with each other on all issues. You need a detailed plan for skills and knowledge transfer to local communities before you enter a country. Expect to pay for and build the infrastructure required for an operation in a remote location. Management needs to be on the ground, not managing from the country s capital city or from overseas. Know your legal rights regarding the security of your tenure. Resource nationalism is a reality you need to factor into your business plan. Labour issues and union militancy are expected to increase. Develop a robust plan for managing facilitation payments. Capital is constrained and markets are favouring good management teams with proven ability, as well as operations with an upfront source of cashflow.

2 2 Mining in Africa Six keys to success 1. Real community engagement Australian companies going into remote locations need to understand the cultural sensitivities of the various tribes and people on the Continent. They even need to understand that, like any part of the world, because a country has certain borders, it does not mean that communities and various levels of government within that country will necessarily see eye to eye on everything. You cannot go into the Democratic Republic of the Congo (DRC), for example, set up shop in Kinshasa, and think you understand what s happening on the ground, when your mine is located more than 1500km away in the Katanga province close to Lubumbashi. You could have no handle at all on the real community issues because there could be a complete divide between the thinking of government and provincial areas in the Kinshasa jurisdiction versus those of Lubumbashi. Africa s borders of countries have been established as a result of colonisation which has not take into account tribal divide and different tribal and community issues in various jurisdictions. This is the basis of many modern-day conflicts (North and South Sudan, Nigeria and Rwanda to name a few). Community issues need to be deeply understood. Proper community engagement and a solid plan for skills and knowledge transfer In remote locations there is a transfer of operational knowledge that needs to occur from overseas experts to local expats, and then to local communities. Mining operators who dictate terms to communities will not be successful on the Continent. Communities need collaborative engagement otherwise operators may be stalled or locked out. Most countries now require a plan for up-skilling of the workforce and the transference of knowledge. Developers and operators must have this plan established before they go in, rather than working it out when they get there, or talks are likely to cease altogether. You need to be upfront with community leaders in stating that you re coming in with expats when outlining your detailed skills and knowledge transfer plan. Indigenous partnerships are now widely being undertaken to support this. Infrastructure and the community If you enter Africa and start a project in a remote location, the infrastructure you would expect is either unlikely to be there or is often not at the standard required for a mining operation. You cannot expect the government or provincial government to build all the required infrastructure, despite the obvious community benefits. There are two main reasons for this:

3 Mining in Africa Six keys to success 3 1) Many governments want to see genuine commitment from the mining companies and they are also cautious about investing in infrastructure for projects that may not give back to local communities. 2) Most governments often don t have money to spend on infrastructure. Even before the global financial crisis many African nations were highly indebted, and many have large loan commitments to pay back to organisations like the International Finance Corporation (IFC) and the World Bank. Your development plan, therefore, may need to incorporate the full pit to port solution that caters for infrastructure as well. If you want to build a coal mine in Mozambique, you may well need a plan in place to build a rail line down to the port and you may have to build the port as well. There are many success stories of mining companies establishing operations in remote locations where there has been no infrastructure in place. These companies have often extensively engaged the community in which they operate to achieve this success. A notable example is Toronto-based Iamgold, which in the early 1990s as a junior exploration player entered into one of its first joint ventures with AngloGold Ashanti in Mali. Iamgold then conducted other joint ventures and over time made its own small, growing investments. Today, Iamgold produces over a million ounces of gold around the world with Africa a key part of its strategy. Iamgold and AngloGold Ashanti s first mine was developed in Mali, 500km away from Bamako, the capital of Mali. The nearest town, Kayes, is situated approximately 80km north of the mine. There were no roads constructed, so Iamgold/AngloGold Ashanti built the road. There was no water, so they built a 70km pipeline to the Niger river and a water purification system, then trucked in diesel, using a series of generators and diesel storage facilities to generate power. The mining operation encroached on an existing village, so they relocated the whole village and built them a complete new village nearby. In addition, they built a village for the mining team with 500 houses, a recreation facility, a school, a clinic (which became Mali s best in-country clinic) and other social infrastructure. This is just one example of what you need to do to stay in business in Africa and successful companies are realising this. African culture dictates that, when it comes to investment, development and policy, there is an ongoing dialogue that is not necessarily fixed with certainty, nor transparent. Notions of equity, fairness and order are different from the euro-centric way of doing business. If you want to build a coal mine in Mozambique, you may well need a plan in place to build a rail line down to the port and you may have to build the port as well.

4 2. Operating on the ground Relationships, government, contractual arrangements More and more Australian companies are shifting their people and other resources closer to projects and local partners. Today, mining companies simply cannot successfully manage a mining project in Africa primarily from a base in a city overseas such as Perth, Denver or Toronto. Historically, mining companies would set up a very small team in-country and try to manage the operation from abroad, however, many have found that they cannot operate and deal effectively with government and communities in remote locations under this model. In addition, governments across the Continent do not want to do business this way. They increasingly expect to see the mining company management team on the ground. They want to see real commitment to the community and they can be suspicious of companies which have one small in-country office with one country manager and all the key decision makers flying in and out. KPMG has seen a distinct migration of those mining companies bringing more and more of their management team onshore and onsite. For example, the British CEO of a successful mining operation in Africa has a home in Mauritius but spends around nine months of the year on the Continent at the various operations of the company. Being on the ground has many advantages, including the ability to understand the local feel, the lay of the land, and therefore being more likely to see regime and regulatory changes coming and to plan well for them. Many in Africa were caught by surprise over the Mali Tuareg Rebellion in 2012, when in March the president was ousted in a coup d état yet many mining companies on the ground in Mali realised months beforehand that this was a real possibility. If you re not on the ground, you can get caught out, not knowing how to react. Your relationship with all areas of government remains critical Companies need to be aware of intragovernment silos. Many believe they have a strong government relationship because their connection with the mining ministry, for example, is exceptional and they have a number of dispensations to do business in that country. However, this is just one ministry and another ministry, such as tax or finance, may veto the dispensation if they did not agree to it. You therefore need to understand the government s decision-making process and structure and build your relationships not only with one ministry, but across multiple ministries aiming to build an integrated network of relationships. The importance of getting your initial agreement sorted Mining companies entering remote locations in Africa need to understand the tax rules, regulations and other government arrangements in the jurisdiction and that arrangements in place can change at a moment s notice. Many African countries are quick to invite in foreign investors, waiving a number of taxes, providing tax holidays through stability or convention agreements, etc. However, four or five years down the track, companies can end up in robust debate with the government about whether their stability agreement has come to an end, or whether changes such as new tax laws override the agreements in place. This is especially prevalent in countries where there has been a change in government, or where substantial tax reforms have taken place. The new government was not the one that invited a company in, or granted it tax waivers, and so it may not feel compelled to support the actions of the previous government.

5 Six keys to success for mining in Africa 5 A government may also change its regulation retrospectively, with a new act overriding initial stability agreements. This can be exacerbated by slow, ineffective and under-resourced government departments and poorly-managed licensing regimes. These occurrences can cause instability to mining operations and, subsequently, return on investment. The only way companies can manage that process is by: 1) having people on the ground with established contacts; and 2) intimately knowing how these countries operate in order to negotiate effectively with government. The security of your tenure understanding your rights Being on the ground and knowing the lay of the land is not enough to operate successfully. Companies need to understand their legal rights when operating in remote locations and the legal recourse available to them if the security of a tenure changes overnight. We have seen many cases where companies lose their license and are forced out of the country. They thought they went through the correct process they applied appropriately for a mining license and it got awarded only for that mining right to be taken away after two to three years following large capital outlay. A notable example is First Quantum losing its license in the DRC and ENRC being awarded that license. Ultimately, after mounting a challenge across three continents, a legal settlement occurred with First Quantum receiving US$1.25 billion and it s uncertain as to whether this was enough to cover the investment already made. Every country in Africa has different tax and mining rules for the awarding of mining licenses, many of which lack specific details and may be archaic (some mining laws and applications date back to the colonisation era). Because little guidance is provided, there are significant elements of ambiguity and rules can be open to interpretation. In response to a desire to attract investment, reduce sovereign risk and retain revenues, many governments are in the process of substantially adding to their tax and mining laws, revamping them to bring them into line with modern day trends. Engaging with in-country legal, advisory and tax professionals where experts are based on the ground is essential for companies to understand the nuances of a country s legal system. Equally important is to use lawyers and advisors in Australia (or linked to Australian experts) to corroborate work performed in Africa to ensure it is aligned with Australian standards. Companies need to understand their legal rights when operating in remote locations and the legal recourse available to them if the security of a tenure changes overnight.

6 6 Mining in Africa Six keys to success 3. Resource nationalism Get used to it

7 Mining in Africa Six keys to success 7 Not a day passes without an African country talking about tax reforms or extra equity interest. The shifting goalposts as governments seek to reap the benefits of their country s resources creates challenges for the progress of projects and securing finance. Australian mining companies should be creating some kind of buffer in their business models for Africa to take into account swift changes in government policy. Africa is much more politically stable than years ago, however, political instability remains to this day. Even in countries that we perceive to be safe havens, such as West Africa, there has been volatility. There is a continuous ebb and flow of uprising and community issues in Africa that can result in changes in government. It s a fluid investment environment and operating models need to have this flexibility built in, both in terms of costs and timing. Project delays on the Continent are generally caused by two primary issues resource nationalism and volatility in the global economy. Resource nationalism as a global phenomenon (through mechanisms such as royalties and tax regime changes) is making investors more cautious. For example, mining investments being made in South Africa have stalled due, in part, to uncertainty caused by the calls for nationalism of the industry. As a result, other countries such as the DRC, with arguably more uncertainty when it comes to security of tenure, are being favoured for mining investment. Equity interest requirements by some governments are another form of resource nationalism. The sudden spikes in demand for equity interest, even in democratic countries, are contributing to increasing operating costs. Upon election, Zambia s new government sought to impose additional royalties and is now looking at an equity interest up to about 25 percent for new operations. Namibia is considering changing its investment landscape and introducing some form of required equity interest. Guinea recently announced that it wants 35 percent equity interest. Zimbabwe has announced the Indigenisation and Economic Empowerment Act where all companies have to be 51 percent owned by local Zimbabweans they have therefore effectively nationalised all of their industry. Mozambique, with its large coal deposits, is now considering additional taxes and equity interest requirements. Ghana has also declared substantial tax changes recently. In November last year it announced a rise in company tax for miners from 25 to 35 percent, and the imposition of an additional 10 percent tax on windfall profits, among other measures. Many mining companies were caught off-guard by the plans. Not a day passes without an African country talking about tax reforms or extra equity interest (with no payment in return) or additional royalties. This can have a serious impact on any mining company s cash flow model and investment decisions.

8 4. Labour Costs on the rise and the fight for talent Investment in a skilled labour force in Africa comes at a large price There is an acute shortage of skilled labour across the Continent in all industries. From a mining perspective, the shortage is even more heightened and this will remain the case for many years to come. Africa is not a working environment that is generally a preferred destination for skilled professionals. It competes with countries such as Chile where weekends can be spent at the sea or skiing, and Australia, where workers have fly-in-flyout arrangements. Companies going into Africa need to factor in paying top dollars (above that paid on other continents) for these skilled professionals, including engineers, metallurgists, and geologists. The other challenge companies can expect is holding onto their skilled workforce, even expats who have returned home. Returning expats knowledge and skill sets, but transient There is a trend of African citizens who have been educated overseas returning to their country to work. However, the more skilled these professionals become, the more marketable they are and in general they tend to move easily on the Continent. Although for many there is an element of loyalty back to the community, remuneration plays an increasing role in choosing where to work. Rising labour costs uncertainty and aggressiveness on the rise Given labour supply is such a big issue in Africa, we expect to see more militancy from unions across the Continent in the coming years. South Africa has recently seen some strikes that have turned violent strikes at platinum mines in 2012 have resulted in the deaths of a substantial number of workers. Workers are looking to address a legacy issue in the industry where unskilled labour were paid meagre wages. They are also looking at current wage levels of projects in other countries on the Continent where people are being paid more to do the same work. Company cash flow models therefore need to factor in labour increases above CPI a cost that may become unsustainable in the longer term. The skilled labour force does understand the labour issues and the competitive nature of the industry. The unskilled labour force on the whole, however, tends to focus on the short-term gain of the employees rather than the long-term sustainability of the mining industry.

9 5. Facilitation payments A 2011 KPMG Global survey 1 of British and US business leaders found that seven in 10 executives believed there were places in the world where it was not possible to do business without engaging in bribery and corruption. Although an issue across many mining jurisdictions around the world (and indeed across other industries), facilitation payments and issues associated with corruption are pervasive across the Continent. Companies need to understand that it is a reality of doing business in parts of Africa. US legislation recognises this and permits facilitation payments if they are recorded. However, stringent new UK legislation criminalises facilitation payments. The net extends beyond cash payments to practices such as paying inflated rates for goods or services owned by influential individuals. These new UK laws make it illegal for mining companies to not only offer or receive bribes, but also to fail to prevent bribery, even by third-party service-providers. Only businesses with adequate procedures to prevent bribery have a defence. Penalties for breaches are high and include jail terms for company directors. 1 KPMG Global Anti-Bribery and Corruption Survey 2011 The UK laws have global reach and pose substantial risks not only to miners listed in Britain, but also miners doing business around the globe. Meanwhile, Australia is reviewing its own anti-bribery legislation, although historically, Australia has been much less active than the US in enforcing anti-corruption laws. However, this is changing. There are many significant initiatives on the Continent to try and stamp out these practices, such as the Extractive Industries Transparency Initiative (EITI), but these practices are still occurring. This subject creates a challenge for companies in developing a robust approach to managing facilitation payments, bribery and corruption in their business models. Getting your strategy wrong can cause significant reputational damage. It is not as simple as saying that your code of ethics means you make no facilitation payments the reality in some countries in Africa is that if you re not prepared to make facilitation payments, you will simply not be able to do business. You need a workable solution. If you re going to go into Africa, you must understand your legislative exposure (FCPA or UK), have your anti bribery and corruption framework in place and include parameters for dealing with the various situations which may arise, including those situations that are lifethreatening. Getting your strategy wrong can cause significant reputational damage.

10 10 Mining in Africa Six keys to success 6. Capital considerations Australian, Canadian and UK public markets are generally closed for equity raisings in the current economic climate. At the same time, corporates are looking to take on more risk to diversify their investments and are considering higher-growth emerging markets such as Africa and South America. While it is not easier to raise money for projects in remote locations, the success of companies that invest overseas has historically been significantly greater than those operating in Australia alone, and is forecast to continue to be greater. There are countries in Africa and South America that couldn t be accessed over the last years due to political turmoil and they are now opening up to opportunity. The hot spots in Africa attracting large amounts of investment right now are Mozambique, Guinea and Liberia, with continued significant investment in countries like DRC, Zambia and Botswana. The importance of a good management team What the market is prepared to fund now are projects that the management team can operate well. Investors are looking at operators with a proven ability to explore, develop and operate mining assets. This is the case for both debt and equity, where institutional investors are very keen to meet and understand the management team. A good management team is critical by the time a company receives debt funding, their operation is mapped out and, save large unknown factors, from that point one of the ways it can fail is through poor management. Markets are also no longer just looking at spruiking that you will succeed. The days of garnering enormous success from an IPO are over, for now. While there will always be demand for quality assets, the appetite for large, speculative plays is decreasing. There are so many attractive deals on the market at the moment with good management teams in place that investors don t need to take a punt. Focus on cashflows Because companies struggle with going back to the market for funding in this capital constrained environment, having an upfront source of cashflow within an operation is highly prized. There is a strong focus on cashflows entering into production as opposed to pricing calculated on multiples. Instead of a sole exploration play, mining companies and investors are looking at assets with short term cashflows to supplement exploration. This can include projects with tailings nearby, which can provide somewhat instant cash to reinvest into exploration. Overall, there is a trend away from pure exploration-driven valuation towards operation-driven valuation coupled with exploration/blue sky. Therefore rather than just the speculation that a company might find something and possibly get it into production (without the substantial risks infrastructure presents) or sell it to a BRICE nation valuation is increasingly being attributed based on the capabilities of management to deliver effective commercial production, infrastructure solutions (both existing and to be

11 Mining in Africa Six keys to success 11 What the market is prepared to fund now are projects that the management team can operate well. constructed), the assessment of CAPEX, the ability of the company to source, as well as the very important resource-insitu assessment. Private equity activity with vulture funds set to swoop While public markets are flat, we are now starting to see a major push by private equity companies (and other private investors) into the mining sector, both in Australia (e.g. Pacific Road, The Sentient Group, RSC) and internationally. Private equity funds are being raised in the vicinity of up to US$1.5 billion each. These investors will look anywhere for a good opportunity, with Africa and South America currently being the darling destinations. For some investments, they will look to secure an asset and then wait a number of years before taking it to market. There are many buying opportunities on-market, with some gold companies trading at a P/E ratio of 2:1. We believe there will be an emergence of experienced, cashed up vulture funds which will pick off the best in the resources sector through both friendly and hostile takeovers. We expect some will be large transactions, in the vicinity of US$ million. These transactions may cause some industry backlash, but underlying some of these deals are many disgruntled shareholders who want to retrieve their investment from illiquid securities. It s a good buying time, as long as you know what you re doing. Rewards still worth the risks Ultimately, for companies that have the capital, we believe the rewards of mining in remote locations in Africa are still worth the risks. Africa houses the bulk of the world s mineral resources and will remain mineral rich for decades. If you seek the right advice on doing business on the Continent, if you can engage communities collaboratively, and if you can appreciate how the landscape might change from a political viewpoint (and be flexible enough to adapt your operating model accordingly) the road to success becomes a lot smoother.

12 12 Mining in Africa Six keys to success KPMG s Australia Africa Corridor KPMG in Australia has recognised the strategic and commercial importance of the African region to the mining and broader resources industry and has worked in conjunction with KPMG s strong Africa practice to establish the Australia Africa Corridor. The Corridor is our response to an overwhelming market need to bring together a network of resources, both here in Australia, and most importantly on the ground throughout Africa, to work together to resolve the challenges and magnify the benefits of exploring and operating in Africa. The Corridor comprises people from a variety of backgrounds, cultures and experiences, across countries in Africa, who work daily with resources organisations, many of whom are led from Australia. They work in conjunction with our team in Australia, which includes professionals who herald from Africa or have lived and worked in that region. The underlying principle that drives the Corridor is to bring together people that understand living and operating in Africa and translate that into tangible strategies for Australian companies to deliver success in the region. Contact us Helen Cook National Partner Energy & Natural Resources KPMG in Australia Greg Evans Partner Energy & Natural Resources KPMG in Australia Michael Bray National Chairman Energy & Natural Resources KPMG in Australia Ian Kramer Partner Energy & Natural Resources KPMG in South Africa This publication is intended only to provide a summary of the subject matter covered. It does not purport to be comprehensive or to render specific advice. No reader should act on the basis of any matter contained in this publication without first obtaining specific professional advice. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, ( KPMG International ), a Swiss entity. All rights reserved. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. August NSW_N09958MKT.