Independent director s cut. Mergers, acquisitions and capital raising in mining and metals 2014 trends, 2015 outlook

Transcription

1 Independent director s cut Mergers, acquisitions and capital raising in mining and metals 2014 trends, 2015 outlook

2 At a glance This paper is one in a series that summarizes the key findings from EY reports from the independent director s perspective. Mergers, acquisitions and capital raising in mining and metals This report examines transactions and financing in the global mining and metals sector and provides our outlook for the year ahead, helping you to consider the implications for your own M&A strategy. In addition, you will find an in-depth analysis of deal trends by geography, buyer and commodity, capital markets, and resulting capital flows.

3 An independent director s perspective Key trends and outlook; buy, build or return? The mining and metals industry exits 2014 battered and bruised, but with an eye on recovery. Volatile commodity prices and an uncertain economic outlook provided the backdrop to a fourth consecutive year of falling deal activity in 2014, while risk aversion and capital discipline among investors and producers alike stymied both the availability and spending of capital. But with the industry set to undergo a period of historic restructuring, a shift in focus toward longer-term growth and value creation is required if companies are to position themselves competitively to take advantage of the global supply rebalancing. We are starting to see if the mining boom was accompanied by a similar lift in mining governance, as more boards are tested. Literally thousands of boards and directors are grappling with low commodity prices, lack of access to capital and constraints on strategic direction, at the same time as a once-in-a-generation opportunity to acquire quality assets. Deal activity has declined for the fourth consecutive year A number of factors contributed to 2014 s anemic deal activity, including: The continued disparity between buyer and seller valuations The misguided perception that M&A is value-destructive An acute focus on return on capital employed, leading to short-term corrective measures A pro-cyclical and very short-term approach to investment A focus by the major producers on existing optionality looking internally, rather than externally, for growth opportunities These factors have combined to create an environment in which neither buyers nor sellers are agitating to do deals, in which it is difficult for management to justify major acquisitions to shareholders, and in which execution challenges and risks are high scorecard: M&A $44.6b of deals completed, down 49% on 2013 down 23% on 2013 Only 11 megadeals (>US$1b) 60% of targets in developed regions, with North America taking the lead Gold, the most-targeted commodity by volume; steel, the largest y-o-y increase in deal value to 544 deals completed, $9.8b Independent director s cut: mergers, acquisitions and capital raising in mining and metals 3

4 Project capital remains largely inaccessible Capital raised by the industry decreased by 15% year-on-year (y-o-y), with a number of factors impeding investment in, and by, the sector: Access to debt capital markets remains largely the preserve of high-grade borrowers, predominantly for refinancing. The absence of equity risk capital is severely impacting junior exploration spend. Uneven economic recovery and divergent monetary policies set the scene for continued volatility in global markets. Perceived misallocation of capital toward organic growth is weighing on sentiment, as increased supply coincides with lower demand growth. Many producers remain focused on near-term operational improvements and deleveraging, with limited appetite or capacity to raise new debt for projects or M&A. Some investors may also consider opposing director elections based on poor oversight of capital raisings. Underwriting of Rights Issues Australian Council of Superannuation Investors June 2014 Boards and their directors need to consider the risks in capital raisings not only the alternatives but also where these may limit future funding options. This is creating a complex and challenging funding environment for developers who have been forced to seek funding from multiple providers and structures scorecard: capital raising $230b capital raised, 15% y-o-y fall $27b equity proceeds, down 24% 15% project finance share of $152b of syndicated loan proceeds 17 IPOs, a drop of 94% vs. pre-global financial crisis peak The proceeds from 57% of capital raisings were for less than $1m, which is barely enough to fund a six-month exploration program. This means that during the year, many of the 1,230 equity issuers will need to go back to the capital markets to raise funds. Boards of these struggling juniors have a great responsibility to ensure shareholders are not excessively diluted. 4 Independent director s cut: mergers, acquisitions and capital raising in mining and metals

5 The industry is set for major restructuring in 2015 The strategic imperatives that compelled some companies to undertake deals in 2014 are primed to intensify in 2015, setting the scene for new competitors and diverging business models. Sell-side: Distressed selling Portfolio optimization Buy-side: Private capital buyers Supply security government and trading houses Joint ventures for synergies and risk mitigation Positioning for the next wave of growth The question remains as to when the major producers will have both the confidence and permission to invest in the next wave of growth. But standing still is not an option, and companies face the challenge of building portfolios that can best cope with volatility and take advantage of the opportunities it presents. The bright line indicator of a single capital allocation strategy for the industry has disappeared. But whichever path is pursued whether build, buy or return capital successful evaluation and execution of that strategy will be critical in the face of emerging competition from those brave enough to invest now for the long term. Independent directors should be thinking about what combination of build, buy or return will maximize shareholder value over all parts of the mining and metals cycle. The company needs to anticipate the future of cyclical opportunities and risks and build it into the business strategy. Note: The data is primarily sourced from ThomsonONE. $ refers to US dollars. Independent director s cut: mergers, acquisitions and capital raising in mining and metals 5

6 Role of the independent director today The role of the independent director in organizations considering or undertaking mergers, acquisitions and capital raising is one of an independent, objective and trusted adviser around two key strategic areas: Deal rationale While the independent director s role is typically seen as centered on the execution of a transaction (be it a corporate deal or a fundraising), now it also increasingly encompasses strategy and the impact of capital allocation decisions buy, build or return on the underlying performance of the company in question. A strong board is a valuable and critical sounding board for management when it comes to strategy. It provides an independent view on the risks involved in pursuing a particular strategy and, more importantly, helps management broaden its thinking beyond a single transaction and across the various options available. Independent directors often hear from shareholders at the bottom of the cycle that M&A destroys shareholder value. In examples quoted, pro-cyclical exuberance is often to blame for these instances; however, the vast bulk of M&A does add to shareholder value. Our view is that M&A failures have a number of lessons for boards, which are: Not prepared or confident enough to act quickly when the right opportunity arises, especially when counter-cyclical Acquiring a good business not aligned to strategy Not insisting on real due-diligence rather than boilerplate due diligence Focusing on commercials and ignoring culture and leadership capability Not setting up executive accountabilities and measures to extract synergies and full value from a deal Allowing the executives to get trapped in the emotion of a deal that becomes a juggernaut Not getting independent advice unfiltered by management Not aligning the capital structure to match the merged organization but taking whatever capital is available Deal execution The role of independent directors in a major transaction is critical. Typically, some or all of the independent directors will form an independent committee (IC) that ultimately holds the responsibility of recommending the transaction to shareholders. The importance, therefore, of fully understanding the dynamics of the transaction, cannot be underestimated. While independent directors may seek independent advice on particularly large or difficult transactions (e.g., a deal involving a related party or distressed asset), often the committee will rely on the advice provided to management by external advisers. A key part of the committee s role is to test the adequacy of this advice and the validity of the conclusions drawn. Concerns are often centered on the following three key areas: 1. Value Whether the transaction relates to a divestment or acquisition, of central importance is the underpinning valuation get this wrong and ultimately shareholders pay the price. One of the key areas that the IC concerns itself with is, therefore, how the valuation has been derived, and if it is appropriate. This may be as simple as diligence over, and questioning of, management assumptions around valuation and sensitivities thereon, or as formal as requesting an independent expert to provide an independent valuation report. 6 Independent director s cut: mergers, acquisitions and capital raising in mining and metals

7 The insights provided by an experienced and strong board can be incredibly reassuring for management in such situations. Valuation is not an exact science, and having knowledge of prior situations is a distinct advantage. This may extend beyond the pure valuation, to include structuring around how consideration is paid, the way in which the sale and purchase agreement (SPA) is structured to manage deal leakage, and suitability of working capital and financial leverage. 2. Contractual obligations It is rare that a transaction provides an entirely clean change in ownership, with certain contractual obligations often continuing between the vendor and purchaser after the transaction. Additionally, even with a clean transfer of ownership, the underlying contractual arrangements between suppliers, finance providers, employees and other stakeholders require careful management. The IC plays a critical role in challenging and questioning such contractual terms specifically, whether any of the posttransaction agreements present unnecessary risks to the ongoing business, or are overly generous in order to help a transaction through at the cost of future earnings. The remuneration packages of senior management (both existing and those coming across), in particular, are a key focus for the IC, given the need for unbiased and independent views in this respect. 3. Reputation Ultimately, even if a transaction is seen as value-accretive and has passed appropriate scrutiny in respect of its structure and post-deal contractual obligations, there is a further reputational question that needs to be asked: Is this a deal we should be doing? This is perhaps the hardest part of the role for the IC, as ultimately the decision to recommend or otherwise can hinge on a very subjective determination of facts presented. Part of it plays to general governance but there is also the question of strategic direction and understanding of what the company stands for and expects to deliver to shareholders. Independent director s cut: mergers, acquisitions and capital raising in mining and metals 7

8 Considerations for independent directors Strategic direction Establish whether the organization s investment strategy is pro-cyclical, long-term or political Scrutinize all alternative uses of capital before making a final decision Provide creative and constructive challenge to management to broaden its thinking beyond the specific transaction Risk Establish the organization s risk appetite and how this influences decision-making for example, investing in emerging regions versus lower-risk, developed economies Consider risk-mitigation options such as joint ventures and divestments Scrutinize the valuation test the adequacy of independent advice and the validity of the conclusions drawn 8 Independent director s cut: mergers, acquisitions and capital raising in mining and metals

9 Governance Monitor performance of management with regard to progress against strategic objectives post-transaction Review forecast data; liquidity and cash flows; and quality of internal controls, including fraud, anti-bribery and corruption controls Identify new areas of responsibility e.g., oversight of international operations, litigation and investigations, cybersecurity and the impact of political shocks Provide insight over impacts on valuation e.g., consideration structure, value leakage and financial leverage Review and challenge remuneration packages of senior management (both new and existing) Stakeholder management Communicate strategic direction to the board, shareholders, analysts and media Ensure compliance with latest industry regulations e.g., government payment disclosures, conflict-free minerals Identify and address reputational threats arising from the transaction Manage post-transaction obligations between the vendor and the purchaser, as well as between suppliers, finance providers, employees and other stakeholders Independent director s cut: mergers, acquisitions and capital raising in mining and metals 9

10 EY s Global Mining & Metals Center With a volatile outlook for mining and metals, the global mining and metals sector is focused on margin and productivity improvements, while poised for value-based growth opportunities as they arise. The sector also faces the increased challenges of maintaining its social license to operate, balancing its talent requirements, effectively managing its capital projects and engaging with government around revenue expectations. EY s Global Mining & Metals Center is where people and ideas come together to help mining and metals companies meet the issues of today and anticipate those of tomorrow by developing solutions to meet these challenges. It brings together a worldwide team of professionals to help you succeed a team with deep technical experience in providing assurance, tax, transactions and advisory services to the mining and metals sector. Ultimately it enables us to help you meet your goals and compete more effectively. Area contacts Global Mining & Metals Leader Mike Elliott Tel: michael.elliott@au.ey.com United States Andy Miller Tel: andy.miller@ey.com EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com EYGM Limited. All Rights Reserved. EYG no. ER0232 BMC Agency BACS ED None This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice. ey.com/miningmetals Oceania Scott Grimley Tel: scott.grimley@au.ey.com China and Mongolia Peter Markey Tel: peter.markey@cn.ey.com Japan Andrew Cowell Tel: cowell-ndrw@shinnihon.or.jp Africa Wickus Botha Tel: wickus.botha@za.ey.com Commonwealth of Independent States Evgeni Khrustalev Tel: evgeni.khrustalev@ru.ey.com France, Luxemburg & Maghreb Christian Mion Tel: christian.mion@fr.ey.com India Anjani Agrawal Tel: anjani.agrawal@in.ey.com United Kingdom & Ireland Lee Downham Tel: ldownham@uk.ey.com Canada Bruce Sprague Tel: bruce.f.sprague@ca.ey.com Brazil Carlos Assis Tel: carlos.assis@br.ey.com Chile Lachlan Haynes Tel: lachlan.haynes@cl.ey.com Service line contacts Global Advisory Leader Paul Mitchell Tel: paul.mitchell@au.ey.com Global Assurance Leader Alexei Ivanov Tel: alexei.ivanov@ru.ey.com Global IFRS Leader Tracey Waring Tel: tracey.waring@au.ey.com Global Tax Leader Andy Miller Tel: andy.miller@ey.com Global Transactions Leader Lee Downham Tel: ldownham@uk.ey.com