Kevin Thomson is a senior partner at Davies Ward Phillips & Vineberg and one of Canada’s leading mergers and acquisitions lawyers. He has acted for bidders and target companies in a large number of solicited and unsolicited takeover bids, including RX Gold & Silver’s merger with U.S. Silver, Minmetals Resources’ $6.3-billion bid for Equinox Minerals and its $1.3-billion offer for Anvil Mining and Fronteer Gold in its $2.3-billion acquisition by Newmont Mining. He recently sat down with The Northern Miner for a chat about the M&A market.
The Northern Miner: We have seen a number of takeover bids in recent months. Are you optimistic that M&A activity is picking up?
Kevin Thomson: Cautious optimism is the best way to put it. What I will say is that we have a large number of pending transactions. But many transactions have been pending for a long time. The key question is how many of them will actually get signed and announced. And we’re not unique — I hear the same thing from my colleagues that practice in the M&A area, with a mining twist all over Canada.
TNM: Is it slowing down?
KT: Well, I wouldn’t say slowing down. The M&A market in the last 15 months or so has been slower than historical norms. But that’s talking about deals that get announced. What is more consistent with historical norms is the number of deals that are in contemplation, that are being worked on, where confidentiality agreements have been signed and people are talking. I would say that that part of the activity scale is as high now as it has ever been. There is an awful lot of behind-the-scenes activity. The question is, what percentage of those types of discussions, negotiations and pending transactions will result in a marriage?
I have an active practice in the M&A space generally and in the mining space in particular, but only a fraction of the deals that I’ve been retained on over the years get to an announced transaction. It’s difficult to find a transaction that meets all the metrics for both sides. If the buyer is happy about a deal it typically means the seller is not so happy about the deal, and vice versa.
TNM: A number of takeover offers that are announced fall through.
KT: Yes. It was interesting to see the Inmet offer for Petaquilla Minerals fall apart, and that shows the kind of conservatism that I’m referring to. Inmet put the bid out there at a price it was happy with, but didn’t satisfy their minimum tender condition, and they just let the bid fall away. That’s unusual. Anybody who makes a hostile bid rarely expects it to succeed at the first price they put out the door. But Inmet probably looked at it and said: ‘We’re not going to chase the price, we’re going to be conservative here, and if it means we don’t do the deal now, we’ll wait.’ It’s an example of the conservative thinking we have been seeing in the M&A space, and conservative thinking is not good for activity in the M&A market. You need a bold, strategic vision — that is what drives M&A.
TNM: What are you seeing and hearing about M&A?
KT: I had lunch today with a client in the mining space who said: ‘Hold on to your hat, because deals are coming, and the mining sector is going to be consolidating at a pace we haven’t seen for many years.’ Now who knows if that is right or wrong. It’s just a prediction, and a lot of things could cause it to come unglued, but when you look at the underlying fundamentals that have driven a lot of the consolidation in the sector historically, you can see that after a pause — which we clearly have been in for the last 15 or so months — there is pent-up demand. We are cautiously optimistic that the next 12 months will see an increase in announced M&A in the mining space.
TNM: How big an increase?
KT: A significant increase from the last 15 months. I think that each of our major competitors has a book of business going on right now, just as we do. Talking to colleagues and friends of mine who practice M&A in other major Canadian law firms, it’s a similar story. Everybody has a lot of behind-the-scenes activity going on, the question is, how much of it will hit the front page of the paper?
TNM: So how long will it take?
KT: I’m not talking the next couple of months. I’m looking out past the U.S. fiscal cliff. You get past that, and I think most people are pretty optimistic that they’re not going to let the cliff hit, and if you get past that, Obama is in his last term of office, things are a little more stable, the market is not gyrating by 10% or 15% over 30 days, that’s what you need for people to say, ‘OK, now it’s time to get on with it.’ We’ve been held up for a long time.
TNM: Are private equity players coming back?
KT: We act for quite a number of private equity buyers, and if you went back and looked at M&A activity in 2005–2008, almost 30% of all M&A was private equity buyers. They totally dropped off the map in 2008. It just eviscerated that whole sector of the M&A market. They stopped buying when their access to funding dried up. And what we’ve seen in the last 12 or so months is that private equity players are starting to come back. They have money to spend and they want to spend it. It’s this pent-up demand. You can only hold back so much before suddenly, you’ve just got to move. The mining space is likely to see the same thing: this pent up desire to grow, this pent up desire to replenish production when looking at curves that may show a dip two or three years from now. That pent-up demand is going to get unleashed, and it’s just a question of when.
TNM: Are you saying that in a year we’ll see M&A pick up steam?
KT: We hope earlier than that. We think the next couple of months could remain soft if this U.S. situation remains unsettled, which I think it will be for a while, but hopefully when you hit 2013. And hopefully it’s not the end of 2013.
TNM: What factors are at play?
KT: One of the important themes is that investors are looking for two contradictory things: If you have growth, especially as a producer, you are going to attract a valuation that is substantially higher than a company that is perceived to have low growth or no growth. On the other hand, investors are making it clear that they want yield from companies they invest in, including in the mining space.
Investors historically have not invested in the mining space to achieve a yield on their investment, i.e., cash dividends. But that has flipped in the last several years. Freeport-McMoRan has been a fairly significant dividend payer in the copper space for a long time, but in the gold space, we are seeing increased emphasis on dividends. Barrick has had a dividend for a long time and recently increased its payout. Newmont has a gold price-linked dividend, which is interesting. Goldcorp, Kinross and Yamana all have a dividend. Investors are making it clear that they want and expect cash to be sent back to shareholders as an inducement for investors to own the stock.
So companies have these two competing trains coming at them. They have investors who are looking for yield and investors who are looking for growth. An obvious way to grow is through acquisition. If you’re spending your money developing a project, it goes without saying that you are not going to have much in the way of free cash flow that you can send back to your shareholders. That was one of the key themes that came out of Newmont’s third-quarter press release — that they don’t expect to have much in the way of free cash flow until the end of 2013. And the stock got punished.
Newmont is saying: ‘Look, we have to use our cash to develop our projects, that’s where the future of Newmont comes from.’ So it’s difficult. Putting on the hat of a chief executive or a board of directors who are trying to appeal to a diverse group of investors — some of which are prepared to pay a substantial premium for growth, some of which are screaming loudly that they don’t want companies spending money that could otherwise be given back to shareholders — you really have a bit of a dilemma.
TNM: What challenges are facing junior companies?
KT: In the M&A space there is a lot of talk about multiples. In mining, the metric that is most often used is a multiple to net asset value. And if I was to go back 15 years, the senior gold producers would have a multiple that would exceed two times NAV — 2.1 times, 2.2 times or 2.3 times, depending on the premium valuation that you were getting. Mid-tier producers in the gold space 15 years ago would be 1.5 times, and juniors would be right around flat, maybe slightly less than flat. The multiple compression that has taken place in the mining industry is incredible. In the junior space, some of the multiples that are being paid right now are 0.2 times, 0.3 times and 0.4 times NAV. So imagine you looked at exactly the same company that has exactly the same metrics today as the company had 15 years ago — the company is worth less than half, even though the commodity price may be 300% to 500% higher than it was. It’s staggering. I’ve sat in on a number of presentations to boards of directors of companies we act for in the junior space in the last several months that have been as dour as you could imagine, based on the valuations that are being paid right now. It’s safe to say that valuations of many juniors right now are 50% to 60% of what they were 15 months ago.
TNM: That’s pretty bleak. Is there a silver lining?
KT: Multiples have come down, but there’s a view that that can correct itself over time. That exploration success can drive real wealth creation. And if a junior has a good project — meaning a project that is in a relatively stable jurisdiction and where they’re not hundreds of miles away from infrastructure, and where they have a higher-grade deposit so that they can de-risk the development and they’re not quite as sensitive to cost — there is a strongly held view that those kinds of companies are going to be in strong demand, and that consolidation is going to pick up.
TNM: The rules about foreign takeovers in Canada are unclear when it comes to the test of net benefits to Canada. This may discourage companies from trying to pick up mining assets in Canada. Can you comment?
KT: The Harper government has promised on a number of occasions that it would clarify what the net benefit to Canada test means, especially when it relates to a state-owned company on the buying end of a transaction. But that is a difficult test to articulate because it depends so much on the facts you’re dealing with. It’s a devilishly complicated issue. It’s complicated because following what happened in Saskatchewan on Potash Corp., the provincial premiers, to a person, believe they now have a significant role to play in these types of decisions. So you have the federal government on the horns of a dilemma. Do they devise a prescriptive test about what it means, and if they do, do they need to have provincial consultation? So I’m sympathetic to the difficulties the Harper government has in trying to provide greater guidance as to how the net benefit test will be interpreted.
TNM: Do you think Chinese companies are getting discouraged from attempting to make acquisitions in Canada?
KT: I think the whole situation is difficult for the Chinese as well. What it means for their appetite to make further acquisitions in the mining space, I don’t know. I think that’s yet to be seen. I do know that the Chinese read the commentary in Canada carefully relating to their acquisition activities. And Canada is not unique. China has experienced similar regulatory sensitivities in Australia. The last thing a Chinese enterprise would willingly do is put their name out publicly on a deal that fails to get regulatory approval. So I think they would be waiting for some clarity from Ottawa before they are willing to push the button on any significant deal that requires Investment Canada’s approval.
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