Growth Strategies for the Mining Industry: acqusition or exploration?
Executive
Summary & Table of Contents
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Mineral deposits - the core assets of the mining industry - are by nature finite. Therefore mining companies must replenish ore reserves on a continuous basis in order to maintain output. For example, U.S.-based Newmont Mining produces about four million ounces of gold every year. Just to maintain the reserve base that supports this production, the gold producer must find or acquire an average of closer to five million ounces on an annual basis. That challenge alone is daunting, given the scarcity of deposits of this size but mining companies, particularly in the North American and Australian gold sector, must not only replace production but also respond to shareholder demand for growth in both output and reserves.
There are only two ways in which mining companies can meet this demand for growth: exploration or acquisition. Some growth strategies, such as that of Newmont, emphasize exploration because it is cheaper and more easily planned than acquisitions, which are opportunistic by nature. At the other extreme are companies such as Barrick Gold, whose growth strategy is dominated by acquisitions because they are perceived to be quicker and less risky. Most producers of both gold and base metals try to strike a balance between these two strategies by maintaining an exploration program while keeping an ear to the ground for opportunities to acquire mineral properties. In addition, almost all the senior producers joint venture with junior exploration companies in order to better their chances of participating in an economic discovery. An increasing number are also forming partnerships among themselves in order to share the risks inherent in global exploration and development.
Recent trends have had a dramatic impact on this strategy balance. The globalization of the mining industry over the past decade has increased competition and made growth even more important to survival. At the same time, the long-term decline of metal prices makes exploration spending more difficult to justify while lowering the cost of acquisition and increasing the appeal of cost-saving mergers. As a result, mining companies are spending record amounts on mergers and acquisitions. In 1998 the industry spent more than $25bn on mergers and acquisitions - twice the amount spent two years earlier. By contrast, exploration spending peaked in 1997 at $5.1bn and has been in decline ever since. The total budget allocated to worldwide nonferrous metals exploration in 1999, at $2.7bn, was more than 50% lower than it was in 1997.
This report examines the different growth strategies available to the industry. Case studies are used to illustrate the benefits and risks of each strategy and to provide strategic insights. Exploration executives provide their opinions on a variety of pertinent issues. The emphasis on gold producers in these studies is incidental. Barrick and Newmont were chosen because they are comparable mining companies that both provide excellent practical examples of the disparate growth strategies. It was also instructive to compare Royal Oak Mines and Kinross Gold as examples of similar strategies that had vastly different outcomes. Although the rationale for growth is somewhat different in the base metal sector, these strategies can, and are, being used by base metal miners.
In Chapter 4, Barrick Gold is used an example of growth by acquisition and two of its purchases, Arequipa Resources and Sutton Resources, are examined in detail. The chapter comments on the unique aspects of Barrick's corporate structure that gives the company a significant advantage in the competition for replacement reserves. The acquisitive strategies of two intermediate producers, Royal Oak Mines and Kinross Gold, are also compared to offer some insight into the importance of controlling the risks associated with acquisition.
Chapter 5 profiles Newmont Gold, and the Yanacocha and Batu Hijau discoveries in particular, as an example of growth by exploration. The chapter examines some of the factors that can minimize the risk of exploration and highlights the importance of consistency in exploration strategy.
The role of the junior sector in project generation is dealt with in Chapter 6 and the importance of persistence in exploration is illustrated by a case study detailing the discovery of the Ekati diamond mine. In Chapter 7, Teck Corporation is used as an example of how partnerships with junior companies - a grey area between exploration and acquisition - can minimize the risk and cost of reserve replacement. The chapter also comments on the increasing popularity of this model as a means of reserve replacement. Billiton is one example of a leading base metal producer that is adopting this approach.
A long-term decline in metal prices has forced mining companies to be more conservative in their investments and has increased the importance of property valuation. Although the economics of valuation are beyond the scope of this report, Chapter 3 provides a general guide to the techniques mining companies use to value potential acquisitions, including the benefits and pitfalls of these techniques. The report also looks at recent and future trends in the mining industry and their effect on growth strategies in Chapters 2 and 8.
Although low metal prices have encouraged growth by acquisition and mergers at the expense of exploration, this strategy is limited on an industry-wide basis. An industry that spends 10 times more on acquiring deposits than it does on finding them has no future. Eventually, most of the deposits worth acquiring will have been assimilated and the larger companies formed by mergers will require replacement reserves on an ever larger scale. The demand for new, high-quality deposits should encourage a more balanced approach to growth. But an increased commitment to grassroots exploration by the senior sector - although crucial to the long-term survival of the industry - appears unlikely given the poor historical average returns of this kind of investment. More probable is an increased, and ultimately dangerous, dependence on the junior sector to provide the mines of the twenty-first century.
CHAPTER 1: GROWTH STRATEGIES
Introduction
Executive Commentary
Key regions
Cost of reserve replacement
Financing
Risk
CHAPTER 2: RECENT TRENDS
Introduction
Metal prices
Consolidation
Partnerships
Bre-X fallout
Venture Capital markets
Exploration spending
Reliance on juniors
CHAPTER 3: PROPERTY VALUATION
Introduction
An imprecise exercise
Methods of Valuation
Factors affecting value
CHAPTER 4: THE CASE FOR ACQUISITION
Introduction
The growth of Barrick Gold
Case Study: The Pierina acquisition
Case Study: The Bulyanhulu acquisition
Strategy behind the bids
Strategic lessons
Acquisition by intermediate producers
Overpaying for assets
CHAPTER 5: THE CASE FOR EXPLORATION
Introduction
Keys to success
The growth of Newmont Mining
Case Study: Yanacocha deposit
Case Study: Batu Hijau deposit
CHAPTER 6: THE ROLE OF JUNIOR COMPANIES
Introduction
Exploration strategies
Financing
The junior cycle
Exploration success
Case Study: Ekati diamond mine
CHAPTER 7: PARTNERSHIPS AS A GROWTH STRATEGY
Introduction
Benefits & risks
Types of partnerships
The growth of Teck Corporation
Case Study: the Teck-Western Copper partnership
Adopting the Teck model: Billiton PLC
Senior-senior partnerships
CHAPTER 8: FUTURE TRENDS
Introduction
Consolidation
Two-tier industry
Partnerships
Exploration spending
Acquisition-Exploration balance
South African competition
Deeper deposits
Technological innovation
Costs
CHAPTER 9: CONCLUSIONS
Introduction
External factors
Limits of acquisition
A new commitment to exploration
The "right" balance
APPENDIX
GLOSSARY
BIBLIOGRAPHY
LIST OF TABLES
Table 1.1: Average acquisition
costs for gold properties ($/oz) 1997-1999
Table 1.2: Average acquisition costs for gold properties 1986-1999
Table 1.3: Average Cost of exploration per oz of gold
Table 1.4: Exploration costs according to exploration stage & type of company
Table 2.1: Spending on Mergers & Acquisitions in the mining industry 1995-99
Table 2.2: Some major mergers and acquisitions 1998-99
Table 2.3: Mergers, acquisitions and IPOs by target country
Table 3.1: Methods of Valuation
Table 3.2: Net Present Value of the Pierina deposit in 1996/1999
Table 5.1: Major Grassroots Discoveries by senior companies
LIST OF FIGURES
Figure 1.1: Estimated worldwide
exploration spending by location, 1999
Figure 1.2 Acquisition costs for gold exploration properties 1997-1999
Figure 1.3: Acquisition costs for gold development properties 1997-1999
Figure 1.4: Acquisition costs for producing gold properties 1997-1999
Figure 1.5: Senior North American gold companies: Exploration track record 1996-98
Figure 2.1: Base metal prices 1993-98
Figure 2.2. Gold prices 1993-98
Figure 3.1: Barrick's acquisition costs Vs the gold price
Figure 4.1: Barrick's gold reserves 1994-98
Figure 5.1: Total shareholder return (TSR) for 33 mining companies 1986-95
Figure 5.2: Market response to the Grasberg discovery
Figure 5.3: Newmont's annual gold reserves & historic exploration expenditures
Figure 6.1: Number of completed financings by Canadian juniors 1997-99