M&A in the mining industry
In commodity industries, a key aspect involves pricing assets based on expected commodity prices, often influenced by current prices. For instance, when valuing a gold mine, we consider the remaining mine life based on reserves.
To illustrate, if a mine has a million ounces of gold in reserve and produces 100,000 ounces a year, it has a 10-year mine life. You apply the cost structure and a gold price assumption to come up with a valuation. However, gold prices have fluctuated significantly in the last seven to eight years, ranging from under 1,200 to over 2,000 an ounce.
Assets are priced based on analyst consensus for future prices, but these expectations are often incorrect due to market volatility, leading to valuation risk and opportunity being key factors in mining M&A.
Mines are capital-intensive operations with long lifespans. Acquiring a gold mine based on an expected $2,000 gold price, then experiencing a crash to $1,300, could result in a significant impairment and a poor deal. Conversely, purchasing an asset at the bottom of the price cycle can be highly profitable, regardless of operational efficiency or cost control.
Valuation and deal structures in the mining industry
A lot of times, deals are cross-border. In fact, it's rare in our industry to have a deal that is not cross-border. This is typically because public mining companies are usually based in Canada, Australia, or South Africa, where mining capital has concentrated over the years, with Canada being a clear leader in the Western Hemisphere.
Almost every public mining company is Canadian. So, straight out of the gate, regardless of where the assets are, you're probably dealing with a Canadian company.
We're one of the only US-listed precious metals mining companies, and there are only a handful of such companies. The assets could be located anywhere, and our footprint is North America, including assets in Mexico, the U.S., and Canada.
In the past, we've had assets in Bolivia, Argentina, Chile, and Australia. It's quite typical for mining companies to have assets in jurisdictions all over the world, even in places where a traditional M&A professional may not have done a deal involving an asset.
It's not unusual to have at least three different jurisdictions involved in every transaction, given that the parent company is probably based in Canada, the asset is based wherever it is, and we're a U.S. company. So, cross-border deal mechanics pretty much always apply in our situation.
Depending on the jurisdictions where the assets are located, there can be elevated risk and due diligence around things like FCPA compliance. There's a saying in mining that you can't control where the minerals are. Many of the richest mining projects in the world are in countries that are difficult to do business in, where corruption and the risk of nationalism of resources are very high.
If you're looking at acquiring a gold asset in a country with fantastic grades, meaning low unit costs, and maybe it has a long mine life, you can develop quite an attractive cash flow model for this asset.
However, if it's in a country that has recently had a military coup, like what happened in Mali in West Africa, and the new government decides to increase its share of mining project profits, it can be very difficult to negotiate back to the original deal.
You have to take into account political risk, both on the business side and also on the legal compliance side. FCPA stands for Foreign Corrupt Practices Act, which pertains to bribery. In many countries, governments and officials expect to get paid along the way as they process your permit application or renew your operating license.
For a company like us, based in the U.S. with the highest compliance and ethics standards, we can't and won't operate that way. It's important to do due diligence on assets in those countries to determine if the prior owners have engaged in such behavior.
If you're buying from an ownership group based in a country where they're not as strict about ethics or don't have any corruption laws, the prior owner may have just paid those bribes when asked.
As a U.S. company, stepping into this field, you could face liability, particularly if you fail to conduct investigations and promptly report any findings. This risk isn't unique to mining but is heightened due to the substantial capital investment involved. With hundreds of millions or even billions of dollars sunk into a project, encountering political or regulatory issues could halt operations and result in significant losses.
Foreign corrupt practices act
M&A is essentially an application of FCPA. It's not specifically an M&A law; it applies anytime you're operating outside the United States. It's a criminal offense, not only for the company but for its executives, to offer any bribe to any government official.
A bribe is defined broadly as anything of value, so it doesn't have to be money. There are cases where companies arrange internships for the children of government officials who award contracts.
The company's obligation is to have a proactive training and compliance program, training your people on what's permitted and what's not, and to have an audit program where potential issues are looked for on a periodic basis.
The only way for a company to avoid direct liability for an event is to convince the U.S. government that it has taken all reasonable preventive measures. This is akin to insider trading laws, where both individuals and companies can be held criminally liable. To absolve themselves of liability, companies must demonstrate that they took all necessary steps to prevent such activity.
While it may sound like a law school exam question, there's an exception for ordinary commercial hospitality. For instance, buying dinner after meeting with government officials, if customary, wouldn't necessarily violate the FCPA. However, extreme examples could potentially pose issues.
Importance of ESG in M&A
In many ways, ESG has always been important, although it's a relatively new acronym and label for a broad range of issues and priorities that companies have paid attention to for a long time. Currently, there's a lot of political and media noise about ESG.
Most of this noise is because some people view ESG as related to extreme issues unrelated to what a for-profit corporation should be concerned about. However, this view is probably misguided. If you unpack it, there are a host of issues under the acronym that represent real risk and real impact on long-term value.
Taking the 'E' for example, environmental, many people think about climate change and decarbonization when they hear ESG. Reducing greenhouse gases is a key issue now for all companies, primarily because it's a key issue for stakeholders. If the owners of a company say it's a priority, then it should be a priority.
But beyond this, the more traditional environmental issue for mining companies is the tailings dam integrity. Catastrophic tailings dam failures impact local communities significantly and will decrease the company’s valuation because they will incur enormous liabilities, possibly including criminal, depending on the jurisdiction.
Other ESG issues tied to risk and valuation are workforce-related. There's a talent shortage in the mining industry, and our strategic advantage is being an employer of choice. Our diversity, equity, and inclusion initiatives are not because it's part of someone else's agenda, but because we're trying to find good people wherever they may be.
These are just a couple of examples as to how ESG is important and why it's related to risk and valuation.
Disaggregating ESG
We may be on the verge of disaggregating the components of ESG, as the acronym has become contentious in the U.S., which has significant influence globally. Earlier this year, attention was drawn to BlackRock’s annual letter, which, despite focusing on stewardship, did not mention the acronym ESG.
BlackRock has been a leader in driving companies to improve sustainability, responsibility, or stewardship—factors that can impact long-term value—and has consequently become a target for anti-ESG investing proponents.
We might start calling it something different or stop bundling it all together, addressing each of these categories individually. Companies have long been rated on their governance, a valid and important investment criterion.
However, bundling it under the ESG acronym draws negative attention, leading to attempts to introduce legislation saying such considerations should not be allowed. It’s form over substance, but perhaps we’ll stop calling it ESG, which, to me, would make more sense.
Sustainability in today's market
There are various ways to evaluate ESG. Some leading third-party rankers and raters provide ratings to public companies, largely based on companies' own disclosures and, to some extent, on the rater's assessment of risk exposure.
For instance, the mining industry is inherently high risk, so regardless of risk management, it won’t have as high of an ESG rating as industries with lower inherent risk, like tech or financial services companies.
Another way to assess companies on ESG is by their performance on issues identified as most important by leading stakeholders, such as greenhouse gas reduction and carbon footprint, which remain key issues for investors globally despite the prevailing political and media noise.
There are over 5,000 signatories to the Principles for Responsible Investing and the Net Zero Asset Managers coalition has over 300 signatories managing over $59 trillion in assets, committed to having a net-zero portfolio.
The issues laid out as important by these investors, whether it's greenhouse gas reductions, diversity and inclusion in the workforce, good governance, community relations, or indigenous relations, allow for easy judgment of companies based on their own disclosures and track records on these identified priorities in our sector.
Balancing ESG and profit
There are situations where ESG considerations are a trade-off, and many where they are directly aligned. EY conducts one of the leading risk surveys in mining every year, known as the EY Top 10 Risks in Mining. It’s comprehensive, with input from mining company executives globally.
In the most recent version, ESG risks are three of the top four in the mining industry. Number one is ESG, number three is climate change, and number four is ‘social license to operate,’ a common phrase in the mining industry. If these aren’t managed well, profitability and valuation can be negatively impacted, sometimes even nullified.
For instance, there’s a massive polymetallic deposit project straddling the border between Chile and Argentina. One of the largest gold companies in the world has invested five billion dollars in this project. However, it came to a halt several years ago when its environmental permit was challenged and revoked by an environmental group, and the project has been stuck ever since.
This situation underscores the importance of ESG components like community and indigenous relations and ensuring host communities support and see long-term benefits from the project. It’s a crucial area of diligence when doing a deal. Without good ESG, a major 5 billion project can be stopped, leaving the business dead in the water.
Like most public companies, probably half of our shares are owned by about five large institutions, and they have their own sets of ESG priorities. They hold us accountable for those and expect to see progress every year.
It ultimately impacts the investability of the company. While a private company could decide on its own what is important, a publicly held company must respond to the priorities of its largest shareholders
ESG considerations during M&A
Before extensively deploying internal resources and subject matter experts, we conduct a desktop analysis when assessing a potential deal. Regarding ESG, this involves reviewing companies' responsibility, sustainability, or ESG reports, which are commonly published annually. As these reports are unregulated, we apply our own lens, considering international frameworks and voluntary disclosure documents.
We use publicly available information, reading media or analyst reports about the company or the asset involved, and checking the company’s reputation in the communities where they operate. We look for any controversies or protests against the construction or operation of their facilities and assess whether the company is operating responsibly.
If we progress to a deeper stage, like signing an LOI, we involve internal subject matter experts in areas under the ESG umbrella. Our environmental team oversees our assets and those we are looking to acquire, often conducting site visits to inspect elements like tailings dams and water treatment facilities, ensuring water is discharged in a clean state after use.
We also conduct diligence on workforce issues, ensuring there are no allegations of unfair treatment or human rights issues, especially in countries with rich mineral endowments but poor labor practices history. We need to ensure that the asset or the company we are acquiring doesn’t have a bad history.
HR is a key ESG diligence component, checking for any red flags in terms of employment liability and reviewing feedback from culture surveys. This is crucial as ESG has become a sort of a lightning rod of an acronym, encompassing traditional corporate deal diligence like employment diligence, ensuring there are no underlying issues.
It's likely similar to Industrial M&A in general. If a significant portion of the asset value is a physical asset, chances are we're going to send people to inspect it firsthand, not just rely on desktop analysis. We sometimes bring in experts, and at times, we'll engage a third-party environmental firm to conduct a review, take soil samples, water samples, etc. These can add up, but it would be foolish not to for any deal to acquire operating sites.
Evolution of ESG approach
It's been an evolution. While traditional areas of risk were always covered in diligence, the external ESG profile of a company is now a key factor. When assessing potential M&A targets, we must consider these emerging issues.
For example, discussing greenhouse gas emissions, if there are two projects roughly equal, and one runs on clean hydropower while the other runs on diesel generators, the carbon footprint of those two assets will be very different. We have our own public goals, and everyone is under pressure and expectation to continue to decarbonize their footprint.
Greenhouse gas emissions are a key issue in ESG these days, noted during the initial screening of an asset. While not the sole determinant, it's considered alongside traditional financial metrics to gauge the ESG impact on our portfolio. Will it enhance or detract from our goals?
ESG diligence in M&A
We would be asking, in many cases, for the data behind the reports. Like many companies, we publish data on emissions, water usage, and various other issues. We would look for the data behind what they publicly report.
In all cases, we would conduct management interviews and probe on how they are achieving their goals, any incidents they may have had in the past that may not have made it into public disclosures, and any pushback they may have received from local communities.
While media reports and social media are valuable resources, we would also inquire directly with management. Often, subject to negotiation, we try to get some representation and warranty coverage for these issues.
Red flags during ESG diligence
Community support, including from indigenous communities where applicable, is a significant factor for mining projects. Even with excellent mineral resources and financial models, community issues can attract NGO attention and well-funded opposition campaigns, potentially derailing a deal.
For instance, the Pebble project in Alaska, boasting one of the world's largest undeveloped gold deposits, situated in the sensitive Bristol Bay Watershed. Despite substantial investments, it's faced controversy, with past JV partners withdrawing. Before investing or purchasing such assets, addressing community opposition is paramount.
In remote British Columbia near the Yukon border, our asset faces territorial claims from two First Nations. During diligence, we confirmed that the formal agreement with the First Nation was upheld and that a positive relationship existed. Regardless of deposit richness, community, especially indigenous, opposition can stall project progression.
Deal stoppers
Compliance is critical. Past impropriety in obtaining permits to build or operate a mine could halt a deal. You don’t want to inherit such issues, as under the U.S. FCPA, there’s a legal obligation to conduct an internal investigation post-closure to confirm no issues arose.
In M&A, the successor will inherit all the liabilities of the target company. This is why anything related to compliance and proper past conduct is crucial for buyers. If there are issues like bribery or discrimination, stay away from it.
Similarly, in light of the Me Too movement, any significant pattern or indication of workplace impropriety, discrimination, or harassment would be a huge red flag and potentially a deal-breaker.
Designated person sustainability
It varies across companies and may depend on the industry and organizational structure; there's no one-size-fits-all answer. Surveys suggest that, in many cases, it reports up through legal, which is the case for Core, where I wear both hats. It can also report up through HR, or in really large companies, it may report up through communications. However, reporting up through legal is quite typical.
Diligence execution during M&A
It's a shared responsibility because, in mining, many aspects now categorized under the ESG umbrella have been considerations for a long time. Before the era of ESG, environmental experts would conduct diligence to ensure that the target was acting responsibly and not contaminating water or air.
In many respects, Traditional subject matter experts remain crucial during diligence. While I may lack expertise in specific areas like water treatment or tailings dams, I oversee the company's overarching ESG profile. This involves assessing our perception when consolidating various ESG aspects into an overall rating.
My team looks at the public disclosures of the target and makes assessments on key issues like decarbonization and biodiversity protection. It's a shared responsibility with many experts contributing to the overall effort. The overlay is something new in the last few years, and it falls largely on my team.
ESG on cross-border deals
Cross-border deals have complexities that apply in any sector and any subject matter, including employment considerations and local laws, which can vary, including in ESG. For example, many companies in Canada have subscribed to a framework called Towards Sustainable Mining, requiring asset-level disclosures about numerous issues.
If you acquire an asset committed to reporting under TSM, it can bootstrap your whole company into reporting under that framework, as it would be odd to have only one of your assets reporting under a portfolio.
Cross-border deals can change your external profile in this sense. From a diligence focus, you'd look at the history of the local communities and consider what that implies for post-closing. It's crucial to retain or acquire the appropriate local expertise to understand the nuances and potential risks that may not be obvious from operating in jurisdictions like the U.S. or Canada.
Negotiations on cross border deals
Legal aspects can be complex, especially across multiple jurisdictions involving both the asset and parent company. M&A professionals often refer to precedent. In top-level corporate deals, reliance is typically placed on public disclosures and representations and warranties of the parent company.
There's more flexibility in private deals, allowing for more bespoke risk allocation and potentially longer and more protracted negotiations. Structuring around risk is possible with carve-outs and contingent payments, tailored to the counterparty's sophistication and acceptance, and our own tolerances.
Like any company, we have to make trade-offs between the urgency of closing and the perceived value of the deal, which impacts how much tail risk you're willing to take in the deal structure
It's a long working group list. For instance, we had an acquisition where we bought a public company in Canada that owns a significant project in Mexico. For a deal like that, we have our main outside M&A counsel, which for us is a U.S. firm.
We also have a close relationship with a Canadian firm, as most of our targets are Canadian, and a Mexican firm due to the location of the asset. Everyone has to work together, and they do. Our team works very well together, but it involves a long working group list and many people on the controls during all hands calls.
Advice for practitioners
I would advise practitioners to understand what’s important to the acquiring company. Some issues are going to be crucial in every deal, but some are more deal-specific. For instance, in the mining industry, it's imperative to ensure that the indigenous community supports the deal. This may not be the case for other industries.
What’s important is to consider ESG risk as a business risk. Many risks fall under the ESG umbrella, which has a direct impact on the value of the company, and how it operates.
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