M&A in the Mining Industry
On the business side, one of the main risks and opportunities in a commodity industry is always pricing your assets based on expected commodity prices, which tend to be driven by current prices. For instance, when valuing a producing gold mine, we would consider the number of years of mine life left, 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 typically long lives. If you acquire a gold mine expecting gold to trade at 2,000 over the life of the mine, and then there's a price crash to 1,300, you're likely looking at a huge impairment and a terrible deal. Conversely, acquiring an asset at the bottom end 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 that, you could potentially incur that liability, especially if you don't conduct an investigation and immediately report anything that you find. It's not a unique risk to mining, but it's an elevated risk because these projects are so capital-intensive. You could have half a billion, a billion dollars sunk into a project, and if you run into any sort of political or regulatory trouble and everything stops, then it could be game over.
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 if an event happens is to convince the U.S. government that the company has taken all reasonable measures to prevent such activity. It's similar to insider trading laws, where both the individual and the company can be held criminally liable, and the only way for the company to absolve themselves of liability is to show that they did everything they could to prevent it.
That sounds like a law school exam question. I suppose there could be an extreme example where it would be an issue. However, there is an exception for ordinary commercial hospitality. So, if it's customary to buy dinner after meeting with government officials, that's not necessarily going to be an FCPA violation. But, one could probably conceive an extreme example where that could be an issue.
Importance of ESG
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.
Beyond greenhouse gas emissions, more traditional and longstanding environmental issues for mining companies are things like tailings dam integrity. Mines store tailings, leftover rock after processing to extract minerals, in storage facilities that are basically large lakes behind dams.
There have been catastrophic tailings dam failures, impacting local communities significantly. Tailings dam integrity and proper management of tailings have been significant issues in the mining industry for decades, and they also fall under ESG.
Such failures are directly tied to valuation because companies that experience major tailings dam failures see their valuations decrease overnight due to mine shutdowns and enormous liabilities, possibly including criminal liability 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.
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 example, 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
From the beginning, when we start looking at a potential deal, before deploying extensive internal resources and subject matter experts within the company, we conduct a desktop analysis. In relation to ESG, this analysis involves reviewing the responsibility, sustainability, or ESG report that most companies now publish annually, detailing their performance on various issues. These reports are currently unregulated, so we have to apply our own lens to the published information, 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 has certainly been an evolution. Many of the traditional areas of risk I described would always have been covered in diligence. However, the external facing ESG profile of a company is now a key factor. When we look at potential M&A targets, we must consider some of these very topical and recently emerged 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.
Not that greenhouse gas emissions encompass everything in ESG, but it's a key issue these days and something we note as part of the initial screening of an asset. It's not the most important factor and doesn't necessarily drive whether we do a deal or not, but at the same time that we're looking at some of the more traditional financial metrics, we're also considering what the ESG impact of this asset or these assets will be on our portfolio. Is it going to make us better? Or is it going to set us back?
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
A significant factor is community support, and where relevant, support from indigenous communities. This can be a major impediment for any mining project. A project could have a great mineral resource, high grade, and a robust cash flow and NAV model, but if there’s trouble with the community, which can attract attention from NGOs and potentially lead to high-profile, well-funded opposition campaigns, it could halt a deal.
For instance, there’s a project called Pebble in Alaska, one of the largest proven, yet undeveloped, gold deposits in the world. It’s located in the very sensitive Bristol Bay Watershed. The current owner has invested a substantial amount of money over the years, and it has been mired in controversy, with previous JV partners backing out. Before investing in or purchasing such an asset, it’s crucial to be comfortable that any community opposition has been addressed.
We have an asset in remote British Columbia, near the Yukon border, where two First Nations have territorial claims. During the diligence on that asset, we ensured that the formal agreement signed with the First Nation was being honored and that there was a good relationship because no matter how rich the deposit is, if there’s community and especially indigenous opposition, the project won’t progress.
Anything related to compliance is crucial. For instance, if there’s any indication of past impropriety in obtaining the necessary permits to build or operate the mine, that could halt a deal. You don’t want to inherit such situations, as under the U.S. FCPA, there’s a legal obligation to conduct an internal investigation post-closure to affirmatively determine there have been no issues.
If any are uncovered, as the successor, it becomes your problem to address. So, if there’s a significant compliance issue, such as bribery or any other violation, we would likely avoid the deal.
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, those traditional subject matter experts continue to be responsible during diligence. I don't have the expertise to assess whether a water treatment plant is operating correctly or if a tailings dam is structurally sound. However, I do have responsibility for the overarching ESG profile of the company, assessing how we are viewed when we consolidate all different aspects of ESG into an overall profile and 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
Let's discuss the legal aspects. It can be complex, especially when there are multiple jurisdictions involved, considering both the location of the asset and the parent company. Like any good M&A professional, everyone refers to precedent. If you're conducting a top-level corporate deal, you generally rely on the public disclosures and the 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. You can structure around the risk with carve-outs and contingent payments, depending on the sophistication of the counterparty and what they're willing to accept, and what we're willing to live with.
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 to ensure that you know what issues are important. Some issues are going to be crucial in every deal, but some are more deal-specific. For instance, in the mining industry, if you're looking at an asset that sits in the traditional territory of an indigenous community, it's imperative to ensure that the indigenous community supports the deal. Consider ESG risk as business risk, as many of these risks will fall under the ESG umbrella.