Ernst & Young finds private equity houses may be targeting mining
After years of avoiding mining investment due higher perceived risks in the sector, a recent Ernst & Young report suggests that private equity houses may actually be targeting mining.
In a recently released report, Ernst & Young Global Mining and Metals Center declared that the mining sector, which used to be of little interest to private equity houses, may now be under reconsideration as a private equity target.
Ernst & Young asserted in their report, "Mining Is Now the Time for Private Equity," that mining management is "behaving more astutely in limiting capacity expansion and future overproduction. As a result, normal supply/demand economics are being established."
"Short-term cash returns are potentially higher than acquisition prices would suggest, making the exit a less critical part of the overall return to private equity investors," the financial consultants suggested. "Coupled with the availability of IPO, the opportunity for private equity to make a target return on mining investments is greater than ever before."
Private equity houses used to ignore the mining sector because it was a cyclical industry, mining cash flows were unpredictable, and capital costs were significant on aging and depleting assets. In addition, mining companies were viewed as "price takers, not price makers," requiring "specialist knowledge to succeed, according to Ernst & Young.
In fact, the financial consultants contend that "the mining industry may not have the same nature of cycles as typically perceived by investors. The current level of high metals prices appears to be holding up and the predicted peak keeps on moving. There is a significant supply/demand imbalance in many metals which will take several years of higher prices to be resolved, possibly beyond a private equity exit period."
"As many mining companies have large amounts of cash, lazy balance sheets, more pricing power, and are controlling the amount of new supply hitting the market, there are good grounds to believe that, while they are not controlling the cycle, mining companies can influence the length and strength of the cycle. Therefore, they themselves are pursuing under-valued opportunities with their sector."
"Several of these organizations have unused credit capacity, are consciously ‘unhedged', and are aggressively consolidating to find growth opportunities through M&A activities. If metal prices remain high, we expect that these characteristics will only become more pronounced," they added.
Nevertheless, the lack of possible exit options has been a real bone of contention for private equity houses in the past, according to the analysts. However, Ernst & Young's report now asserts that "the changing fundamentals in the [mining] industry mean that there are more exit opportunities, whilst the importance to the overall investment return is diminishing."
Their analysis suggests that IPOs may have become a new exit route, particularly due to the success of offerings in areas previously considered politically risky, such as Kazakhstan, Peru and Africa.
"Given the changing fundaments, a significant element of the required return on investment may be achieved prior to exist," the report suggested.
These include: the increasing capacity of mining companies to pay significant dividends from substantial retained earnings; the unbundling of corporate assets such as mines and smelters, which are being sold to other mining companies; and improved cost savings at operations.
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