NOT in the Saturday Financial PostMINING FOR MONEY
So much cash in hand, so little on hand to buy
BY PETER KOVEN
sources Ltd.
Noront Re-
Diamonds galore, Page FP4
Everyone in the mining world wants to give Richard Nemis money these days. Mr. Nemis, 69, has been in the industry almost four decades. But until recently, he was an anonymous character running an unremarkable junior company called
That all changed on Sept. 10, when Noront unveiled a potentially huge nickelcopper discovery in the James Bay Lowlands. At Noront’s annual meeting in Toronto last Tuesday, he was welcomed as a conquering hero by investors who became very rich, very fast.
“There have been many times when I was willing to say ‘uncle’ and quit this business,” Mr. Nemis told his applauding audience. “But when it’s all said and done, you’re doing it for exactly what’s happened with this little company.”
As commodity prices hold near historic highs, mining companies are awash in excess cash. Tiny companies such as Noront are getting all the money they want on the hopes they will find something, and major companies are scouring the earth for ways to spend their excess dollars. The question now is, will investors see any of it?
To call the James Bay discovery “early stage” would be a gross understatement; Noront has only produced drilling results from 17 holes to date.
But that hasn’t prevented the majors from taking a serious interest. Those visiting Mr. Nemis’s office read like a who’s who of mining: BHP Billiton PLC, Rio Tinto PLC, Xstrata PLC, CVRD Inco, even billionaire promoter Robert Friedland.
With plenty of cash to go around in the industry, finding ways to spend it has become one of the industry’s greatest challenges. Stockpiling it is no longer an option, making plays like Noront look very attractive. In some cases, too much cash can be a big negative.
In the past few years, there have been two major trends in mining — rising prices and consolidation. Canada has bid goodbye to a number of large companies (such as Inco Ltd. and Alcan Inc), mid-tier companies (LionOre Mining International Ltd., Aur Resources Inc.) and juniors (too many to mention).
For the remaining players, acquisitions have become few and far between, especially at prices they are willing to pay. A giant such as Barrick Gold Corp. can afford to drop $773-million for a stake in a project that is several years and billions of dollars of investment away from production. It did that this week by buying Arizona Star Resource Corp. in an all-cash deal. But Barrick is the exception rather than the rule. Companies such as HudBay Minerals Inc. are constantly on the lookout for deals — and not getting anything done.
In the meantime, their coffers are overflowing with cash. HudBay, for example, is sitting on about $565-million, more than four times what it had in 2005. As the miners report earnings this week and next, the cash reserves are building across the board, particularly in the booming base metal sector. Precious metal companies are not seeing the same amazing growth, but they also have healthy cash positions.
“The Canadian [base metal] guys are getting picked off because of the cash,” one analyst says. “The cash is something you don’t want, because if you’re not putting it to use, someone will strip the cash, use it to bid for you and take your asset.”
Investors don’t want to see cash building on the balance sheet, either, says Peter Jones, HudBay’s chief executive. “The traditional approach of putting it in the bank and waiting for a down cycle is not on anymore. It’s more, ‘Let’s get on with it and make some serious cash, whether through exploration or an M&A-type activity’,” he says.
But if acquisitions are too expensive, then what to do with the cash? A lot of mining companies were investing in short-term instruments such as asset-backed commercial paper. Needless to say, you can scratch that option off the list.
The next step appears to be a new frontier for most mining companies: share buybacks and dividend growth.
Barrick and Teck Cominco Ltd. have dabbled in both, but the practice is far from widespread. It is also hard to find an investor that ever bought a mining stock for either of those benefits.
But if the companies have nothing better to do with the money, then why not? It could even expand the shareholder base for a lot of mid-tier companies. A lot of dividend funds, for example, could be looking for new opportunities now that the income trust party is over.
“If you’re going to be [generating] cash flow of at least $400-, $500-million a year, to set up a $200-million dividend annually and establish it for a minimum of five years, that is the kind of thing that will get dividend funds excited,” says Tony Lesiak, an analyst at UBS Securities.
It was not that long ago that mining companies were derided for this kind of activity. In February, Teck announced a share buyback program and was criticized in some circles for not finding anything better to do with its cash flow.
But today, there are increasing calls for miners to return cash to shareholders, and the company in the middle of it is HudBay. Hedge fund SRM Global has bought about 16% of the Winnipeg-based firm and is pushing it to do a buyback or dividend.
It puts Mr. Jones in a tricky position. Returning cash is a distant third in his priorities, after organic growth and acquisitions. He would much rather talk about the company’s recent zinc discovery in northern Manitoba than a buyback. On the other hand, the cash is building up faster than he is spending it.
“Certainly, building additional cash substantially above where we are today falls into the category of [becoming] attractive to others as a potential takeover target. And you get statements by financiers and investors that we’ve got a lazy balance sheet and we need to do an investment,” he says.
There is another option for mining companies looking to spend cash but without the stomach for acquisitions — make strategic investments that scare prospective buyers away. Then, buy the whole company.
There have been a number of deals like this recently, most notably Rio Tinto’s investment in Mr. Friedland’s Ivanhoe Mines Ltd., and Teck Cominco raising its stake in Fording Canadian Coal Trust to 20%.
Industry experts expect more of this in the future. “If you look at what Teck has done, [Fording] is basically theirs,” says George Topping, an analyst at Blackmont Capital Inc.
“Nobody else can come close to it now. They’ll wait for an opportune moment and then take it inside, maybe after the income trust tax holiday ends in 2011.”
There is another option: bite the bullet and make the acquisition, no matter how expensive it looks. The fact is that Canadian mining stocks are still remarkably cheap. “ The [Canadian] mining stocks are sort of trading at 10 times earnings. To go out and buy a mining company at that valuation doesn’t seem excessive if you believe that the commodity prices will stay higher for longer,” says David Whetham, a resource fund manager at Scotia Cassels Investment Counsel Ltd.
The blatant exception is Noront, which boasts a market cap north of a half-billion dollars thanks to those 17 holes in the desolate, mosquito-infested lowlands. Of course, the companies that have expressed interest in Noront — Xstrata, CVRD, for example — are precisely the ones most willing to throw their cash around.
Assuming everything goes as Mr. Nemis plans, it is only a matter of time before a pile of excess cash heads his way.
“I could probably do our next financing at $10 [a share],” he says.
The last one was at 60¢.