How Newmont tries to balance financing, risk-taking

From an address to the Financial Times World Gold Conference by Gordon R. Parker, chairman, president and chief executive officer of Newmont Mining Corporation.

To talk about financing companies is to simultaneously address the broader issue of risk taking.

If many of us in mining tend to think of our business as being risky, a major reason is the need to spend risk capital to renew our sources of supply by exploration. Risk capital excludes general debt obligations. Exploration is not bankable. Nor do we have the option to rely on others. There are exploration companies — some traded on stock exchanges — but they will all rely on 100% equity financing, and their successes cannot be bought for less than the cost of one’s own grass roots program.

Stepping beyond exploration, new projects often have incalculable features: large amounts of capital are committed on the basis of drillhole data that can, despite geostatistics of a high order, mislead; and many natural hazards such as rock stability, water problems or lack of ore continuity are common tricks played by Mother Nature. We all have in our minds major projects which have failed to live up to their feasibility studies.

Projects vulnerable to such upsets should have little or no debt unless they are undertaken by a company large or diverse enough to be able to put the attendant risks onto other assets.

Expansions of existing successful projects are, by contrast, largely free of this order of risk and can be debt financed on, say, marginal cost analyses.

Added to these operational risks and providing good cause for caution in the use of debt, even by large and diverse companies, is the volatility inherent in the commodities markets. Natural resources companies classically have little ability to impact the prices of the products they sell — margins depend on market-driven price fluctuations and on the ability to contain costs.

Although something of a diversion, let me briefly examine some arresting histories of price movements.

This illustrates the price volatility of three metals — gold, copper, and molybdenum — from 1978 through 1987. Whereas the prices are unadjusted for inflation, they have been normalized over 1978 levels to illustrate the point on volatility.

In early 1978 gold was at $160 per oz. Over the next three years, the price rose almost fourfold due to the second oil shock and fears of inflation. Then from 1981 to 1982, the price fell 40%, only to rise again in 1983 and again in 1986. For an underground gold mine operator with costs in the $300 per oz range, one can imagine the frustration in development planning.

Copper prices have only come back to 1979 levels since November, if we are willing to ignore the ravages of inflation in the interim. Yet enormous porphyry copper deposits can require hundreds of millions of dollars in capital investment and years of development time before revenues flow, and then perhaps another 10 years until payback.

Molybdenum is one metal that has actually lost ground even in nominal terms. We remember the spot market pressures of the late 1970s when oil pipelines were being built and inventories were short — prices rose almost fi vefold until coproduct and byproduct supplies swept into the market, along with vanadium and columbium, and then demand shrank.

Many major mining companies produce all three of these metals. For those fortunate enough to have a strong gold component to their sales, their average revenue per ton probably exceeds 1978 levels. But prices have been painfully volatile, and any staying power provided by diversification has been cherished by its holders.

Companies reliant on any single commodity must be particularly adept at cost control, debt and debt service burden reduction, not merely at clever management. We are all well aware of the impact of soft copper prices on the fortunes of a company such as Phelps Dodge in recent years. Only through extraordinary management skills directed at the achievement of low- cost production has that company driven down its debts and again begun to reward its equity holders.

Inherent risks can be managed, and financing opportunities provided, through diversification. The impact of individual commodity price movements can thereby be diminished — to the extent that the separate commodities are on different cycles or patterns, or to the extent that the markets in certain commodities (e.g., coal) allow for long-term contracts around which other commodities might cycle.

Further, diversification can itself provide financing opportunities to the extent that component parts can be self-financing, or to the extent that a strong parent can finance its “down-cycle” operations from above. Certain financing mechanisms that I promised to leave to the bankers (e.g., partial IPO’s) can help focus the equity and debt markets’ attention on the component values within a company. And to the extent such financing helps firm the parent stock price, the parent has enhanced its ability to raise equity capital.

As a final basic consideration, we know that, over time, equity must be more expensive than debt. Hence the temptations of gearing or leverage. There is no time here to examine the various capital market pricing approaches, but since an equity holder is subordinate to a debt holder, he runs a higher risk of not achieving a return on his investment. Rational investors expect higher returns on higher risks. But equity provides invaluable flexibility in the face of the previously mentioned operating risks. With a stronger equity base, a company can respond more quickly and imaginatively to challenges and opportunities.

Finally, equity represents permanent capital, service on which (dividends) remains under the control of management and the board. Stockholders expect any delays in such service to be remedied by more than simple catch-up or even compound interest.

And now to Newmont Mining Corporation.

From the $2 billion level at 1987 year-end, Newmont’s debt has been reduced to $1.6 billion through the first quarter. At the same time the characteristics of the debt have been altered by substituting a one million ounce gold borrowing, the largest ever completed, for $448 million of bank debt. The low interest rates of this financing (currently in the 2.5% range) will save Newmont Mining approximately $25 million at an annual rate compared to bank borrowings. Kept at the Newmont Mining level, the structure of the loan insulates Newmont Gold Company from the forward sale economics implicit in a gold borrowing. Newmont Gold Company remains an unhedged gold play. The loan does, however, hedge for the parent company approximately 15% of the parent’s equity in Newmont Gold’s production over a 5-year period at $448 per oz.

During the second quarter of 1988, Newmont completed the sale of its southern African interests and its holdings in Sherritt Gordon Mines, providing another $160 million toward debt reduction. The impact of the 1988 transactions so far described is to reduce annual interest expense from an initially budgeted $210 million to $105 million. With the planned sale of Newmont Oil Company and of Newmont’s remaining position in Magma Copper Company, Newmont’s consolidated debt will have been cut in half, and about half of the remainder will be represented by the low-cost gold loan. When the debt drops below $1.25 billion, interest rates on the maxi-credit are reduced by 3/4 of 1% and on the gold loan by a full 1%, a combination which will save a further $9 million in annualized interest.

Newmont’s obvious strength resides in its principal underlying assets — its 90% of Newmont Gold Company, with the largest reserves in North America; its 75% of Newmont Australia, the second largest producer there, and its 49.9% of Peabody Holding Company, Inc., the largest U.S. coal company.

When one compares Newmont’s market capitalization of just these principal assets, there is a significant gap, even after one assigns all of Newmont’s consolidated debt to their $5 billion aggregate market value. Our 90% share of Newmont Gold had an implied value of over $4 billion — more than double the market capitalization of all of Newmont Mining before the one subsidiary was opened to the public in 1986. Our 75% share of Newmont Australia was valued at $550 million by the marketplace, and our 49.7% interest in Peabody, based on our and Eastern Gas & Fuel’s cost of $10 million per percentage point in 1987 transactions, was estimated at $500 million. It is our belief that if Peabody were publicly traded this estimated value could well prove too conservative.

Newmont has been and remains an international mining house. Its essence is the collective experience of its management and operators, an essence refined and distilled over the past six decades in every major mining theatre in the world. Today, we are the company we were because the staff, management and spirit that built Newmont continue intact.

Newmont’s exploration enterprise is at the spearhead of Newmont’s future. The Carlin Trend in Nevada is being developed today because Newmont Mining Corp. geologists discovered gold there. Our NAL property in Telfer in Australia was discovered by Newmont Mining Corp. geologists. The same team has made recent discoveries in Papua New Guinea.

This year, despite our necessary focus on asset sales and debt repayments, we will spend more that $47 million on exploration for gold. This is four times the annual budget just five years ago.

At the same time, we also are forging ahead with a $420-million expansion program at Newmont Gold. With 30.9 million ounces in geologic gold resources, Newmont Gold is poised to become the third largest producer in the world by 1991, with an annual output of 1.6 million ounces.

So I am comfortable in assuming the wheel will turn fully, in due course, and Newmont will return vigorously to the very exciting challenge of balancing financing with risk taking. We will no longer be unique in the quality of existing assets.

Along with our competitors in natural resources, we will face the old foes: — The extraordinary risks associated with new ventures — The volatility of commodities markets.

As in the past, I suspect these factors will drive us all to degrees of diversification and to “conservative” use of debt.

Perhaps this renewal of conservatism and diversification will lead to another round of vulnerability to “slice and dice” raids, at times when investor sentiments favor calling in the auctioneer and selling the family possessions. Perhaps on the other hand institutional investors, or even regulators concerned with national economic health, will break the patt ern whereby arbitrage money reshapes entire industries and sometimes cripples leading components. I consider Newmont’s narrow escape from the Wall Street wolf pack to be a fortunate one for its stockholders and for the industry sector which Newmont still hopes to lead. Innovative financing will surely continue to be a hallmark of our progress.