Miners debate M&A as COVID-19 sends shares lower

In early March, BHP (NYSE: BHP; LON: BHP) Chairman Ken MacKenzie said the mining giant was in a strong position should COVID-19’s impact on the market create M&A opportunities.

“On balance, the business is in very good shape,” Reuters reported MacKenzie as saying during the Australian Financial Review summit in Sydney on March 10. “I’m not sure if there will be any opportunities that will come from this, but if there are, we are actually in a position to act.”

In the intervening weeks, COVID-19 has begun to take a dramatic toll on the mining industry. Operations around the globe have been forced to close by governments or have been voluntarily shuttered or limited to contain the spread of the virus. Share prices are down as the virus batters the world economy.

In this uncertain environment, M&A activity in mining and other sectors has taken a hit. Refinitiv, which provides data on financial markets, reported that global mergers and acquisitions activity dropped 28% year-on-year in the first quarter of 2020 to sit at its lowest level since 2016. The number of deals in the quarter also dropped by 14% year-on-year.

Looking specifically at mining, global mining M&A deals in February totalled US$1.26 billion, an 18.4% increase from January, but a drop of 61.7% when compared with the last 12-month average, which stood at US$3.29 billion, according to figures released on March 27 by GlobalData, a U.K.-based data analytics and consulting company.

BHP Billiton’s Western Australia iron ore mining complex. Credit: HP Billiton.

North America saw the highest dollar value of deals at US$400.66 million that month. It also had the highest volume of deals, followed by the Asia-Pacific region and Europe. Looking at countries, Canada took the top spot for deals, with 40, followed by Australia with 15 and the U.S. with 12.

Even as the devastating effects of the coronavirus are being felt, deals have continued through March, including Endeavour Mining’s (TSX: EDV; US-OTC: EDVMF) $1-billion takeover of Semafo (TSX: SMF), creating what the companies said in a press release would be a top-15 global gold producer and the largest in West Africa. MegumaGold (CSE: NSAU; US-OTC: NSAUF) and Osprey Gold Development (TSXV: OS; US-OTC: OSSPF) have partnered up, while Argonaut Gold (TSX: AR) plans to merge with Alio Gold (TSX: ALO; NYSE.A: ALO), and Seabridge Gold (TSX: SEA; NYSE: SA) snapped up the 3 Aces gold project in southeastern Yukon from Golden Predator Mining (TSXV: GPY).

John Wilkin, a partner at Blake, Cassels and Graydon in Toronto, said he expect M&A activity to continue, but notes that companies that are considering a deal — and those that are in the process of closing them — now face many more risks than they did just months ago. “I think parties who have a will to do the deal are going to spend a lot more time discussing the risks,” he said in an interview.

Jay Kellerman, a partner at Stikeman Elliott and head of the firm’s mining group in Toronto, said he thinks deals will slow in the short and medium-term. “My sense is, notwithstanding Endeavour and Semafo, senior management teams and boards are focusing right now on keeping their existing companies going as opposed to thinking about M&A activity,” he told The Northern Miner. “These companies need to be in operation to sell their product, to make money and … at what point in time is cash going to become very thin at some companies? I would think companies are in that mode of thinking as opposed to being opportunistic and thinking this is a good time to go buy.”

Wilkin sees three major areas of volatility that could impact the execution of a transaction. The first is for buyer companies trying to price their targets. “If you’re a board of directors trying to decide on pricing a deal, it becomes very difficult when the share price of your target is moving around significantly [from] trading session to trading session,” he said.

An analysis of M&A issues on Stikeman Elliott’s website noted that deal-pricing could create a valuation gap between a buyer and its target. As share prices have plummeted, companies being targeted for acquisition may receive an offer less than what management thinks the organization is worth.

The law firm suggests earn-outs can be an effective work-around. An earn-out agreement effectively splits the purchase price of the deal into two payments — one up-front, and one post-closure that’s based on the acquired company’s actual future performance. “With an earn-out, some of the purchase price could be pushed out to a future time period after recovery,” the March 19 online briefing stated.

The second major source of volatility is deal financing. Companies that can’t use shares to finance their acquisition may find it more difficult to come up with capital, experts say. In addition, miners that have signed deals for third-party debt financing may want to check their contracts to determine what ability their lender has to walk away from funding obligations.

Vancouver-based SilverCrest Metals (TSX: SIL; NYSE.A: SILV) is facing this reality. The company signed a $75 million bought-deal financing underwritten by a banking syndicate led by National Bank Financial, which also included Eight Capital and Scotia Capital, on March 11, only to see the deal terminated seven days later.

National Bank Financial said it was using the “disaster out” clause in the agreement because of the pandemic. SilverCrest disputes the bank’s justification, calling the situation “fully evident when the bought-deal financing was agreed upon with expectations that the precious metals market would respond positively to this known risk.” The Mexico-focused mining company said it intends to pursue legal options against the bank.

While financing will be challenging now, there are alternate routes companies may be able to pursue, Wilkin said. “We may see the mining finance companies and private equity companies that have a stomach for the volatility step in and take opportunities.”

Workers in front of a portal at SilverCrest Metals’ Las Chispas silver-gold project in Mexico. Credit: SilverCrest.

There are also multiple operational risks that could impact a deal. “We’re seeing countries … where the government has ordered that mining operations cease, at least in the short-term while we deal with COVID-19,” Wilkin said. “So you’ve got potential targets whose operations have stopped, and [there’s] uncertainty of when mining activity can start again and minerals can start to move.”

If operations are closed and companies can’t deliver on their supply contracts, they may need to declare ‘force majeure’ — a clause in contracts that can discharge one party of its obligations if an event beyond the control of either company makes performing its duties impossible. The Financial Times reported on Feb. 27 that in response to the coronavirus, the China Council for the Promotion of International Trade issued more than 1,600 force majeure certificates to companies across 30 sectors to attempt to protect them from contract damages that stemmed from not performing their obligations.

Buyer companies should be paying particular attention to their targets’ contractual obligations and force majeure clauses. Because pandemics and epidemics are often mentioned in these clauses, it’s likely the coronavirus would be covered.

In addition, noted Wilkin, government-enforced shutdowns would very likely be covered, or when critical employees are prohibited from leaving their homes or refuse for safety reasons to attend work. “That can get a little more challenging for a company to demonstrate, but it’s the type of thing that a company may argue.”

However, force majeure clauses are very fact-specific. “Where it gets potentially more complex is if an operator elects to cease operations, isn’t forced to by a government but makes the election to do so because it thinks it’s the right thing to do to protect its employees. It’s not as potentially crystal clear.”

A buyer company will also have part of its due diligence process frustrated by global travel restrictions that would prevent representatives from visiting the target’s sites, said Kellerman.

Material adverse changes (MAC) clauses will become particularly important as companies sign or finalize deals. The clause requires proof of a sustained decline in business as a result of a change specific to the business, or a broader change that affects the business disproportionately. Previous judgments involving material adverse changes clauses tend to be very fact-specific, and the effects of the pandemic are so unique, so it’s hard to say how using the clause to terminate a contract in this environment would go over in a court, said a March 23 analysis from Blakes on the law firm’s website.

“We’ve been asked this question a lot, and first and foremost it comes down to what the [contract] language says, and they’re not all the same,” said Kellerman. As well, he noted, different courts and different jurisdictions will interpret the question differently. “It’s a definite ‘it certainly may,’ but it just depends on the contract.”

For new transactions, it may be more difficult to make the case that a MAC event has occurred, because the pandemic is now considered a known event, said the online Stikeman analysis, but companies can still draft language that specifically acknowledges coronavirus-related risks.

For deals that have already been signed and not closed, the interim period will become particularly important, the experts agreed. A typical covenant requires the target company to carry out business “in the ordinary course” until the deal closes to ensure the asset remains the same value. This will likely be complicated by site closures or reduce-work orders, and the online Stikeman analysis suggested parties be flexible to give a target company the room to respond to the virus.