Appian Capital brings long-term money to mining business

Private equity firm Appian Capital Advisory LLP closed its first natural resources fund in 2014 taking in US$400 million. Since then, the London-headquartered firm has helped bring five mines into production and expects that another two investments will start production within two years.

In March, Appian marked its first major exit from an investment with the US$350-million sale of Avanco Resources, which owns the world’s fifth-highest grade, open-pit copper mine in Carajas, Brazil to Oz Minerals (ASX: OZL; US-OTC: OZMLF).

The fund is also invested in Roxgold (TSX: ROXG), owner of the Yaramoko gold mine in Burkina Faso; Harte Gold (TSX: HRT), whose key asset is the Sugar Zone gold property, 80 km east of the Hemlo gold camp in Ontario; and Peak Resources (ASX: PEK), which owns the Ngualla project in Tanzania, one of the world’s largest and highest-grade undeveloped rare earth assets.

Michael Scherb, a dual Austrian-Singaporean national, founded Appian Capital after working for JP Morgan Cazenove’s mining team in London, where he worked on US$185-billion worth of deals across M&A, equity and debt. His work included advising clients such as Xstrata, Rio Tinto and BHP Billiton. Before JP Morgan, Scherb completed a finance degree and lived for two years in China (2001–2003), where he invested European capital and family office money. Scherb recently spoke with The Northern Miner about his career and Appian Capital’s investment philosophy.

The Northern Miner: You were 19 years old when you finished your undergraduate degree in international business and economics in Canterbury, England, and decided to move to China. What did you learn from your two years in Beijing and Shanghai?

Michael Scherb: I went to Beijing just before the supercycle. I was curious and it was the right business decision. I really came to understand the Chinese mentality and got a real sense of where demand was coming from. It gave me great exposure and an idea of how the Chinese think. The Chinese mentality is to think on 200-year terms. We in the West are thinking in two-year terms, or even in quarterly terms, and it’s very difficult to plan a business that way.

TNM: Wasn’t that one of the reasons you left JP Morgan — frustration over how short-term thinking was being applied in mine finance?

MS: It was too much short-term capital and short-term thinking. The people, the institutions, management, hedge funds — they were all trying to invest in a long lead time, capital-intensive business, with a short-term mentality — so I set up Appian Capital to provide long-term capital. We are a 10- to 15-year investor. That’s the deal horizon we think is best able to support management teams and projects in the mining sector. We don’t put pressure on them at the wrong point in the cycle. We want to build mining projects, put them into production, and sell them with everything we have. It’s that type of capital that the industry needs, because the mining business has a short-term mentality.

We like backing a project and supporting it every step along the way to production. Imagine a CEO not having to waste his time going to trade shows, constantly raising funds on the street, dealing with retail investors? Imagine if he has a backer that will provide the capital and he can focus on what he does best, putting that asset into production? It eliminates the short-termism. They come to us and get a long-term, supportive backer.

TNM: Tell us more about the first fund you launched.

MS: We have made eight investments, five of which we’ve brought into production in a very short period of time, and we’re expecting another two in production in the next 18 months. What we’ve done is proven that the business model works, and now we’re going to scale up in size. We had about US$1.2 billion in interest in the first fund, but we accepted only US$400 million.

TNM: Can you tell us more about the second fund you plan to launch?

MS: In our new fund, which will be larger in size, we would simply scale up on what we have proven to be a successful business model. The only other difference is that we will get involved in a small amount of advanced exploration, only because the industry has cut back on that in the past five years. This is something new. There are a lot of strategic opportunities for us to help projects grow.

TNM: Appian says it prides itself on being different from other private equity firms in terms of in-house capabilities (i.e., technical expertise on strategy, metallurgy, geology and mine build). Wouldn’t most private equity firms say the same?

MS: Our model is a bit different. First we capture the long-term value of it, and second is how much support we provide management teams. You take a CEO who invariably is a geologist or engineer. They need help and support, and members of our financing team in their previous lives have advised and assisted in over US$200-billion worth of deals. Our technical team members over their careers have brought more than 60 mines into production. So every group we support has capital through to production. They have financial support to understand markets and have technical support to put their projects into production. If your project is stuck for financial or technical reasons, we sit at the table with you and figure it out. Appian is a good long-term partner.

TNM: Is it true that last year you looked at 409 projects and made only three long-term investments? Why did so many fail to meet your requirements?

MS: We’re very selective. It takes us three to six months of due diligence. I’d say the diligence is deep because we’re going to back the project for as long as it needs backing, and that’s why we take a lot of time to understand the project. Often CEOs find capital with the path of least resistance, they’re tapping capital markets, which might be a quick solution. However, when things go bad that capital isn’t going to support them. Take Roxgold, for example. It has phenomenal assets. When Burkina Faso was having problems, everyone was selling, but we were the only group supporting that asset. When we’re in, we’re in. You know you’re going to have that backing for a long time. Now that means a lot of projects aren’t for us, so we have a very selective hit rate.

TNM: Can you talk about the success you had in selling Avanco Resources to Oz Minerals?

MS: That was a great exit for us and Avanco is a perfect example of what we do. We went there early, we oversaw it through permitting, financing, development — and put it into production. It was us that brought in Oz Minerals, and we closed the deal with the Oz Minerals team, and, ultimately, that ended up being a great result for all the shareholders. It was nearly four years between the time we invested and the time they went into production.

TNM: You’ve also acquired some private projects, a copper-gold project in Brazil that you are fast-tracking to development. Which one is that? And another investment in a nickel sulphide project with cobalt as a by-product, also in that region. Can you talk about those?

MS: We kept those private. Those are both owned by us, 100% owned, and we have the same management team overseeing them both. They’re both permitted. They’re both construction ready, and we’ll be bringing the nickel project into production in the next 12 months and the copper-gold project into production over the next 24 months. Then likely we’ll do an initial public offering of some sort or we might stream dividends back to our investors, but we’re focusing on the technical side right now and bringing those two into production.

TNM: What about royalties? Is that going to become a bigger part of your portfolio?

MS: That’s one area where we’ve branched out from traditional equity exposure. We have four royalties, one producing copper royalty — we own a royalty on a copper-gold asset in Brazil, some of the offtake on Harte Gold, and Peak Resources, we have a royalty on that, so that’s a very attractive royalty package and we are seeking one or two more with either a stream dividend so shareholders hold, or exit our royalty position.

TNM: You’ve said a common mistake is to get too large too quickly. Are there other tips for investors in the space?

MS: Our model is being long-term value investors, so we apply what we think is the appropriate methodology and a technical overlay. In some areas, mining deviates from those traditional methodologies. For example, mining is a finite business. It’s not purely capital appreciation over the long-term. You need to seek extensions. I think a common mistake is having a short-term mentality: the move for volume versus margin. Bigger isn’t always better and with mining, people should be more and more profitable rather than just having scale.

TNM: How does private equity in mining compare with the oil and gas sector?

MS: For investors who back private equity groups in mining and oil and gas, all they need to see is an investment model that provides appropriate downside risk protection while keeping upside optionality. The oil and gas sector seems to have done it very well, but it still seems that mining takes too high of a risk relative to reward. If you can move them away from that philosophy of how much they can make rather than how much they can lose — they’re focused on making the 10-time returns rather than making stable returns, which is what the mining industry needs. So the way to do that is focus on fundamental asset quality, high margins, low cost and turning mining into a bottom-up fundamental analysis as a long-term value investor would do, rather than just a pure punt on a commodity. Essentially, it needs to be more focused on bottom-up fundamentals, rather than just making a gamble.

TNM: Why is that thinking so pervasive in the mining industry?

MS: It’s the heritage of it. It’s the chance of hitting it big on an exploration play — that’s in the DNA of mining. It’s amazing that oil and gas has matured where mining still seems a bit frontier, and it doesn’t need to be. We’re on the cutting edge of applying a long-term investment model, and what we’re doing is pretty different than anything I’ve seen in the space, and it seems to be working.

TNM: What is the best financing model?

MS: We’re going through a unique time in the industry, where there’s an identity crisis when it comes to mine finance. Mining just came through a very turbulent time where it was very challenging for nearly everybody, and that changed peoples’ risk profiles. It changed the appreciation for different types of capital. Before that, you’d take whatever capital was available, and people are realizing there are advantages and disadvantages in each type of capital they take on, and management teams are thinking more and more about what partners they want to have. And I encourage that debate. Rather than taking that hot money on the table, is that the true right capital to be with you in good and bad times? You have to consider all the aspects.

TNM: Often people talk about the need to diversify. What is your view and how have you structured your investments on that score?

MS: The economic theory out there is to be perfectly diversified in your portfolio, but I don’t believe that’s true. If you have 25 good investments to make, the theory is to allocate to all 25, in case some don’t work out. But that’s not accurate because you’re going to spread yourself too thin. I would analyze those projects deeply, and then I would spend a lot of time and choose the top eight, and then back them with everything I have. If you’re going to invest $1 you might as well invest $100. You have to have that level of conviction in every investment you make. So we’re not macro investors calling commodity prices, we’re investors seeking bottom-up, fundamental value through analysis.

TNM: Have you had any duds?

MS: I don’t what to jinx it, but in Fund I, we have not!