Study examines growth strategies for mining industry

Does an industry that spends ten times more on acquiring deposits than it does on finding them have a future? A new study by Toronto-based mining writer Virginia Heffernan suggests that if history is any guide, an unhealthy number of these mergers and acquisitions will generate low-to-zero returns to shareholders.

What’s more, eventually most of the deposits worth acquiring will have been assimilated, and the larger companies formed by mergers and acquisitions will require replacement reserves on an even larger scale. And with junior companies struggling for survival, Heffernan dares to pose the question: from where will these reserves come?

Published by Financial Times Energy, a division of London-based Financial Times Business, the report is based on real-life case studies that provide excellent examples of sometimes disparate growth strategies. Growth Strategies for the Mining Industry: Acquisition or Exploration? also examines recent trends that have prompted companies to emphasize acquisitions over exploration, and assesses the long-term prospects for the industry.

Heffernan begins the exercise by taking a hard-nosed look at the “gradual deterioration” of the mining industry since the 1980s. This downturn was brought about by declining commodity prices, over-supply, recession (particularly in Asia) and substitution by materials such as plastics, recycling of metals, and slower growth in manufacturing. At the same time, the globalization of the 1990s increased competition for projects and made growth even more important for survival.

During the 1990s, Heffernan notes that mergers and acquisitions became “infinitely more popular” than exploration as a means of generating replacement reserves, increasing production or both. “In 1998,” she writes, “mining companies spent US$25 billion on mergers and acquisitions, seven times more than they spent on exploration, and the gap continued to widen in 1999.”

The most significant risk of this strategy is paying too much for assets. Heffernan cites several examples of how mistakes of this type have haunted many a mining company over the years, including Broken Hill Proprietary’s ill-fated purchase of Magma Copper. Even Barrick Gold’s 1994 US$2.2-billion bid for Lac Minerals might have made the list of ill-fated acquisitions, had it not been for subsequent exploration success at certain key properties, namely the Pascua deposit, which straddles the Chilean-Argentine border.

In contrast, the most significant exploration risk is discovery risk; that is, the low odds of success relative to the high costs. With financing more difficult to raise than ever (because of competition from high-tech companies), exploration spending has been on a steady decline since 1997, when it reached a peak of US$5.1 billion. Heffernan notes that the total 1999 budget for worldwide non-ferrous metals exploration was a mere US$2.7 billion — slightly more than half of what it was in 1997.

While partnerships between juniors and seniors for grassroots exploration are the obvious solution to the challenge of project generation, Heffernan doubts that financing from senior companies will be sufficient to maintain a vibrant junior sector. “If the industry wants to improve the reliability of project supply,” she writes, “it must find ways to support the juniors with innovative financing vehicles and other incentives that will keep this sector viable throughout the market cycle.”

Heffernan’s report is a well-researched, clearly written treasure trove of information about how companies grow and why some go bust. Among the more interesting case studies are Barrick Gold’s remarkable track record of growth by acquisition and Newmont Mining’s growth through discovery (focused on the Yanacocha project in Peru, and Batu Hijau in Indonesia). The role of the junior sector is not given short shrift, with the success of Dia Met Minerals being one remarkable example.

The report also examines successful partnerships between juniors and majors, with Teck used as an example of how partnerships of this type can minimize the risk and costs of reserve replacement. This model is being adopted by other companies, Billiton being a recent convert.

Heffernan says the demand for new, high-quality projects should encourage more companies to strike a balance between the growth strategies of exploration and acquisition. But whether this more balanced approach to growth will come about remains to be seen. If it does not, she warns, senior companies will find themselves dangerously dependent on the junior sector to provide the raw materials for the mines of the 21st century.

Copies of Growth Strategies for the Mining Industry may be ordered by phoning +44 20 7896 2241. Fax: +44 20 7896 2275. E-mail: info.energy@ft.com. Web site: http://www.energy.ft.com.