Private Equity Owning Mines? A New Investment Approach
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News of a premium cash offer for Dalradian Resources (TSXV:DNA) in June raised some eyebrows as it involved a private equity group called Orion Mine Finance. Private equity has long invested in the resource space, but for a PE fund to buy an asset with an eye to permitting, building, and operating it themselves is a newer phenomenon. What should we make of these private equity groups in the world of junior mining?
The short answer is that private equity stands to benefit the sector greatly with leadership, expertise, and financing – and I think these ventures into asset ownership suggest that PE investors are approaching mining with a new, broader perspective: that in addition to buying shares that they can sell when up and providing debt that generates returns, these funds can reap cash flows from operating mines.
In the case of Orion and Dalradian, the cash offer will put over $425 million into shareholder’s hands when the deal closes in the third quarter. The deal is simple enough with a premium cash offer widely supported by shareholders, but it has some nuance.
(A note here: we owned Dalradian in the Maven portfolio, buying shares in late 2014 at $0.63 and selling in February 2017 at $1.42. As such we locked in a 125% return and, as it turns out, exited 16 months ago at almost the same price as this deal offers.)
In October 2017, Osisko Gold Royalties (TSX: OR) and Orion both bought just under 10% of Dalradian and received provisions like anti-dilution rights. Those rights are the reason that Osisko will be a "Remaining Shareholder" after everyone else is bought out at $1.47 per share. Note that Orion and Osisko worked together just a few months ago in providing a massive funding package for Victoria Gold (TSX: VIT) that included the two investing $125 million as equity, Orion providing credit facilities totaling US$175 million, and Osisko buying a royalty for $98 million.
The takeover price for Dalradian looks good at a 49% premium to DNA’s 30-day volume-weighted average share price, but it’s important to note that it’s the same price Osisko and Orion paid for DNA shares back in October. Since then, Dalradian increased the measured and indicated resource at Curraghinalt by almost 50%! It appears the market penalized Dalradian because of permitting delays, but that created opportunity for Osisko and Orion with a friendly takeover offer at similar valuation as their prior investments.
Private equity is on the hunt for new deals in the mining space. At the end 2016, Preqin estimated such groups had around $5.5 billion capital allocated to mining that was not invested. They also had invested $10.7 billion into stakes from which they had not yet exited. In 2017, there were approximately 60 deals worth $2.3 billion by private equity groups in mining. That leaves approximately $3 billion un-invested by private equity companies through 2017, which is significant money on the sidelines!
Private equity firms typically focus on near-term production stories. Dalradian’s Curraghinalt is near-production, but the deal structure is a little unique as Orion is actually taking over Dalradian. Orion usually does debt, equity, streams, royalties, and offtakes – they don't usually undertake permitting, building, and operations themselves.
I see two possible reasons for the change of approach.
The first point is inarguable. One of the biggest stories since the sector turned in early 2016 has been how all the majors have huge teams out assessing projects, so that miners can get a toehold into good projects by investing early. These strategic investments have provided a huge amount of needed exploration capital. Another big story has been how the royalty and streaming space, which barely existed a decade ago, is now teeming with groups competing to buy royalties and streams. Debt has also become highly competitive, with investment banks like Sprott lining up against PE groups to offer debt to development assets.
Put all that competition against a dearth of development-ready projects and you can see why PE groups are experimenting with new deal structures – they simply have to if they want to secure opportunities.
On the second point: profitable mines generate good cash flow, which is actually a mandated requirement for many private equity funds. These groups are different from venture capital groups who fund technology start-ups or exploration juniors for the chance to gain on the investment. A mandate requiring cash flows is why many PE groups long limited their junior mining involvement to providing debt packages, as debt generates cash flow.
But Orion buying Dalradian fits with several other examples I’ve noticed over the last year, where PE groups are seeing another way to invest in mining and still base their moves in cash flow: by looking at the bigger picture of rising metal prices and seeing mine ownership as a source of strong cash flows ahead.
Greenstone Resources is another PE group making these kinds of moves. Greenstone owns 60% of two copper developers: Coro Mining (TSXV: COP) and Excelsior Mining (TSXV: MIN). The group doesn’t own these assets outright but they own large enough stakes that they can’t be intending to flip their shares for a profit – they must be viewing these copper projects as sources of cash flow.
Investing in new mines also provides PE groups with an edge in winning the competition to provide project financing, effectively doubling their opportunity to win. Of course, Orion was careful to secure rights to match other offers to debt finance Curraghinalt back in October 2017.
This new PE perspective is positive for the sector in several ways. First, it means PE groups investing in development-stage juniors are not just buying shares with the view of selling again when the market improves. Such selling exacerbated mining’s cyclicality, I’m sure, so longer-term holding is a good thing. Second, if this perspective spreads, if Orion is successful in making money by owning Curraghinalt and Greenstone shows long-term benefit from almost owning Coro and Excelsior, then more PE groups will likely get interested in the mining space. More dollars being interested in a sector is only ever a good thing.