African Exploration: Accessing Finance in Challenging Markets

Andrea Stucchi

DAR ES SALAAM, TANZANIA – As many of our readers will be all too conscious of, access to capital for junior mining companies has recently been severely impeded. While those with advanced-stage developments continue to attract equity to fund the development of quality projects, early-stage explorers are facing fewer options, particularly for greenfield prospects.

The reasons for this are simple: the US credit rating downgrade and the Eurozone debt crisis caused dramatic stock market volatility during the second half of 2011 and the fact that, historically, junior mining companies relied heavily on equity capital markets as a source of finance is contributing to further exacerbation of an already difficult situation. What is less simple is how junior companies can overcome these hurdles: particularly those operating in Africa, commonly seen as a more risky investment destination.

Having so far spent a month in Tanzania researching the mining industry here, one thing has become clear; prospectors in Africa maintain that raising capital through international stock exchanges is still the most efficient way to finance junior companies. However, today the proceeds raised from issues of equity are down significantly year on year, the result of a decline in investors’ appetite for risk and lower valuations, which have resulted in issues being too dilutive for shareholders. Increases in commodity prices are often not fully reflected in share prices, whereas decreases are.

This disparity can be explained partly by the fact that some investors and analysts simply do not believe that the higher price of commodities such as gold will last for long. The best evidence of this is that analysts use steeply backwardated price decks in their earnings and net asset value (NAV) models. In other words, year-by-year they forecast a lower price for the yellow metal, and calculate their earnings estimates and valuations accordingly. Unfortunately, backwardated pricing assumptions (which establish that the current price of gold is the highest we will ever see) are doing today more harm than good, scaring investors away from gold mining equities at a time in which gold prospectors need full support from their investor base.

Debt financing is also an increasingly difficult option. With Basel III making it increasingly difficult for Western banks to provide anything other than short-term loans at competitive prices, the traditional long-term project financings are also at risk. Challenging capital requirements for banks could lead to increased costs for lenders and therefore borrowers. The reforms are not due to be phased in until 2013 to 2019, but are already creating uncertainty and risk aversion amongst lenders.

The only exception to this challenging scenario appears to be reserved for corporate bonds issuers. Record low benchmark interest rates in the US enabled leading mining and metal companies to issue bonds with exceptionally low coupons and long-term maturities. The first half of 2012 already saw a greater share of volume by emerging market issuers accessing US dollars investors, looking to secure interest rates ahead of an increase in US treasury yields. With funding options narrowing for juniors the corporate bond (debt) avenue seems to be the most appropriate form of capital raising activity available today. Bond investors with higher risk capital such as hedge funds may be increasingly willing to sponsor quality projects in smaller companies.

How does this specifically affect African explorers? Africa is traditionally a high-risk environment but the rewards are potentially more significant in terms of gaining access to resources with a low extraction costs and long mine-life. Many of the prospectors currently operating in the continent already have a portfolio of growing assets, meaning that their immediate task therefore consists in developing funding strategies to build these assets in the current environment, which is increasingly challenging. Given this situation, the experience of the mining team of developing mining projects in these higher-risk frontier geographies will be decisive in promoting these companies and attracting a solid investor base.

During 2012, the traditional forms of financing; bank financing and equity; are unlikely to become any less challenging for junior mining companies. However, equity financing is the lifeblood of juniors and when the equity markets stabilize and confidence returns the global growth ambitions of prospectors in Africa should lead to an increase in cross border IPOs, particularly on the London and Hong Kong stock exchanges. Until then, junior prospectors should look at alternative means of raising finance: sovereign wealth funds, strategic partnerships and private wealth are increasingly being utilized as alternative sources of finance. Perhaps the best recommendation to weather this storm would be to track more than one option concurrently as this could put companies ahead of their competitors who may be delayed if they focus on one option that later proves to be unsuccessful.

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