Article

For mining firms being big matters

Four factors determine whether African mining firms can meet investor expectations.

Par Alan Bird

First published on juillet 28, 2010
min


Despite the recent recession, mining fundamentals remain strong, fuelled by robust demand from urbanising economies, especially China's, and by constrained supply for many metals and minerals. This is good news for the major mining nations in Africa. The continent produces more than 60 critical commodities, including platinum group metals, diamonds, uranium, manganese, chromium, nickel, gold, iron ore, coal, bauxite and cobalt, and new discoveries are opening large opportunities. Overall, Africa holds some 30 percent of the world's known mineral reserves. Yet it remains tough for mining companies operating in Africa and elsewhere to meet investors' growth expectations. Existing assets constantly erode over time, while bringing new assets to production increasingly requires massive, risky investments. For miners, being big matters in acquiring and developing the assets that will meet their growth targets. Indeed, where big enough used to be good enough, this is no longer the case. Today, being the biggest matters the most. Four factors determine the progress that mining majors can make towards that goal: scale, diversity, option value and repeatability. Let us examine why. First off, scale players can derive a number of synergies in areas ranging from procurement to greater leverage of shared mining know-how. The advantages extend to marketing reach and shared infrastructure for processing, rail transport and port facilities. One large operator normally can mine more effectively and efficiently than two or three operators working on the same ore body. Yet scale's dark side is the increased possibility of complexity, which can destroy value. Second, diversity inherently lowers risk. By having a wide range of assets in several regions and in multiple commodities, companies can lower their exposure to geopolitical turbulence and to price fluctuations. Smoother cash flows and reduced exposure to catastrophic loss, in turn, lower the cost of debt and the overall cost of capital, contributing to balance sheet strength. A stronger balance sheet enables firms to undertake more large-scale projects, even amidst a downturn and tight credit conditions. In other words, future growth isn't compromised as a result of capital constraints delaying attractive projects. Third, option value is greater for large, diverse asset portfolios. Most investment projects today are measured in terms of net present value - but NPV tells only part of the story. NPV cannot reveal the true value of mining assets. Uncertainty over future outcomes adds option value. This is critically important given the inherent uncertainty over future prices as commodities get scarcer. Prices tend to rise, eventually making sub-economic assets viable. Option values in mining are consequently far higher than in most other industries. Another key factor to understand is that the total option value of a portfolio of assets is greater than the individual option values added together. That is because the full portfolio gives management a wider scope for action in response to external triggers, such as price fluctuations or political instability. Finally, repeatability acknowledges that mines run out. Growth depends on constantly acquiring new assets and bringing them to production on time and on budget. Even among today's largest players, the number and scale of major new assets acquired and developed in a year is small. Here again, size confers benefits. Being a large-scale mining company not only helps to pay for these assets, it can also accelerate the pace of learning and help attract and deploy the best talent, which in turn lays the foundation for repeatable success and improved performance. For African governments, this constant drive from the world's biggest miners to invest can be a windfall. Yet governments need to ensure that the right skills, infrastructure and political will are in place to sustain a viable local mining industry. After all, meeting big economic growth targets matters a lot to them, too. Alan Bird is a partner with Bain & Company in South Africa and London, and a leader in Bain's global mining and minerals practice.

Despite the recent recession, mining fundamentals remain strong, fuelled by robust demand from urbanising economies, especially China's, and by constrained supply for many metals and minerals.

This is good news for the major mining nations in Africa. The continent produces more than 60 critical commodities, including platinum group metals, diamonds, uranium, manganese, chromium, nickel, gold, iron ore, coal, bauxite and cobalt, and new discoveries are opening large opportunities. Overall, Africa holds some 30 percent of the world's known mineral reserves.

Yet it remains tough for mining companies operating in Africa and elsewhere to meet investors' growth expectations. Existing assets constantly erode over time, while bringing new assets to production increasingly requires massive, risky investments.

For miners, being big matters in acquiring and developing the assets that will meet their growth targets. Indeed, where big enough used to be good enough, this is no longer the case. Today, being the biggest matters the most. Four factors determine the progress that mining majors can make towards that goal: scale, diversity, option value and repeatability. Let us examine why.

First off, scale players can derive a number of synergies in areas ranging from procurement to greater leverage of shared mining know-how. The advantages extend to marketing reach and shared infrastructure for processing, rail transport and port facilities. One large operator normally can mine more effectively and efficiently than two or three operators working on the same ore body. Yet scale's dark side is the increased possibility of complexity, which can destroy value.

Second, diversity inherently lowers risk. By having a wide range of assets in several regions and in multiple commodities, companies can lower their exposure to geopolitical turbulence and to price fluctuations. Smoother cash flows and reduced exposure to catastrophic loss, in turn, lower the cost of debt and the overall cost of capital, contributing to balance sheet strength. A stronger balance sheet enables firms to undertake more large-scale projects, even amidst a downturn and tight credit conditions. In other words, future growth isn't compromised as a result of capital constraints delaying attractive projects.

Third, option value is greater for large, diverse asset portfolios. Most investment projects today are measured in terms of net present value - but NPV tells only part of the story. NPV cannot reveal the true value of mining assets. Uncertainty over future outcomes adds option value. This is critically important given the inherent uncertainty over future prices as commodities get scarcer. Prices tend to rise, eventually making sub-economic assets viable. Option values in mining are consequently far higher than in most other industries.

Another key factor to understand is that the total option value of a portfolio of assets is greater than the individual option values added together. That is because the full portfolio gives management a wider scope for action in response to external triggers, such as price fluctuations or political instability.

Finally, repeatability acknowledges that mines run out. Growth depends on constantly acquiring new assets and bringing them to production on time and on budget. Even among today's largest players, the number and scale of major new assets acquired and developed in a year is small.

Here again, size confers benefits. Being a large-scale mining company not only helps to pay for these assets, it can also accelerate the pace of learning and help attract and deploy the best talent, which in turn lays the foundation for repeatable success and improved performance.

For African governments, this constant drive from the world's biggest miners to invest can be a windfall. Yet governments need to ensure that the right skills, infrastructure and political will are in place to sustain a viable local mining industry. After all, meeting big economic growth targets matters a lot to them, too.

Alan Bird is a partner with Bain & Company in South Africa and London, and a leader in Bain's global mining and minerals practice.