Digging for Treasure

Rising interest of private equity (PE) firms in the mining sector has been widely reported, including a recent transaction by a global firm in an iron ore and bauxite mining company. There have been a few cases of PE transactions involving end-use assets packaged with a backward integrated mining business. Has mining really arrived on the radar of private equity?

Traditionally, Indian mining sector has not been attractive for PE firms due to challenges unique to the industry. In India, private sector companies that could potentially be targets for PE funds, have had restricted participation as government owned companies dominate in most major minerals including coal. The miners have traditionally been price takers till recently and have, even globally, underperformed the markets. That has changed for now. There are, however, talks of institutionalizing regulatory mechanisms for pricing coal and the government has not refrained from coercing iron ore miners to keep them from rising prices further.

All this are further to the global cyclicity of the commodities markets and long gestation periods of project implementation. According to a study conducted by the erstwhile Central Mining Research Institute (which has been re-christened as Central Institute of Mining and Fuel Research) the new project implementation have taken, on an average in the past, about seven years. This is certainly longer than the investment horizon of some of the reputed PE firms. The cash flow prediction under such circumstances, with large uncertainties in preparatory works, approvals and clearances, is challenging to say the least. The policies and procedures for grant of approvals for mine planning, environment and forest clearances are not objective and hence, have been unpredictable in their assessment of applications received. Even the statutory provisions and legal frameworks have been in the state of flux due to incremental changes occurring sporadically.

Political and social issues have become more prominent than ever, with cases of state governments asserting their rights over mineral properties and societies around mineral deposits resisting mining activities quite vociferously. A consequence of these is also the reputation risk, where a Machiavellian wisdom may lead to impairment of brand.

While not many of the issues discussed above have changed significantly and hence, may serve as inhibitors to PE interest in the sector, there are several positives for the sector that is looking up. The cyclic nature of the commodities market is indicating a super cycle, likely to provide adequate returns. The demand for raw materials has been rising and has been relatively inelastic even in light of expectations of global slow down. The growth of Chinese and Indian economies is likely to continue to drive growth in mining sector.

The miners have also increasingly taken up the role of price makers, current inflation management practices of the government notwithstanding. In the international markets, the major mining companies have negotiated tough deals for supplies of iron ore, metallurgical coal and thermal coal, and have made many of the downstream companies rushing to acquire mineral resources. Metal prices have also been strong and the predictions of peaking off have been proved wrong time and again. Higher prices have also resulted in rising profit margins. Indian mining companies have outperformed global counterparts, one of the key reasons being lower costs of labour. Although, scarcity of human resources is likely to lead to rise in the operational expenses, Indian mining sector may still be attractive.

Another important development has been the enhanced liquidity of the mining assets, providing much needed exit options for the PE firms. The new National Mineral Policy of 2008 has proposed permission to transact in licenses, which is likely to further help the cause, and may make mineral prospecting and exploration businesses lucrative too. Development of vibrant capital markets has also added a new dimension, by adding initial public offers (IPO) as an exit option for the PE firms.

There are risks, but there is potential for compensating rewards too, and hence, it does appear to be the time for the PE firms to look at mining sector more closely.

(This article was published in the Financial Express on 28th August 2008).