A briefing on alternative tools which can be employed by mining companies in financing their projects. First published in 2013.
A royalty is a right to receive payment based on a percentage of the minerals or other products produced at a mine or of the revenues or profits generated from the sale of those minerals or other products at a mine. Royalties are commonly granted to governments, pursuant to mining legislation, or to land owners, pursuant to mining leases. However, royalties can also be granted to investors or financiers as a means of providing enhanced returns.
While royalties are used frequently in the mining industry, it is not possible to say that there is a 'standard form' of a royalty. However, royalties typically fall into four general headings: profit based royalties, net smelter return royalties, production royalties or royalties in kind.
Royalties tend to be granted during the early stages of mining operations and are typically for pre-feasibility costs. A royalty of between US$10 million and US$40 million is most common. There are specialist royalty companies – Royal Gold, Silver Wheaton, International Royalty, Franco Nevada. The majors and traders – Rio Tinto, BHP Billiton, Glencore and Trafigura – are also known to purchase royalties.
Royalties are typically paid from the top of the cascade. Project finance banks view royalties payable to governments and/or land owners as unavoidable operating costs of the project. However, royalties payable to other creditors or investors in the project may cause issues as the royalty may be seen as an enhanced return to equity or other creditors paid in priority to senior lenders.
Although streaming is a form of royalty, the streaming investments can be for much larger amounts. The royalty companies mentioned above will all make streaming investments, typically for precious metals. We have also worked on transactions where end users have made streaming investments in order to secure long term supply.
Streaming finance is raised by selling a right to a commodity (typically a by-product) in exchange for an up-front payment. A stream is distinct from a royalty as it creates a right for the purchaser to purchase all or a portion of one or more metals produced from a mine rather than, in the case of a royalty, creating a right to a percentage of revenue from the sale of production. Traditionally streaming has been used in mining operations in which gold or silver was a by-product. The mine operator is able raise significant capital by selling its by-product gold or silver production for an up-front payment and, in some circumstances, an on-going price contribution or tolling/refining fee or continuing purchase of product over a period ranging to the life of the mine.
Recently, several large streaming investments have closed in the Canadian market, these include a US$1 billion gold and silver streaming investment by Franco-Nevada into Inmet Mining Corp. to finance the construction and development of a giant copper mine in Panama and a US$750 million gold and silver streaming investment by Silver Wheaton Corp. into HudBay Minerals Inc.
Where a streaming investment is unsecured, the investment should sit well alongside project financing as it is typically concerned with a by-product (which is usually not featured in the lenders' financial model) and, in some circumstances, will provide an additional source of revenue to supplement the main product revenue stream. Of note, it is also possible to structure streaming financings for the funding of mine acquisitions, so that the upfront payment (either separately or in conjunction with senior leveraged finance) is utilised for the purchase of a mine.
Difficulties arise where the streaming investment is secured, particularly where the investment is made prior to project financing. In these scenarios, prior to the project financing, the streaming investor is first ranking. It is conceivable therefore that a mining operator may be held to ransom by an incumbent streaming investor who may well have agreed to be second ranking behind project financing lenders, but frustrates the incoming project finance lending arrangements by refusing to agree reasonable intercreditor arrangements. It is critical in these instances, that the mining operator agrees bankable intercreditor principles as part of the streaming agreement (in conjunction with the release of any stream security) with rights to terminate the streaming investment in the event that the streaming investor fails to agree to sign an intercreditor agreement based on these principles.
The purchaser (or 'offtaker') of the production of a mine is often a good source of additional finance. Trading companies or end users, often eager to secure supply of the mine's production, commonly provide additional funding to mining projects. Offtakers may be prepared to make an equity investment and/or provide straight commercial debt (in some cases subordinated). However, the most common form of offtaker financing is a combination of:
- an advance payment for future production (a prepayment) which is amortised against deliveries
- a discount to market price under the offtake agreement.
Advance payments for product tend to be between US$10 million and US$50 million and are usually only made once the assets are operational as the margins do not reflect construction risk. For high margin advance payment funding, see Streaming above.
Other lenders to a mining project with offtaker financing will be concerned to ensure that sufficient revenues will be generated through the offtake agreement to ensure that the mining operator can service its other lenders. Where the advanced payment is amortised against deliveries and/or the price of the production is discounted, the financing offtaker enjoys a structural 'super senior' position as it does not wait for the application of the cash waterfall in order to receive its return. It is for this reason that prepayment financings do not tend to sit comfortably alongside project financing unless the advance payment is amortised equally with the senior debt and sharing arrangements are agreed between offtakers and senior lenders.
In times of uncertain equity capital markets, private equity investors, hedge funds and other investors are prepared to provide equity bridge loans to bridge the gap until equity capital markets return. An equity bridge loan is usually priced like equity and may include other enhanced returns through the grant or royalties or warrants. An equity bridge is usually fully secured against the project assets.
An equity bridge is typically a bridge to equity and therefore is taken out by an equity raise prior to the project financing being drawn and therefore should not create intercreditor issues.
Warrants give the holder the right to subscribe for ordinary shares at an exercise price which is fixed at the time that the warrant is granted. The exercise price may be nominal and there may also be cash-out rights.
Warrants may be 'stapled' to ordinary shares or issued as a standalone security. There is no ongoing return with a warrant as they are subject to exercise. The return of investment is made through the sale or exercise of warrants and disposal of shares and/or the 'delta' of cash out.
Warrants are rarely used as a standalone method of financing but can be used as an equity 'kicker' alongside other types of financing. Warrants are an effective means of providing an enhanced return to financiers as the financier can benefit from increases in share prices often caused by the certainty of secured financing. In addition, warrants are common in Canadian equity financings and are often seen as part of a pre-IPO financing structure.
Warrants can effect the shareholdings of existing shareholders as these will be diluted when the warrants are exercised. Therefore the presence of warrants tends to depress the share price.
Convertible bonds are a form of hybrid security which give investors the right to convert their bonds into shares of the issuer (or sometimes into shares of another company) during a specified period and at a specified conversion price (usually set at premium to the current market price of the shares at the time of pricing). On conversion new shares are issued to the convertible bondholders as consideration for the redemption of the convertible bonds.
Convertible bonds are a comparatively cheap method of funding. The annual servicing costs for convertible bonds are generally lower than those for plain vanilla bonds because the coupon paid to investors is lower.
The issuer benefits from being paid upfront for shares which are to be issued in the future. This may be of particular value where an issuer is reluctant to seek funding directly through the equity markets because it feels that its shares are currently undervalued.
The listing requirements for issuing convertible bonds are less onerous, and therefore also less costly, than those for listing of shares. As a result, convertible bonds can be issued quickly, efficiently and at a lower cost to a rights issue, for instance.
Provided that the convertible bonds convert, no additional funding will need to be raised by the issuer to cover the costs of redemption of the bonds.
- Risks of no conversion – convertible bondholders are unlikely to want to take up their option to convert in circumstances where the price of the underlying shares remains below the conversion price. This being the case the issuer will need to consider how it will finance the redemption of the convertible bonds.
- Equity dilution – the shareholdings of existing shareholders will be diluted if the convertible bonds are converted and new shares issued to the convertible bondholders.
- Shorting – certain investors hope to make a profit from convertible bond deals by exploiting the pricing differentials between the convertible bonds and the underlying shares in the issuer. Typically this is achieved by investing in the convertible bonds and shorting the shares of the issuer at the same time. This type of activity has been associated with putting downward pressure on the price of an issuer's shares.
Traditionally, debt capital markets have only been available to fully operational assets. However, in recent years some companies (e.g. Fortescue Metals Group and Northland Resources) have successfully raised funds through debt capital markets for greenfield mining projects.
Although debt capital markets are an incredibly efficient means of raising capital; however, they are inherently turbulent and the market is still growing accustomed to greenfield covenant and collateral packages. It is possible that during the time it takes to prepare for capital raising, the market falls away.
Manufacturers of mining equipment have traditionally provided financing to mining projects to enable them to purchase their own equipment and therefore enhance their sales volumes. Straight equipment financing or leasing usually sits alongside project financing as it concerns itself only with the financed equipment.
More recently, however, equipment manufacturers have established lending arms in order to participate along side (and on the same terms as) senior lenders in providing senior secured debt of sometime up to an additional 100% of the value of the mining equipment to be sourced in the project.
Export credit agencies
Export credit agencies can provide credit support guarantees to commercial lenders, thereby substantially reducing the risk (and pricing) of the financing of the project. Each ECA has its own requirements and criteria to satisfy in order for their participation. A commercial bank is always required to provide the funding.
Development finance institutions
Multilateral and development finance institutions may be willing to fund part of the project development costs, usually where there is a direct development benefit to the country where the project is based. Each DFI has its own set of criteria (usually including environmental and sustainability requirements) in order for the project to be eligible to receive such funding.