Miners debate M&A as COVID-19 sends shares lower

In early March, BHP (NYSE: BHP; LON: BHP) Chairman Ken MacKenzie said the mining giant was in a strong position should COVID-19’s impact on the market create M&A opportunities.

“On balance, the business is in very good shape,” Reuters reported MacKenzie as saying during the Australian Financial Review summit in Sydney on March 10. “I’m not sure if there will be any opportunities that will come from this, but if there are, we are actually in a position to act.”

In the intervening weeks, COVID-19 has begun to take a dramatic toll on the mining industry. Operations around the globe have been forced to close by governments or have been voluntarily shuttered or limited to contain the spread of the virus. Share prices are down as the virus batters the world economy.

In this uncertain environment, M&A activity in mining and other sectors has taken a hit. Refinitiv, which provides data on financial markets, reported that global mergers and acquisitions activity dropped 28% year-on-year in the first quarter of 2020 to sit at its lowest level since 2016. The number of deals in the quarter also dropped by 14% year-on-year.

Looking specifically at mining, global mining M&A deals in February totalled US$1.26 billion, an 18.4% increase from January, but a drop of 61.7% when compared with the last 12-month average, which stood at US$3.29 billion, according to figures released on March 27 by GlobalData, a U.K.-based data analytics and consulting company.

BHP Billiton’s Western Australia iron ore mining complex. Credit: HP Billiton.

BHP Billiton’s Western Australia iron ore mining complex. Credit: HP Billiton.

North America saw the highest dollar value of deals at US$400.66 million that month. It also had the highest volume of deals, followed by the Asia-Pacific region and Europe. Looking at countries, Canada took the top spot for deals, with 40, followed by Australia with 15 and the U.S. with 12.

Even as the devastating effects of the coronavirus are being felt, deals have continued through March, including Endeavour Mining’s (TSX: EDV; US-OTC: EDVMF) $1-billion takeover of Semafo (TSX: SMF), creating what the companies said in a press release would be a top-15 global gold producer and the largest in West Africa. MegumaGold (CSE: NSAU; US-OTC: NSAUF) and Osprey Gold Development (TSXV: OS; US-OTC: OSSPF) have partnered up, while Argonaut Gold (TSX: AR) plans to merge with Alio Gold (TSX: ALO; NYSE.A: ALO), and Seabridge Gold (TSX: SEA; NYSE: SA) snapped up the 3 Aces gold project in southeastern Yukon from Golden Predator Mining (TSXV: GPY).

John Wilkin, a partner at Blake, Cassels and Graydon in Toronto, said he expect M&A activity to continue, but notes that companies that are considering a deal — and those that are in the process of closing them — now face many more risks than they did just months ago. “I think parties who have a will to do the deal are going to spend a lot more time discussing the risks,” he said in an interview.

Jay Kellerman, a partner at Stikeman Elliott and head of the firm’s mining group in Toronto, said he thinks deals will slow in the short and medium-term. “My sense is, notwithstanding Endeavour and Semafo, senior management teams and boards are focusing right now on keeping their existing companies going as opposed to thinking about M&A activity,” he told The Northern Miner. “These companies need to be in operation to sell their product, to make money and … at what point in time is cash going to become very thin at some companies? I would think companies are in that mode of thinking as opposed to being opportunistic and thinking this is a good time to go buy.”

Wilkin sees three major areas of volatility that could impact the execution of a transaction. The first is for buyer companies trying to price their targets. “If you’re a board of directors trying to decide on pricing a deal, it becomes very difficult when the share price of your target is moving around significantly [from] trading session to trading session,” he said.

An analysis of M&A issues on Stikeman Elliott’s website noted that deal-pricing could create a valuation gap between a buyer and its target. As share prices have plummeted, companies being targeted for acquisition may receive an offer less than what management thinks the organization is worth.

The law firm suggests earn-outs can be an effective work-around. An earn-out agreement effectively splits the purchase price of the deal into two payments — one up-front, and one post-closure that’s based on the acquired company’s actual future performance. “With an earn-out, some of the purchase price could be pushed out to a future time period after recovery,” the March 19 online briefing stated.

The second major source of volatility is deal financing. Companies that can’t use shares to finance their acquisition may find it more difficult to come up with capital, experts say. In addition, miners that have signed deals for third-party debt financing may want to check their contracts to determine what ability their lender has to walk away from funding obligations.

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