CAPE TOWN (Business Day) -- The wave of empowerment deals in the mining sector over the past few months has coincided with a boom in commodities prices, which could be risky for new entrants.
Not only are empowerment groups buying into companies whose valuations have appreciated considerably in the past three years, but their financing also depends on the boom carrying on.
Pressure to avoid the usual suspects in empowerment deals can mean finding new entrants to the market who will almost inevitably have fewer financial resources than the established empowerment groups.
Their financing is usually dependent on repayment from a steady stream of dividends for the next few years from the company being acquired.
Commodities companies are cash flush at the moment. Metropolitan Asset Managers senior portfolio manager Nigel Suliaman says there is an exceptional level of bullishness among mining companies, and even the most conservative CEOs appear to hold the view that the world is experiencing one of the biggest commodities cycles to date, and it is likely to continue.
Major groups that have returned cash to shareholders through share buybacks and special dividends recently include BHP Billiton [NYSE:BHP; LSE:BLT], Anglo American [Nasdaq:AAUK; LSE:AAL], Impala Platinum [JSE:IMPO] and Kumba Resources [JSE:KMB]. All of those groups also have a substantial pipeline of planned investment projects.
A good example of how a commodities group can afford both to expand and bring in new empowerment partners was the recently-announced creation of ARM Coal as a joint venture between Xstrata Coal [LSE:XTA] and African Rainbow Minerals (ARM) [JSE:ARIM]. The structure gives ARM a stake both in Xstrata's established coal businesses, and the development of the Goedgevonden project. There will be about R800 million ($94.3 million) of debt in ARM Coal, which will be repaid from cash flows from operations.
De Beers Consolidated Mines' new empowerment shareholders, the Ponahalo consortium, also depends on dividends as it has committed to investing a portion of the dividends received from De Beers to make other investments in South Africa, another portion to fund social projects and the balance to repay debt.
A different structure was used for Merafe Resources [JSE:MRF] to acquire a stake in the Xstrata Merafe Chrome joint venture, to which it has subsequently added the Wonderkop assets bought from Samancor.
Merafe has financed its purchase and share of the costs of developing Project Lion, via a mix of equity and debt. Its stake in the chrome joint venture increases each year, but it is carrying more than R600 million ($95.8 million) of debt, including preference shares.
Repayment of the debt in all of these deals depends on commodities prices remaining resilient. It is tempting to draw a parallel with the wave of empowerment deals of the mid-1990s.
The deals fell apart when the market collapsed in 1998, as they were predicated on expectation of rising share prices and dividends. Empowerment groups which bought into the fashionable companies of the day - media and information technology - cried foul when share prices dropped and stayed low for years.
But Sasfin corporate finance head Jeremy de Villiers says while he could not speak specifically on commodity firms, the biggest difference between the deals done in the mid-1990s and those done today was that in the mid-1990s financing deals were not related to companies' earnings.
Today financiers look more closely at the earnings growth and dividend potential than the performance of the share price.
In general, De Villiers was more in favour of vendor - financed transactions where possible, unless there was a need to introduce new capital, because the company was in a better position to manage the loan than an external financier.
Suliaman says there might be risk in the mining sector's empowerment deals, but the commodities cycle is in an exceptional phase.
The industrialisation of China, which is stimulating demand for commodities, can be compared to the industrialisation of Japan after World War Two.
Although price trends were never a straight upward line, and there would probably be corrections, he is positive for the commodities cycle in the longer term.
