Any solid group should have two things: big deals and lots of them.
A colleague of mine once put it more colorfully: “I’m not a big deal. I just close them.”
Most bankers would agree that they got into the field to affect great change in a sector through strategic decisions (e.g. mergers and acquisitions) – or at least, that’s what they told the interviewers.
And it’s hard to beat the basic materials sector if you want to make big changes: where else could you buy and sell entire gold or diamond mines?
“Basic materials” refers to discovering raw materials and processing them; the 3 main sectors are i) metals and mining, ii) paper, packaging and forestry products, and iii) chemicals.
It’s sort of like a collaboration between industrials and natural resources, with an emphasis on cross-border transactions.
In the first part of this mini-series, we’ll cover the metals and mining angle and you’ll learn:
- How to break in
- What goes down in Team Mining
- How the coverage universe is broken down, including industry and valuation drivers
- Analytical topics, including operating and valuation metrics for both companies and mines
- Life after getting out of the most underground banking department
Now, off to the mines…
Out of the Classroom and Into the Mines
Q: Where do metals/mining bankers come from?
A: Canada (laughs).
Most people in my group were placed here through the campus recruiting process, and some of the senior bankers lateraled over from other banks’ M&A departments.
One guy I know was even recruited from the Colorado School of Mines.
The backgrounds here really run the gamut, and a geology background is neither necessary nor sufficient.
It may help to shape your story, but that can easily be accomplished with other means (ex: extracurriculars).
I read an article about how a senior financial institutions banker was inspired to pursue the calling based on her family’s ownership of a private banking business. And there are plenty of other examples – such as a US Marine Corps officer joining an aerospace/defense banking coverage group.
Really, the sky is the limit when it comes to your story, so put on your thinking cap and learn to spin your way into sounding relevant.
Metals and Mining 101: Scoping the Project to Assure Value
Q: So what does your coverage universe look like? And where do you find metals and mining groups at banks?
A: My group can be found in the industrials group, the natural resources group, or in a team called basic materials – so really, we could turn up anywhere.
Geopolitical factors aside, the main demand-side factor with any mineral is end use, while supply-side factors include operational issues, production constraints, and capacity.
Production constraints aren’t a limit on machinery; it’s a limit imposed by a sort of collusion among producers.
For example, if there’s too much aluminum in the market, producers will agree to limit production to prevent further declines in the mineral’s price. It’s similar to what OPEC does for oil, only it doesn’t seem as controversial since aluminum prices attract less attention.
Moving to a broader perspective, the universe can be divided into these sectors:
Diversified: (key players: Glencore, Vale, BHP Billiton, Anglo American)
BMO Capital Markets noted that holding companies such as Glencore trade at a discount to the sum of their asset values due to a lack of specific access to cash flow, the fact that any bid to subsidiaries would result in a share ownership transfer, and the fact that subsidiaries’ dividend tax is relegated to the parent.
(NB: For an in-depth overview of the market for any of the following minerals, please refer to the US Geological Surveys Mineral Information)
Aluminum: (key players: Alcoa, UC Rusal, China Aluminum Corp – CHALCO)
Historically, producers in this area have selected capacity such that price is equal to the marginal cost of production. In the case of alumina, the input costs include fuel oil, natural gas, caustic soda, and bauxite.
For primary aluminum, the inputs are alumina, electricity, carbon, and materials (source: Alcoa company data).
Compared to other base metals, aluminum is a dominant component used in transportation and packaging. If you’re asking about the price of aluminum, you’ll need to refer to the London Metals Exchange.
Copper: (key players: Freeport McMoran, Southern Copper)
In contrast to aluminum, the New York Mercantile Exchange (COMEX) and the Shanghai Futures Exchange (SHFE) also influence the price of this mineral.
Not surprisingly, diesel, coal, natural gas, and electricity are important inputs. Copper demand reflects construction and industrial production.
Mining operations’ output and recycled scrap material contribute to the supply of copper (source: Newmont Mining company filings). Copper is a dominant component used in infrastructure and electrical applications (source: Brook Hunt).
Iron/Steel: (key players: Arcelor Mittal, Gerdau, Nucor)
These producers compete on quality, cost, and innovation (research for new uses of the minerals).
The demand-side factors, as with any industrial item, include inventory levels, currency fluctuations, and import/export activity. The raw materials here include iron ore, sinter ore, coal, coke, and steel scrap (source: US Steel company filings).
Flat rolled products are a dominant component used in automotive parts and construction products. Tubular goods are heavily used in oil/gas operations.
Nickel: (key players: Norilsk Nickel)
Applications include the production of stainless steel and in the creation of alloys. Compared to other base metals, nickel is a dominant component used in consumer durables and industrial equipment.
Zinc: This mineral can be used in batteries or in the creation of alloys; it’s also used as a catalyst and in the production of white paint. Compared to other base metals, zinc is a dominant component used in construction.
Gold: (key players: Barrick, Goldcorp, Newmont Mining)
This might come as a surprise to you, but the end product of a gold miner is not gold, but doré bars.
These items are made of gold, silver, and other minerals, and are then sent off to refiners to be finished into what you and I would expect to see.
The applications for gold include investment and fabrication (ex: jewelry and decorative uses). Gold owned by governments, corporations, and individuals contribute to the gold supply supported by mining operations.
Silver: (key players: Silver Wheaton, Pan American Silver Corp, Coeur D’Alenes)
The demand for silver is fueled by its most common uses – coins and awards, household wares, industrial uses, and photography.
Q: That was a pretty thorough walkthrough of your coverage universe. But the name of the game is “metals and mining” – where are diamonds in all this? Were they stolen in a heist?
A: Some banks have a coverage team devoted to this area.
Standard Chartered actually has a team there devoted to diamonds and jewelry coverage.
Mining Equipment Equivalents: Your Transferable Skills
Q: So how do analysts and associates compare mining companies or mining projects to each other?
A: Let’s start with a few trading multiples and operating metrics:
Comparable company metrics include:
- Price / NAV (Net Asset Value): With this one, you value the mining company’s assets (gold, silver, etc.), subtract its liabilities and divide by the share count to get NAVPS.
- Price / NPV: (Shown as a percent)
- Dividend Yield
- Commodity Exposure (see pg. 7): Portfolio summary of what a mining company’s business entails.
- Reserves and Resources: Reserves are minerals that are more certain to be extractable and to hold value that’s confirmed by an assessor. You go through a process of converting metals into “equivalent” units so you can compare, for example, a copper producer to a gold producer.
And you would use the following multiples for Reserves and Resources:
- Enterprise Value / Mineral. Eq. (Ex: Cu. Eq. = Copper Equivalent) Reserves
- Enterprise Value / Mineral. Eq. Resources
With mining, there is also a distinction between “Resources” and “Reserves” – basically, Reserves are more likely to actually be extracted from the ground.
And then Resources can be split into Inferred vs. Indicated vs. Measured, or Measured and Indicated (abbreviated to M&I, what a fitting name), and so on.
It’s similar to what oil & gas companies do with their reserves, but there are more categories and sub-categories here because there’s more subtlety with determining whether or not mineral resources are truly viable – and there may be more steps to complete when extracting them.
Operating Metrics for Mining Projects include:
- Mineral Eq. Grade: Essentially the concentration of the desired mineral. It’s just the ratio of the amount of mineral desired / (amount of mineral desired + unwanted ore).
- Stage: How far along the mining project has progressed. If you’re interested in equity capital markets, or equity origination, less certain projects might be of interest to traders and speculators; more stable projects are of interest to institutional buyers (ex: endowments, pensions funds, etc.). The stages include Scoping Study (for early-stage projects – includes inferred resources), Pre-Feasibility (Stricter calculation requirements and includes reserves and resources), Feasibility, Construction, and In-Production.
- Average Mineral Production
- Reserves and Resources Composition
- Cash Cost of Net Product Sold, By Product (Currency / Mineral): This is similar to Cost of Goods Sold for manufacturing or retail companies – it would include all of the expenses for producing each unit of mineral, plus potentially other payments such as royalties.
- Development CapEx
Then there are different ways of looking at transaction metrics for both mining projects and mining companies. For mining projects, you might look at Precedent Premium Analysis (for 1-month, 1-week, 1-day, and so on).
The numbers there would be affected by the Approach – Hostile deals usually have higher premiums than Friendly deals – the Stage (Development, Production, or Mix) – you would pay more for a more certain cash flow stream – and the Commodity (Copper, Gold, Aluminum, etc.).
The following metrics and multiples are specific to company acquisitions:
- Tangible Asset Backing: Corporate acquirers use this framework to determine the value-add of what was acquired. This approach assumes the target’s machinery is still in use.
- Multiple of Net Assets
- Market Price / Gross Cash Flow
For the diversified companies, it may be useful to compare the NPV (asset sum taking out debt and cash) to a Sum-of-the-Parts analysis.
I’ve seen a couple variations on the latter; some analysts like to compute a DCF value for each division (NB: use EBITDA – Capex as a proxy for FCF), while others like to collect a set of trading comparables and multiply their range by the EBITDA of the individual departments.
Q: Wow, I can’t imagine that anyone will actually mine for more metrics or multiples after all that. What really drives valuation for mining companies, though?
A: Cash flow. You see there are a lot of approximations around how much of a mineral a mining company can produce, and that’s because they’re using the production levels to approximate cash flow.
The values of these individual mining projects contribute to the total value of the company.
If you are going to acquire a mining company, you’re essentially buying land, equipment, and the management know-how to tap resources – assuming, of course, that the top brass stays at the firm following the integration.
A press release on the discovery or confirmation of a mine’s potential will lead a company’s stock price to pop up.
Q: Got pitch books?
A: Sure, here are a few you can look at:
- Continental Minerals: by BMO Capital Markets
- Konkola Copper Mines: by Rothschild
- Gerdau Ameristeel: by RBC Capital Markets
Also, refer to the following valuation letters and fairness opinions:
- Smelter Acquisition: by Xstrata
- Alpha Natural Resources / Massey Energy: by Morgan Stanley and Perella Weinberg
As you can see in the Alpha Natural Resources / Massey Energy pair of fairness opinions, the valuation metrics can be very similar to those used in the industrials sector.
You’ve got EV / EBITDA and Price / EPS. To the list of valuation approaches, you could add:
- Illustrative Future Stock Price: Start with Historical Enterprise Value / NTM EBITDA, and find out the average share price. Use a multiple to find the future enterprise value, and from there calculate the average share price again. Convert it into today’s currency using the Cost of Equity (see: page 105 of Alpha Natural Resources / Massey Energy).
- Implied Exchange Ratio Analysis: Essentially you assume an all-stock transaction and divide the target’s price per share by the acquirer’s price per share.
Out of the Mines and Into the Molehill?
Q: So what should our readers look at if they’re interested in metals and mining?
A: For starters, the Bloomberg command METT <GO> provides mining sector news.
Financial Times, The Economist, Wall Street Journal, and the book Fisher Investments on Materials are all good resources.
Going beyond the usual suspects, Big Four accounting firms such as Ernst & Young do publish thought pieces on the sector.
In terms of industry newsletters, you should look at Metal Miner, Metal Bulletin, and Platts.
If you want something from an investment bank, run a search for ‘HSBC Metals Quarterly.’
Also check out Miningfeeds.com – as you probably know, the internet provides way too much data that can be analyzed. So you’ve got to pick and choose for yourself what you think is relevant.
In your industrials article, you mentioned primers on aerospace and defense. Here’s a rather dated, but similar and still high-quality primer: “Hard Rock to Heavy Metal Amid Scarcity” by UBS.
For a fundamental perspective, you can try Ian R. Campbell’s series on mining company valuation, which discusses in great detail the more qualitative aspects (read: risks, macro-view, etc.) of mining company analysis.
Lastly, a more academic perspective can be found published by Basinvest.
Q: Wow, thanks for all that. If you’re reading this, you have no excuse for not performing well in any IB interviews with metals & mining groups.
What are the most common deal types in your group?
A: Metals and mining is definitely known for cross-border mergers and acquisitions.
You’ve got to deal with currency fluctuations and, of course, the legal aspect of whether the target is a “strategic asset” in the eyes of the government.
If you’re looking for a strong investment banking experience (eg. advisory and capital markets assignments), look no further than JP Morgan, Citi, and Goldman Sachs – in that order.
Q: So do people in your group really come from Canada? And if so, where do they go afterward?
A: Most mining bankers can be found in Canada (Toronto), United States (Chicago, New York), and of course the UK (London).
As with any other group, activity will be strong where mining companies are active – you don’t exactly see any mines in Manhattan, but there are mines in some of the surrounding areas on the East Coast.
A good number of commodity funds specifically ask for a mining background. Some other buy-side shops also appreciate the background.
At the same time, I’ve seen former metals/mining bankers move into corporate strategy within an investment bank, or join or start a start-up in the sector (not exactly a capital-efficient industry, but hey, it’s an interesting ride nonetheless).
As you may already know, it’s not so much what you do in an investment banking division, but how much you can accomplish with what’s on your plate.
Q: Thanks so much for your help!
A: Anytime. If you have questions, please leave your comments below.