Column Digging for treasure

Written by Dipesh Dipu | Updated: Aug 29 2008, 03:01am hrs
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, the Indian mining sector has not been attractive for PE firms due to challenges unique to the industry. In India, private sector companies, which could be potential targets for PE funds, have had restricted participation as government owned companies dominate in most major minerals including coal. Miners have traditionally been price takers until recently and have, even on the global stage, underperformed the markets. That has changed for now. There are, however, talks of institutionalising regulatory mechanisms for pricing coal and the government has not refrained from coercing iron ore miners to prevent them from raising prices any 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 (rechristened as Central Institute of Mining and Fuel Research), the new project implementations have taken, on an average, about seven years. This is certainly longer than the investment horizon of some reputed PE firms. The cash flow prediction under such circumstances, with 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 often unpredictable in the assessment of applications. Even statutory provisions and legal frameworks have been in the state of flux.

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 may serve as inhibitors to PE interest in the sector, there are several positives. The cyclic nature of the commodities market is indicating a super cycle, likely to provide adequate returns. The demand for raw materials has been relatively inelastic even in the light of expectations of global slowdown. The growth of Chinese and Indian economies is likely to continue to drive growth in mining sector.

Miners have also increasingly taken up the role of price makers, current inflation management practices of the government notwithstanding. In international markets, 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 rush 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 their global counterparts, one of the key reasons being lower labour costs. Although scarcity of human resources is likely to raise the operational expenses, Indian mining sector may still be attractive.

Another important development has been the enhanced liquidity of mining assets, which provides exit options for PE firms. The National Mineral Policy of 2008 has proposed permission to transact in licences, which is likely to further help the cause. It may make mineral prospecting and exploration businesses lucrative, too. Development of vibrant capital markets has also added a new dimension of initial public offers 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 time for the PE firms to look at the mining sector more closely.

The author is principal consultant, mining, PricewaterhouseCoopers. These are his personal views