Introduction
2008 will most certainly be regarded as one of the most tumultuous and volatile years in recent times. The confluence of falling commodity prices, tight debt and equity markets and stubbornly high operating costs have taken their toll on company profits and exerted considerable downward pressure on the share price of many Australian listed mining companies.
2009 is shaping as a challenging sequel. We have set out below our top 10 trends expected to dominate the Australian mining industry in 2009:
1. Work outs, restructures and insolvencies
While it is hoped that many mining companies can survive the current economic downturn, the reality is that some will not. Companies struggling to maintain cash reserves will need to closely monitor their solvency levels to ensure that they do not trigger insolvent trading liabilities. In this regard it should be noted that liability for insolvent trading rests with the directors in their personal capacities and can also extend to holding companies.
Directors should ensure that the following issues are considered when forming their view as to whether they have reasonable grounds to expect that the company will be able to pay its debts as and when they fall due. These issues include:
- current difficulties and delays experienced in the market by companies trying to secure new credit facilities or extensions and roll-overs of existing facilities, and
- future cash flow and working capital requirements which need to be considered in light of the increased counterparty risk of contracts being breached, suspended or terminated, particularly in respect of offtake and transportation arrangements.
2. Project interruptions and shutdowns
A number of companies have recently announced plans to suspend or close mining operations (for example, BHP Billiton’s Ravensthorpe mine). Companies considering placing a project on care and maintenance should be mindful of the following issues:
- ongoing environmental obligations are still required to be met
- minimum expenditure commitments required to keep tenements in good standing still need to be satisfied. There is limited scope under most mining legalisation to defer these obligations solely on the basis of constrained financial circumstances
- particular focus should be given to issues of workplace and public safety in and around the mine-site, particularly if the mine is to be shut-down in preparation for abandonment or sale
- general counterparty risk associated with review or trigger events in contracts with customers and suppliers
- from a native title and Aboriginal heritage perspective, a review should be undertaken of any agreements which the company has with traditional owners to see whether they contain any obligations in relation to operating a project on a care and maintenance basis, and
- regular reporting with regulatory and government agencies should be carried out during the planning and implementation stage of these operations.
Should economic conditions change, companies intending to re-start operations should ensure that a thorough review of legal obligations and methods of management of these are conducted before operations are recommenced.
3. Consolidations and acquisitions of opportunity
We envisage that in 2009 there will be excellent opportunities for consolidation within the resources sector. This consolidation activity will allow companies at differing stages of development to diversify production/development risk, or enter into mergers where there are compatible reserves and capital needs.
We have also seen the continuing interest of Chinese state-owned enterprises in investing in Australian companies and assets, particularly in light of the recent softening in commodity prices. The China Minmetals/Oz Minerals and Chinalco/Rio Tinto proposals are two prime examples.
As debt funding continues to be relatively inaccessible, and as precious cash reserves are preserved for the development of existing projects, most consolidation deals and mergers are likely to involve scrip consideration, particularly where no foreign bidder is involved. This means that a comprehensive valuation of both parties to the merger will normally be required and a clear explanation of the value proposition to target shareholders is essential. Scrip consideration has the added benefit of CGT rollover relief (provided the relevant acceptance thresholds are met).
We expect to see more of these consolidation and merger transactions implemented using the scheme of arrangement method. Schemes provide certainty of outcome and timeframe. Schemes are however only practical in friendly merger proposals. Where the approach is unsolicited, the takeover bid route will still be the only practical option.
As economic conditions remain uncertain, it has become critical to try and reduce the conditionality of any merger proposal. Therefore bidders and targets should work hard to try and minimise any conditions applying to a merger—for example, by working with the FIRB and other regulators ahead of the proposal going live.
4. Foreign investment—testing the national interest
As noted above, lower commodity prices and deflated asset and share values are likely to see a rise in the number of opportunistic acquisitions, particular by foreign entities. In 2009, we have already witnessed at least two high-profile proposals by foreign state-owned enterprises to acquire strategic or controlling interests in distressed Australian assets and enterprises. Suggestions are that more will emerge throughout the year as cash-strapped miners look off-shore for injections of capital. Most notable among these acquisitions is the proposed deal between Rio Tinto and Chinalco to allow Chinalco to increase its stake in Rio to 18 per cent.
These acquisitions, and their examination and assessment by FIRB, will provide somewhat of a litmus test for the new government’s approach to investment proposals by foreign governments and their agencies.
Many readers will recall the Federal Government’s controversial decision in 2001 prohibiting Shell from acquiring a substantial shareholding in Woodside which would have resulted in a change of control of Woodside. This decision, and all those that are made by FIRB, was made by reference to the ‘national interest’ test. This concept is not defined in the relevant legislation and its meaning is not clearly understood. The Summary of Australia’s Foreign Investment Policy (April 2008) provides that ’[t]he government determines what is “contrary to the national interest” by having regard to the widely held community concerns of Australians.’
It is expected that the current wave of investment by foreign state-owned enterprises and sovereign wealth funds will again raise acute and parochial concerns regarding what is and is not in Australia’s ‘national interest’.
5. Securing alternative forms of financing
With debt and equity harder to secure, many companies looking at bringing mines into production are having to turn to alternative sources of capital to fund development activities. We are already seeing an increase in the number of assets being placed on the market, as companies seek to introduce third party equity to their project. It is likely that the divestment of project interests undertaken in conjunction with the offer of commodity offtake rights will continue in 2009.
6. Increased supervision by regulatory authorities
As companies teeter on the financial precipice, it can be assumed that stricter regulatory supervision and controls will figure prominently in 2009. On 3 December 2008, the ASIC issued guidance to entities preparing their 31 December 2008 financial and audit reports. The guidance incorporates specific issues identified through ASIC’s review of 30 June 2008 financial reports. The specific areas of focus are ensuring:
- the appropriateness of the going concern assumption in financial reports
- robust and transparent impairment review processes
- that fair value assessments for property and infrastructure assets are supported by market evidence. Valuations of financial instruments should also be supported by appropriate marked-based information, with methods and assumptions fully disclosed
- appropriate explanations are made as to why certain assets and liabilities are off balance sheet, and
- proper disclose of risks associated with financial instruments.
7. Greater shareholder activism
Falling share prices may also lead to a new wave of shareholder activism. Signs have already emerged in the recent AGM season of shareholders opposing the grant of executive options, re-appointment of directors and increases in non-executive remuneration And it’s not just the institutional investors who are leading the charge with retail investors demanding more than just the free coffee and biscuits.
The previous CLERP 9 reforms, including the reforms which allow a non-binding vote to be taken on a remuneration report, have already increased the level of shareholder engagement. More reforms may be on their way. The recent Parliamentary Joint Committee Report on Corporations and Financial Services (June 2008) entitled ‘Better shareholders—better company’ contained a number of recommendations to government regarding the manner in which companies engage with and communicate with investors. These include:
- greater supervision and monitoring by ASIC of disclosure of company information in private briefings to institutional shareholders, and
- establishing best practice guidelines for the reporting of company financial information.
8. Project disputes
One of the common themes to emerge from previous downturns in the resources industry has been the correlative increase in the number of project disputes. Not surprisingly, most disputes surround a failure to pay. These disputes are often between principals and contractors and can lead to suspension of project works and/or contract termination. Companies looking to carefully manage their credit risk may also request changes to payment terms where uncertainty exists about a counterparty’s financial standing.
It can also be expected that there will be an increased incidence of disputes between project owners, most commonly joint venture parties. In tougher economic times, decisions relating to project expenditures are likely to come under closer scrutiny and vary according to the respective size, financial backing and capacity of each joint venturer. Failure to agree future expenditure commitments may, depending on how the joint venture agreement is drafted, trigger dispute and deadlock breaking mechanisms.
When disputes do arise, parties should carefully consider the prescribed method for resolving them, particularly in light of the recent trend towards adopting alternative dispute resolution procedures for contractual disputes.
9. Contract variation, termination and renegotiation
One wonders whether the experience which Mount Gibson endured in late 2008, when its main offtake agreement was unilaterally terminated and a new offtake contract renegotiated at lower prices, is a harbinger of the changing power shift between miners and offtakers.
In any event, requests for contract variations are likely to increase as the realisation is made that deals struck at the height of the mining and commodity boom are no longer profitable or sustainable. Companies should closely examine their key contracts to identify material adverse change or hardship clauses which may be triggered by the changing economic conditions, as well as termination for convenience clauses.
In circumstances where there has been a default, companies should carefully consider whether to elect to terminate the contract (assuming the contract provides such a right of termination). If a decision is made not to terminate, this should be documented and made without prejudice to any rights a company may otherwise have in respect of the default which has occurred.
10. ASX disclosures and class action threats
In these difficult economic times, companies should ensure that they are keeping shareholders fully and regularly informed and updated as to the company’s activities. The last few years in particular have seen an acute rise in the number of companies being pursued by large, well-resourced litigation funders planning to institute proceedings against companies and their directors for misleading the market. This trend is expected to increase significantly over the coming year.
This article was written by Justin Little, Partner, Perth.
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