Mick Davis and resource investing

I came across two interesting articles recently published on the South African mining news website Miningmx about Mick Davis, his past and a bit on his new venture, X2 Resources. Many of you might followed him at Xstrata and the subsequent merger with Glencore, or maybe you followed the listing of Billiton on the LSE and its merger with BHP. These two articles give quite interesting insight into the investor and business development side of the mining industry, worth a read for any geologist. The first of the two articles, written by David McKay follows.

New mining giant on the way?

New mining giant on the way? Photo: X2 Resources

“There’s a momnet when X2 Resources founder, Mick Davis, can’t contain a smile. Asked whether there was any mischief in the naming of his new company, he replied: “Maybe just a bit of fun.”The psychology of naming, however, runs deep. It’s no coincidence, for instance, that a year after completing the ‘merger’ of Glencore Xstrata, the combined company should resolve at its recent annual general meeting to rename the company Glencore plc. The merger of equals was long dead, but the name change sealed it.

Said Hanré Rossouw, who is head of commodities for frontier and emerging markets at Investec Asset Management of the decision to call Davis’s new venture ‘X2’: “I think the name says it. It’s the Xstrata model rebooted”. Yet is the market similarly positioned for another Xstrata? “I think Mick has got a good track record,” said Rossouw. “He brought change to the industry by introducing a more financial focus. Before that you still had mining engineers running companies.

“The only disadvantage is that because Mick has had success, so it may become more difficult to get the same kind of deals. In the past, he seemed to come out of nowhere”. Rossouw was a CFO of Xstrata Alloys before joining Investec in Cape Town. Davis is of the view that the continued urbanisation in China, India and eventually Africa will continue to underpin the resources market. Where I think it’s inappropriate to blame the industry is for the decision to invest

“My position is actually quite simply that on the demand side of this industry, the secular change that took place in the early 2000s remains in place. You can’t actually urbanise without industrialisation.That means that demand for commodities will generally outstrip rises in GDP. The question is whether that demand is easily satisfied or not? Now for almost 10 years in the first part of this century, demand was not easily satisfied. Even with the blip of 2008, when we had the global financial crisis, you had demand falling away very dramatically as people cut their order books. But straight after those pipelines were absorbed, in 2009, you saw demand not easily being satisfied. The reasons for that is because there’d been a dearth of investment. When companies finally realised they responded, that response took 10 to 12 years to come through. So it’s really only now in 2013 to 2014 that we’re in a position where we’re seeing either balanced or slightly excess supplies as a result of those projects,” said Davis.

“Now we’re back into this situation of this retrenched capacity build. So again a story is being written about the next shortage because as the demand continues, supply will lag” he said.

The mining industry is also structured differently to 15 or 20 years ago. Finding new mining provinces is more difficult, mining grades are lower and collateral investment – infrastructure for instance – is higher.

 “A combination of the fact that the complexity of investment, the retrenchment of growth capital, and declining grades means that we’re probably entering a period of constrained supply. For me, it’s just a very simple equation that translates into again a period of sustained rising prices.”

Analysts were pessimistic about the market last year but there are flickerings today that sentiment is shifting.

UK brokerage SP Angel said in its April Commodity Research Book that while base metal prices had fallen owing to lower Chinese GDP growth, demand for key industrial metals had surprised on the upside with supply failing to keep pace with new demand.

“With growth returning to the system, the market risks running short of certain metals,” said its analyst, John Meyer.

In a report in January titled: ‘Turning Bullish – The First Time This Year’, Citi argued that despite some concerns regarding long-term structural demand for commodities in China, there were better ‘bottom-up’ fundamentals, especially for the major miners.

“We would be rather too early than too late in making this call,” the bank said.

The difference in Davis’ outlook, however, is towards the investment community. One of the reasons for the ‘retrenched capacity build’ is the attitude of investors who Davis believes have lost conviction in the sector.

They are also concerned that left to their own devices, company management will destroy the industry. As a result, investor demand for ever-vaulting growth has been replaced with a requirement for returns.

The behavour that’s being driven among management, many of them new, is to keep investors happy. “Their response is … we are going concentrate on improving our return on investment by making our core assets run a whole lot better.

“As for the non-core assets, basically we’re going to try and see if we can sell them or spin them out, or whatever,” said Davis.

Does that investor attitude make Davis cynical?

“Where I think the criticisms are valid is where companies bought assets at the height of the multiple curves because essentially what they were doing was paying away all the optionality that they were buying,” he said. “Where I think it’s inappropriate to blame the industry is for the decision to invest.”

“This is a wasting-asset industry in which every tonne mined is irreplaceable unless further investment is made. Companies which don’t invest will wither and die. It is true, however, that some projects have experienced cost and timeline overruns and investors are rightly concerned about the impact on returns.”

Lonmin

Xstrata was not without its investment mishaps. Asked to assess Xstrata’s investment in Lonmin, in which it became a 24.9% shareholder in 2008 after having an earlier $10bn bid rejected, Davis said buying the second tranche to secure the exclusivity was a mistake, albeit a small one.

Fortunately, Davis did not make the decision to make an offer for the entire company just as the financial crisis was about to unfold.

“It wasn’t a huge mistake, but it was big enough for us to feel silly. I was more irritated by the fact that we’d made the decision that we weren’t going to bid for Lonmin, but then we said that we’d stop other people from bidding. That was idiotic.”

“In the 40 or so transactions we did, I think we got maybe three wrong that I regret. You can never run anything perfectly, and there is stuff that you do that you regret, but by and large I think we did a reasonable job in building and running Xstrata.”

One of the last transactions Davis attempted was in the dying months of 2012 when Xstrata offered to sell its platinum and chrome division to Lonmin in return for supporting a $1bn equity issue that Xstrata said it would underwrite. It was a reverse takeover as Xstrata would have been handed 70% of Lonmin assuming no other shareholders followed it.

Lonmin rejected the offer but it was academic anyway as the Glencore takeover loomed.

It was the changing status of Glencore that ultimately altered reality for Xstrata, the curtailment of a period as the wunderkid blue chip. It had spent a good part of a decade hoovering up larger and larger assets, gaining scale and momentum.

I was more irritated by the fact that we’d made the decision that we weren’t going to bid for Lonmin, but then we said that we’d stop other people from bidding. That was idiotic

According to a presentation by Xstrata in 2006, it lifted its 2001 pretax profit of $126m to $10.4bn five years later. In 2001, its income was earned from mining zinc (47%) and alloys (53%); by 2006, earnings were derived from nickel, alloys, coal (thermal and coking), aluminium, and zinc.

But things changed with Glencore’s UK listing in 2011. Until then, Glencore had been a supportive 34% shareholder in Xstrata.

“It became apparent to them, as it became apparent to me, that these two companies couldn’t continue to operate independently,” said Davis.

The trigger event, however, had come earlier in the 2007/2008 financial year, after Vale bid for Xstrata, for which the Brazilian firm wanted to have Glencore’s consent. “This transaction could have delivered unprecedented returns for shareholders,” said Davis.

From then there was a change in momentum for the company.The transaction was not completed in the face of opposition from Glencore.

Shortly thereafter the financial crisis occurred. Davis initiated a rights issue ahead of the industry. To facilitate Glencore following their rights and not being diluted, Davis controversially bought from Glencore a coal asset, Prodeco, in an option type structure which, although securing a high return for Xstrata, was criticised by many of Xstrata’s investors.

Davis risked his relationship being strained with hitherto supportive investors because he believed that forcing Glencore to dilute was unfair and was not the way to treat a long term supportive shareholder.

Let me know what you think by commenting below. If you had spare cash, would you throw it in with him? Stay tuned for the second article.

The original article can be found here.

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