http://www.mineweb.com/mineweb/content/en/mineweb-editors?oid=232343&sn=Detail

RCF's blowout rule: Add 25 percent to feasibility capital costs

Resource Capital Funds' Ross Bhappu provided last week's PDAC show with a research-backed view of how private equity sees the mining market.

Author: Kip Keen
Posted: Tuesday , 11 Mar 2014

HALIFAX, NS (MINEWEB) -

In recent studies, Resource Capital Funds (RCF) asked deceptively simple questions about cost overruns and funding needs in the mining industry.

Ross Bhappu, RCF senior partner, presented the basic - but deeply informative - sector research, fleshing out leading industry issues that, for the likes of RCF, informs a healthy dose of scepticism in considering the potential performance of its mining investments.

1. Question: How much money do resource companies need to fund their projects?

Answer: $69 billion to cover 524 unbuilt projects with projected capex up to $500 million and $75 billion to cover 134 projects with capex between $500 million and $1 billion. (Parameters: feasibility stage or better; the focus on sub $1 billion projects reflects RCF's prospect targeting.)

2. Question: But what are the market capitalisations of said companies? It's a crucial question because for resource companies it becomes exceedingly difficult to fund projects - especially with equity - when market cap is vastly less than capital cost.

Answer: Bhappu, in one of the final presentations of the PDAC (Prospectors and Developers' Association of Canada) convention last week, said there were 2,700 companies with market caps under $500 million, yet only 43 companies with market caps between $500 million to $1 billion.

That is, the market caps of these companies are generally far lower than the projected capital costs of the projects they own. Bhappu called it a growing disconnect. On projects with capital costs under $100 million, market caps are pretty well balanced, he said. That's an exception. But over that mark the gap widens incredibly. Take for example projects that are to cost between $700 million to $800 million. Bhappu said on average their owners had market caps a tenth of the project price tag.

3. Another RCF question: What happens to a company's market cap after it releases a feasibility study?

Answer: "On average a company's share price fell by 25 percent 90 days after they released their feasibility study," Bhappu said. "It's completely counter-intuitive."

Of course this is a fairly well known issue - that share prices fall off during the development stage of a company and then pick back up once in production. But RCF is putting some hard numbers to it, ones that investors (especially in the project funding business like RCF) can use to their advantage.

"What the market is saying is: 'Well that's great you've got a feasibility study. You've got a great project. But how are you going to finance it?,'" Bhappu said. For a fund this can be a sweet place to deploy cash because once a company secures cash (say from RCF) then it undergoes a "new re-rating." The looming storm cloud of cashless destruction dissipates. In this, Bhappu called funding of construction ready projects, a "tremendous opportunity."

4. Finally, Bhappu addressed capital cost blowouts. RCF wanted to know how good feasibility studies were at predicting actual construction costs. So it looked at 150 projects over 40 years.

Question: How accurate were they from feasibility projection to reality?

Answer: "Virtually no project came in under budget," Bhappu said. "On average, projects came in 25 percent over budget. Many of them came in two times over budget."

As a result RCF has a rule of thumb: "When we look at a project the first thing we do is add that 25 percent capital," Bhappu said. "In our financial model we add it and say: 'Let's assume there's going to be a 25-percent cost over-run and see if the numbers still work.'"