Navigating the minefield

Sunday, 01 March 2015

Alexandra Cain photo
Alexandra Cain

    The end of the resources boom means directors of unstable mining businesses face a difficult future. Alexandra Cain explains what the downturn means for boards.

    The figures are in and there is no doubt we are in the midst of a mining downturn. Australian Bureau of Statistics’ figures show that in the September 2014 quarter mineral exploration fell by 25 per cent.

    In addition, an increasing number of listed companies have been queried on quarterly reports as a result of negative cash positions. Fifteen of the 19 companies suspended by the Australian Securities Exchange (ASX) on 1 October 2014 for failing to lodge annual accounts were in the mining and energy sector.

    There is particular pressure on smaller miners, especially those in the iron ore and coal industries, which have been hard hit by falls in commodity prices. Now, the burden falls on directors of faltering mining minnows to steer the companies they govern through this difficult period.

    Directors and executives acknowledge times are tough. Erica Smyth FAICD, chairman of uranium business Toro Energy, says “for-rent” signs around West Perth are plentiful; a sure sign the resources sector is struggling. 

    Both listed and non-listed companies are feeling the pinch. But according to Meredith Campion AAICD, a partner at law firm Allen & Overy, the problems of private mining companies are just not as obvious due to the less onerous reporting requirements.

    “While private miners don’t have the financial commitments associated with maintaining a listing, they also don’t have the ability to raise capital through equity markets. Limited means for raising capital places added pressure on owners,” she says.

    Peter Blight GAICD, managing director of tin explorer Stellar Resources agrees the situation can be worse for non-listed businesses. “Investors have no real exit strategy because at the moment it’s difficult to launch an initial public offering (IPO). And investors are unwilling to lock their money away in them.”

    Consequences for boards

    As a result of the downturn, Smyth says boards now need to be very careful about their forward assumptions on when the market will turn and how long it will take to be able to raise working capital even when confidence returns.

    “I believe we are close to the bottom of the market but I could easily be wrong. No board should bank on a forward projection of a positive turn if the consequence of being wrong is insolvency. Most boards would have developed their scenario planning so they know when they will have to move into maintenance mode,” Smyth says.

    To avoid a situation in which they risk trading while insolvent, Alex Atkins GAICD, senior mining analyst with mining consultancy Alternate Futures, notes many boards have made the decision to scale back operations by reducing production rates, cutting their workforce and closing some mines. “Many projects have been mothballed, waiting for the commodity cycle to return to a more bullish market.”

    As Campion notes, for many junior explorers funded solely through equity, shutting down exploration may be the best option. “It appears more juniors are mothballing their operations to ride out the bottom of the cycle.” For instance, iron ore business Mt Gibson has recently announced the decision to place its Koolan Island operation on care and maintenance.

    As conditions have worsened, boards have turned their minds to their appropriate size and composition as one means of preserving capital. “While the retention of skilled directors is important to ensure the company can weather the storm, a number of companies have acknowledged they need to shrink in the current climate,” says Campion, citing Atlas and BC Iron as examples of businesses that have recently seen the resignation of directors.

    Capital-raising options

    It is not surprising that raising capital is at the forefront of many smaller miners’ minds to help them remain a going concern. It’s a difficult task, but not an impossible one.

    “In any commodity cycle those brave enough to invest at the bottom of the market can eventually be winners. But who knows when the time is right? Only companies with advanced projects are likely to attract the little capital that is available,” says Smyth.

    Shaun Fraser MAICD, partner at advisory firm McGrathNicol, agrees funding sources are a particular issue. “Unless you can raise money, your options are limited. Directors need to think out a long way and restructure their balance sheets, renegotiate debt and find new sources of capital.”

    Fraser says if a company’s operations are loss making, any equity issue will be at a deep discount to the share price. But if the company has a good quality asset and shareholders are supportive, it is an option. “If it’s a narrow group of investors who can take a long-term view it might be possible, but it’s a difficult decision to prop up a loss-making business, especially when it’s hard to see when there will be a turnaround.”

    Campion notes there are some examples of junior mining companies raising funds for good quality projects. “Companies have completed small equity capital raisings with a view to solely covering holding costs. But on the whole it is a very difficult market.”

    One resources business that has been successful in raising capital is underground coal miner Bounty Mining. Non-executive director Julie Garland McLellan FAICD says the board had to revise pricing of the offer given market circumstances. “You need to be innovative about sourcing funds. We got there, but there is uncertainty because you end up raising capital to then go back to the market to raise more.”

    Similarly, companies have found it difficult, but not impossible, to obtain new debt. “It depends on the quality of the business’ assets and management team as to whether they can secure new debt with reasonable interest rates. Companies in this position have fared better if they already have in place appropriate funding risk- mitigation plans,” says Atkins.

    Director remuneration is also a tricky issue. Campion notes that a number of mining companies have not only reduced directors’ fees, they are also paying all or part of those fees in equity rather than cash.

    “Payment of board fees in equity is often seen as an appropriate means of cash preservation, addressing shareholder angst, and demonstrating board commitment to the company during difficult times.”

    She says in assessing whether to pay some or all of directors’ fees in shares, boards need to consider the dilutionary impact of the share issues, particularly in times when share prices are depressed.

    “Share issues to directors will generally be subject to shareholder approval under the ASX listing rules, so ultimately shareholders will be able to decide how best to remunerate their board.”

    Trading while insolvent

    Insolvent trading is on the minds of more than a few directors at present. Smyth notes the consequences for directors of declaring insolvency can be career limiting. “This could mean some are tempted to hold on too long before taking action. I hope directors realise the consequences of trading while insolvent are greater than taking action voluntarily.”

    Atkins says: “I believe most directors are performing their fiduciary duties diligently. They’re focused on the balance sheet to ensure debts can be paid. If things are looking dire, there’s an impetus to cut costs and sell surplus assets like plant and equipment.”

    She notes boards must watch key indicators like the debt-to-equity ratio to ensure bank covenants are complied with and to avoid banks forcing early repayment.

    Allen & Overy partner Peter Wilkes agrees that on the whole, directors are generally aware of the need to ensure the company can continue to pay its debts as and when they fall due. “The solvency test is essentially a cash-flow test that requires directors to have a reasonable expectation at the time of entering into a commitment that the company will be able to meet that commitment when it falls due,” he says.

    Wilkes continues: “Clearly in these difficult times, with declining or fluctuating commodity prices and exchange rates, it can be challenging for directors to assess the future cash-flow position of the company and the ability to continue to pay its debts as they fall due.”

    A fine line

    Wilkes says a range of assessments need to be undertaken, including how long prices may remain depressed and available cost-saving measures.

    “It can be a fine line between temporary illiquidity and an endemic shortage of capital. In some cases it makes sense to hold off appointing administrators at the first sign of a cash-flow shortage.

    “Ultimately the directors are required to thoroughly and honestly enquire into the financial status of a company exhibiting signs of distress. Directors must continuously inform themselves of all relevant facts and ask whether they can continue to hold an honest and reasonable belief the company is and will remain solvent,” Wilkes adds.

    “The fact such questions often involve difficult issues relating to the jobs of employees, the investments of shareholders and the future of the company is not a valid justification for procrastination by the board.”

    Campion says directors should ensure the company has a risk-management policy in place if they find they are trading while insolvent. This is consistent with the recent amendments to the the ASX Corporate Governance Council’s Corporate governance principles and recommendations, which bring risk management to the fore.

    “Junior miners have been able to avoid the need for a formal risk-management framework on the basis of the size of their operations. But given the recent corporate governance amendments and the present economic environment, there is likely to be a greater focus on risk management policies and frameworks,” she says.

    Wilkes adds: “The earlier the board acts in times of perceived stress, the greater the range of options that will be available, whether that be selling off non-core assets, finding a strategic investor or suitable merger partner, winding back some operations, placing the business on care and maintenance, negotiating a debt restructure or undertaking an equity raising.”

    Placing the company in administration has the advantage of protecting directors from liability for insolvent trading and creating a moratorium on most creditors being able to enforce recovery of their debts while a review is undertaken of the company’s affairs. But Wilkes notes placing a company into administration is increasingly seen as a last resort to salvage the business.

    Directors of unstable mining businesses face a difficult future. Many are not being appropriately remunerated, and at the same time they have to consider the company’s position and the right way forward on a daily basis. But just because a business is faltering does not abrogate directors’ responsibilities; in fact it probably increases them.

    Directors in this situation should seek appropriate advice and maintain a watchful eye on operations and be prepared to put the business into administration if it is genuinely insolvent.

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