The local mining industry is characterised by impact of political change that has been the catalyst for transformation, divesting of marginal mines by major companies, resource depletion related to increasing movement cross-border, through the government’s initiatives mineral beneficiation has become increasingly important in long term planning, and due to changing environment a change in financing strategies of the banks.

It can be said that BEE companies’ motive is in line with the investors’ minds as they have been the same in achieving the greatest return on investment for the minimal amount of risk. The element that does change continuously, however, is the composition of the investment environment: the participants, the resources, technologies, information available and the geographic locality of asset deployment, and banks’ criteria for providing funds. Before making a decision to invest in a particular situation, or even remain invested for that matter, an evaluation of all relevant information is usually essential. The vital process for BEE companies during sourcing finance would be identifying the optimum funding structure that will meet specific requirements of the project, inclusive of highlighting the risks involved, when carried out diligently and interpreted correctly.

In the light of recent developments in South Africa, mining investors most certainly have been revising strategies around new cultures, evolving politico-economic and legal frameworks, different business and negotiating methods. Ultimately, however, the long-term success of BEE in local mining industry will, to a considerable extent, depend on the relationship between the government, companies and the providers of capital.

South Africa has been experiencing a period of rapid change in the management of its mineral resources at the beginning of the new millennium. Factors contributing to this change include:

• the debates over the ownership of the mineral resources between the State and the private ownership,
• economic empowerment and development of previously disadvantaged communities (sustainable development),
• fight for survival of the emerging private sector enterprises,
• pressure on mineral right owners to release the mineral reserves that they are not planning to utilise based on Department of Mineral and Energy’s "use it or loose it" approach,
• the changing internal rate of return on equity capital investment for the industry as a whole and for each individual mine.

The recent changes have had profound effect upon the minerals industry, particularly with regard to:

• Financing of mineral projects, in terms of increasing debt financing in general,
• Financing BEE companies that have very limited own resources has become a necessity,
• Business capabilities of BEE companies have increased rapidly
• Financial constraints experienced by BEE companies and need for finance has increased rapidly
• The shareholder profile, changing to more speculative investors seeking equity growth,
• The structure of companies, changing simpler, flatter organisations,
• Financial reporting becoming aligned with international requirements, and transparency of information to a more demanding audience; listing requirements both locally and internationally,
• Valuation methodology, becoming transparent and aligned to best practice,
• Competitiveness, in the global arena, for funds,
• Globalisation and its effect on markets and the development of the industry in Southern Africa,
• Changes in mineral rights and tax legislation; changes to environmental legislation, based on the value of competing land concept; requirements of sustainable development

The industry have been influenced by many other elements including the following:

• Downstream investments in the value chain by the producers of various minerals, including gold, platinum and hard metal alloys.
• Changes in the Mineral Act, Mining Charter, and the Scorecard
• Socio-economic changes and their dramatic effect at workplace, i.e. Labour Act and Employment Equity Bill.
• Changing inflation levels and changing commodity prices
• Competing for limited number of economically viable projects
• BEE companies are building on business capacity.

The recent changes in South Africa have also opened investment opportunities abroad for local major mining houses, which were not available under the old regime. Many companies now have access to a much broader investment base that addresses funding needs of projects at different phases of development. The changes taking place in South Africa have had a positive effect on some companies; the mining industry has opened up to many players who were previously excluded by racial laws. The New Mineral Development Bill will greatly enhance mineral portfolio of BEE companies and their partners.

The future of the South African mining industry is to be shaped by competition and co-operation/collaboration and corporate diversity because of change in environment. BEE companies won’t survive without cost-conscious and productivity but they will also have to be more flexible, responsive and smarter considering and adapting to changes around them.

The IDC restructured a few years ago and during this process a mining business unit was formed to take advantage of gaps in the market caused by the demise of the traditional mining houses that were essentially finance houses in their own right. Financiers like IDC can achieve acceptable returns through participation in BEE deals. On the other hand, to disappointment of BEE companies, IDC till requires at least 10% of own equity to be contributed by a BEE in a possible deal. IDC and other financiers, as a cohesive front, could have done much more to present a balanced view of the costs and benefits of mining as applied to the BEE companies.

The South African Government has established clear guidelines and clear rules of the game for all players. The "winds of change" have opened up the South African mining industry to skills, technologies and financing structures, which HDSAs (Historically Disadvantaged South Africans) could not participate desirably. The impact of this on commodity markets and prices might be significant because of implied changes of a new global cost curve for various mineral industries.

As important to mine development as tonnage and grade, the mining method, metallurgy, environment or future markets is the ability to provide the capital for the construction and operation of a mine.

• MONEY: Lifeblood of Mineral Development: The role of money in mine development might be compared to that of blood in the body. Money feeds and nourishes all parts of the process. Money is a multi-faceted tool through which everything surrounding mine development is accomplished. It is the means of comparing a business to its competitors or of judging its benefits to society, or of assessing the success of its initiatives or its planning and negotiations.

• FINANCE: Required as from the Beginning: After exploration expenditures, the first form of financing and usually the most significant in the entire life of a mine is the funding for construction. Decision made on the method of funding can add to or detract from a mine’s success. Funding for a project can be by way of equity or debt, or a combination of both, although preference is usually given to debt funding to avoid dilution of the shareholder’s interest and preserve working capital for use on other exploration properties.

• TIME: Scheduling… The term of the loan is usually a function of the anticipated product price level and the operation’s cash flow requirements. The repayment period, in soft market conditions, would still not normally exceed 50% of the mine life. This allows time for the investor to earn a return at least in the latter part of the mine’s life. It also provides comfort to the banks, which, should the price cycle turn down further, there will still be sufficient reserves to ultimately repay the loan.

• LOAN CONDITIONS: Little Flexibility is Fine: In structuring loan documents that are to be outstanding for a period of five to ten years in general-flexibility is a key ingredient. An additional consideration is the period in which an interest rate prevails.

• MARKET CYCLES: What goes up… : Commodity prices being cyclical, it is not unusual to see repayment schedules incorporating requirements to repay to the banks a percentage of the cash flow from the operation. In this way, the lenders participate in the additional cash flow received by the mine during a period of high prices.

In general the main focus of attention of potential providers of finance to a new project should be undoubtedly on the Bankable Feasibility Study (BFS) or for acquisition of operational mines the Due Diligence Study (DDS). These substantial documents represent the data and facts gathered during the exhaustive investigations into the viability of a project, often conducted over many years. A feasibility study is the final comprehensive report that brings together both the technical and the economic aspects of a minerals project. The feasibility study of a mining project will summarise geology, metallurgy, mining, marketing, capital, and operating costs and cash flows as well as the inferences drawn from the criteria of evaluation such as net present value or rate of return.

BEE companies should be able to address the five following basic investment preconditions in new project development and acquisitions:

• Security of tenure,
• Management capacity and management control where applicable,
• Equity control where applicable
• Provision of acceptable returns on investment

There are mainly two types of BEE companies that need funds for their projects: Public companies and private companies. Two of the most important issues to be considered in raising funds would be firstly, access to funds preferably in favourable terms, and the equitable allocation of the expected benefits derived from bringing mineral resources to account (risk vs. return). Secondly, ensuring that the terms agreed upon will be respected over the life of a particular project (payback conditions, security of tenure and corporate governance).

The source of capital that is available to BEE companies is scarce. How BEE companies choose between these various sources and why, have been the source of much debate. In general, BEE companies have three main sources of capital:

• internally generated funds,
• bank loans
• raising finance in the capital markets.

The resulting mix of debt and equity determines a firm’s capital structure. Most of the BEE companies are in a state of "starting-up" or "emerging" and usually do not have substantial internally generated funds. This is a limiting element especially when considering development of new projects that need seed capital for feasibility studies and formation of new joint venture or partnerships that require funding for early project activities.

Figure: Risk and reward in financing in mining projects (Bennings-RMB 1999)

BEE companies’ focus on the long-term financing needs of the company highlights the importance of risk vs. reward relationship. The logic behind specific packages of debt and equity varies with differing objectives and financing conditions unique to the firm, project, general economic conditions and the timing of financing needs. The packages may be explained in a several different ways:

• The BEE firm will try to minimise the cost of capital; usually debt is cheaper than equity and short-term loans are cheaper than log-term loans but the mixture must be balanced.
• There are tax benefits accruing with alternative mixtures of debt and equity. The objective of the BEE company often is to maximise these tax benefits given the requirements of a project.
• There may be a credit impact on the BEE company as a result of increasing the debt burden that results in higher capital cost and should be avoided.
• Availability of guarantees may dictate certain sources of funding as preferred to others.
• Legal requirements may dictate the financing package.
• In some cases there is great value in sharing risk through joint venture or concentrating the financial resources from a wide variety of sources.
• Project versus non-project financing would control the sources available for a specific package.

Because of the high risk involved in the early "developmental stage" of a new business venture, much of the financing available in this category usually takes the form of equity capital. BEE needs in this category can be in three stages of financing: seed, start-up, and early growth. After a company has been in operation for at least one year (in addition to the time it took to conceptualise the venture), the "expansion phase" of the business life cycle typically begins. In order to progress successfully beyond the development stage, BEE company must secure the necessary expansion capital. Expansion capital can take the forms of retained earnings, additional equity, or debt capital. The specific form that it takes depends on the success of the firm and the specific purpose of capital injection. "Acquisition" represents a situation in which an individual or firm is simply seeking funds to acquire or merge with another company (i.e. Project Equity financing).

BEE companies and financiers need to establish a correct relationship between asset structure and overall capital structure. BEE expects to finance long-term needs with long-term sources in that the timing of cash inflows roughly match the timing of cash outflows required by alternative means of financing. Although current assets are technically convertible into cash within one financial period, the actual Rand level of a portion of these assets increases over time and hence requires permanent financing as indicated in the figure below:

BEE companies and financiers can optimise the structure subject to expected returns. For example, at revenue beyond given amount, i.e. Point A above, the use of financial leverage is clearly advantageous to stockholders. Lower levels of revenue, however, would result in stockholders being better of if less debt was included in the capital structure. Accurate levels of revenue are implicitly required when determining the optimal level of debt.

BEE companies need to achieve an optimum financial leverage to the use of debt with the intended purpose of increasing returns to owners of common shares. Such leverage may, however, have the opposite effect during periods of declining leverage. It is clear that financial leverage may magnify returns to owners in times of prosperity while having the opposite effect when revenues are low. An overall view of this concept in form of a graph is represented in the figure below.

• Resources and reserves
• Degree of economic feasibility
• Production Process
• Markets
• Environment and sustainable development
• Operating Framework

To implement a partnership between BEE companies and financiers that would address these concerns can be called a "push-pull scenario"; with the "push" being generated by the existing barriers in the South African mining industry, and the "pull" stemming from modifications to the countries’ investment and mining codes. This is why the co-operation between the BEE companies and financiers impact on whole future of the mining industry.

BEE financing and the exploitation of mineral properties results in a property life cycle in which value varies according to stage of development. This relationship of evaluation techniques to prospect life cycle is indicated in the figure below:

Future capital availability: There have been examples of failures in the structuring and implementation of financing in minerals industry. Hence, new projects would most probably be reviewed with a more critical eye by private lenders and by public sector/parastatals such as IDC, and international financing institutions such as IFC of the World Bank. In consequence, funds for new projects may not readily be forthcoming unless they can pass stricter standards of viability than have been applied. As an example, the delays in obtaining funds for the development of the Messina Platinum Mine in South Africa might have been caused by this reason, despite the fact that the owner and operator is a reputable Canadian listed mining company.

Project Life Cycle: Stages of mineral projects are not defined by unique time periods; rather the common problems, issues, and activities define them. Financing, information and results obtained during and after each stage, amount of, and the way the resources are allocated play an important role in defining and mitigating with risks.

In terms of the sustainable development of the minerals industry and socio-economic needs of local communities, BEE companies that rely on BEE funding must have provision for outstanding "social capital". These would include issues such as the prevalence of HIV/AIDS, increasing standards of environmental care, training and skills development, education, housing, as well as dealing with residual risks and liabilities. The evaluation of these aspects needs careful consideration.

In recent years, the impact of greater capital requirements on individual private enterprises has been severe; BEE companies are no exemption. In the past, i.e. forty years ago, many mining companies were largely debt free and many of them were, in fact, cash rich. Retained earnings and depreciation generated adequate flow to undertake most new projects without recourse to lending institutions. Inflation has changed that; not only has it escalated the costs of new undertakings to levels that mandate access to the banks and other depletion allowances (based on investments made in the era of limited inflation). In many cases no longer generate sufficient cash to replace obsolescent equipment in existing operations. This is the environment that the BEE companies are operating now and competing for scarce capital supply.

• BEE companies to build on their business capacity that will increase the level of confidence in their business. The decision process for funding a BEE deal can be quite different from that used to make financing available for companies with track record. BEE companies are usually led by entrepreneurs that usually attempt to go through approval processes that are usually necessary to make the investor/financier as confident as possible that:

• The company will not be liquidated and the investor/financier can have at least a reasonable return;
• it will in fact be profitable enough to generate the cash to pay the main capital as well as cost of that main capital;
• most importantly, make the company as attractive as possible to bankers and potential investors.

• Government to consider facilitating BEE through its financing instruments, but the banking sector needs to participate actively and creatively. Government financing instruments to help in dealing with problem areas, such as a lack of collateral for empowerment.

• Major mining houses to provide collateral to BEE companies that they intend to do deals with.

• There are no short-cuts to the financing problems for BEE. What is needed is innovative financing approaches that build-on, and modify existing models and develop new directions that can be applicable to the BEE deals in South Africa. For example, private equity-project equity, in short, refers to the provision of equity capital to unlisted companies. This capital can be put to use for mergers, expanding working capital, facilitating new acquisitions, or strengthening a company’s balance sheet. Several features set this form of financing apart from others and these features need to be considered by BEE companies and financiers, i.e. risk and returns.

• Size of BEE deals: Banks usually apply thorough approval process that drives up transaction costs, and the necessity of closely managing investments ensures the incurring of ongoing management costs. The personnel required to perform these activities are normally highly skilled and command a significant premium in the job market. Given this high fixed cost base equity funds are under pressure to realize high returns. This is exacerbated by the fact that the riskiness of this type of financing inflates the cost of capital. In order to generate these high returns banks typically target:

• larger size investments
• high growth sectors such as IT, telecoms and healthcare
• companies with strong management teams that have deep technical skills and business acumen and solid track records.

• It would seem unsurprising that until recently almost all of finance institutions did not operate in the part of the BEE market that could not provide own equity. The lack of participation at that market appears wholly unsuited to the need of BEE companies. For most of the BEE deals, the average deal size is bound to be medium in the range of R10 million to R50 million and most of BEE companies are likely to be in deals for mature mining projects and not likely to be found in high growth projects, and lacking strong track record is usually the norm. Financiers require a percentage of the funding to be generated from own resources. As a result, many BEE companies are exposed to risk of diluting their shareholding at early stages of their development or failing to bring in the required funds. On the other hand, very limited numbers of BEE recipients of financing are likely to generate the excessive returns that might be required by financiers to justify the capital investment as per their criteria. BEE deals are usually for mature projects that might require a premium for acquisition and usually have limited growth potential; this is an element that BEE companies and financiers need to consider seriously in order to create applicable financing tools.

• The model(s) need to find creative ways of managing high transaction and investment management costs for BEE deals; government and private sector need to develop innovative methods through co-operation and perhaps syndication. This level of cooperation is typical in the competitive mainstream private equity market. Cooperation and networking becomes a win-win solution.

• The model(s) need to find ways of managing the risks that are inherent in investing in BEE companies. The highest risk facing emerging BEE is to compete against established players in the market. This risk can be managed when the company has a medium-to-long term contract that secures for it a predetermined revenue stream. The company is protected from the vagaries of the market and the threat of competition. It can focus on managing its cost base and ensuring that it delivers on the contract. And then from behind the protective cover of the contract the BEE company can begin to explore growth opportunities. Tremendous opportunities are opening up for BEE companies looking to secure contracts. The government has adopted an aggressive pro- BEE procurement policy by way of its preferential procurement policy framework.

• The BEE focused financing model(s) has to address having is low growth potential due to deals relating to marginal mines, mature operations or entry barriers such as competition and lack of information. However, some BEE companies have established themselves in growth projects that can attract investors and financiers; some have excellent growth prospects relative to their size.

• The financiers should provide clear criteria to BEE companies for their evaluation of projects at different stages of the project life cycle.

• New projects are still going forward in some products, such as platinum, in South Africa. In general, project financing is available where the economics of the property are very strong. Whether to use it or not depends on the commitment that the bank requires from the developing company. New projects have to have a very low operating cost, since it must amortise its capital whereas the competitive existing project has its capital already sunk.

• On of the most critical choice is between equity and debt. Common shares and their equivalent are forever. The conundrum is to know whether such equity capital or debt is expensive in the current market or cheap, relative to the high real interest rates.

• Within this content it is evident that current financing tools do not satisfy the need of the establishment of BEE in mineral industry or South African society.

• Therefore financiers need to consider a higher level of co-operation and partnership with BEE companies and review their risk profiles and expected returns for BEE deals.

In many ways it can be said that project equity by the banks is the type of financing best suited to the peculiarities of the BEE market; despite the fact that banks usually require collateral and solid credit histories, which BEE companies do not typically have in great supply. Equity financing is also gentler on the cash flows of young, vulnerable companies than debt with its strict monthly repayment regimen. Importantly, it introduces experienced shareholders who involve themselves most of the times intimately in the management of the company - this is often what BEE most desperately need. Lastly, project equity financing, by ensuring stronger cash flows and bolstering management capability, increases the ability of these "unknown quantities" to leverage loan financing.

There are number of forces at work that are promoting the growth of business linkage opportunities for BEE companies. Many BEE companies do not seem to have the capacity to take advantage of the improving conditions in the industry. However the key challenge for financiers is finding the high potential BEE companies out there and providing them with significant enterprise development support to exploit the opportunities. These companies will have tremendous first mover advantages and realize rates of growth that would put broad smiles on the faces of even the most hard-nosed private equity financier.

It is clear that we face both tremendous opportunities as well as formidable challenges in attempting to bring financing models to the BEE market. Sector transformation charter will play a major role in the economic empowerment of black South Africans and productive co-operation between stakeholders will be required.

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