Welcome to the final edition of WA Resources Update for 2014.
Industry in crisis
By Michael Blakiston
Over the past six months, the deterioration in the sentiment towards the resources industry has been accelerating and those of us who are long-term industry participants are now talking about “the last time things were as bad as they are now was in 1991.” Not a day goes past now without more negative news being fed into the international marketplace.
Other than for those who have already been made redundant, the only real impact of the downturn on the person in the street is the rhetoric of our politicians as they seek to rein in the budget deficits (both State and Federal) as a consequence of the falling royalty and taxation revenue. Yet despite this, Governments, both State and Federal, are continuing to look to the resources sector to provide additional revenues to Government. By way of example, in Western Australia the State Government is continuing with its review of royalties for the resources sector, which review is scheduled to see a report to Government by the end of 2014. Given the potential impact of any increase in royalties, industry groups have been pushing back and in the case of the gold industry, a group of companies formed what is known as “the Gold Royalties Response Group” and this group mounted a “community orientated campaign” in its attempt to head off any recommendation to increase the royalties payable on gold mining
It would be fair to say the public are generally not sympathetic towards our industry when the headlines are dominated by the media releases describing the profits being generated by BHP Billiton and Rio Tinto, companies which have truly world class iron ore bodies. What about so many other companies in our industry which do not have access to such quality ore bodies, yet maintain an optimism which drives their daily endeavour?
The industry is being called upon more and more to be socially aware and responsible. This call ranges from its impact on the environment, indigenous peoples, local communities, local employment and local procurement. In order to address these and the many other issues associated with risk mitigation, companies are looking to institutionalise behaviour. For those companies with world class ore bodies, this institutionalised behaviour is absorbed as a cost and then as we are currently seeing in the iron ore industry, these costs are being mitigated against by increasing both production and mechanisation.
In order to exist, companies need capital. Investors are now demanding returns not growth. For larger companies, their dilemma is their allocation of capital between competing opportunities. With the pressure on returns, decisions are being made to defer greenfields projects in favour of brownfields projects and at the same time, there is a focus on key minerals as has been demonstrated by BHP Billiton announcing a spin-off of its second tier commodity projects and by Rio Tinto announcing that 95% of its current profits are being sourced from its iron ore operations.
Those at the smaller end of the resources sector are struggling with no real investor interest in speculative activity. High cost structures are finally being addressed with many of the junior explorers now in survival mode, as demonstrated by an increasing number pulling back to a managing director working from home or a shared office.
How we regain investor confidence is not simple. Shareholders who have invested must now face the realisation that they have lost their money. The pain this causes is being shared.
The way forward requires clarity of thought and a clear offering or investment proposition.
Commodities are finite and the laws of supply and demand will see the cycle change again. All of us need to determine whether we can adapt to current conditions to survive.
If anyone is not up to it then exit now although doing so may present its own set of challenges. For the rest of us, let’s stop talking things down, the media is doing enough of this.
There is support out there for those with a reassured and clear strategy to get to work.
“Tough times don't last, tough people do, remember?” Gregory Peck.
It's time to talk and walk the JORC: The PFS/FS requirement is mandatory from 1 December
By Cassandra Hay
The annoying thing about writing an update is that we have to open with an introduction, for context and general sensibility purposes. So, if you’ll indulge us for a moment, here is the old news: the 2004 Edition of the JORC Code has been replaced with the 2012 Edition, accompanied by changes to the ASX Listing Rules (in particular, Chapter 5).
But before you roll your eyes and mutter impatiently under your breath,Tell me something I DON’T know… this update is a reminder about the upcoming 1 December 2014 deadline and related guidance provided by the ASX.
The changes embodied in the 2012 Edition of the JORC Code and the new ASX Listing Rules did not come into effect immediately. They were released in early 2013, but all of their requirements (except one) came into effect on 1 December 2013. That exception is the requirement that a preliminary (aka pre-feasibility) study or a feasibility study be completed to declare an ore reserve – this comes into effect on 1 December 2014.
So, if you haven’t already, it’s time to get your ducks in a row. This could mean you need to downgrade your ducks. Or upgrade your row.
We discussed this requirement in more detail in our April 2013 newsletter. But in summary, the new ASX Listing Rule 5.9 requires a company publicly reporting estimates of probable and proved ore reserves in relation to a material mining project (for the first time or where materially changed from when those estimates were last reported) to include a summary of all information material to understanding the reported estimates of ore reserves in relation to (amongst other things) the material assumptions and outcomes from the preliminary feasibility study or the feasibility study. Although not expressly stated in Rule 5.9, it is a requirement of the 2012 Edition of the JORC Code (clause 29) that an Ore Reserve must be ‘defined by studies at Pre-Feasibility or Feasibility level as appropriate’.
There has been some uncertainty about what this means for existing Ore Reserves (i.e. Ore Reserves declared prior to this new requirement). The ASX has indicated that where a company already has an operating mine for an Ore Reserve, its life of mine plan would normally be expected to contain information at better than pre-feasibility or feasibility study level and therefore would meet the requirement for the Ore Reserve to continue with that classification. However, if not, some changes will need to be made.
Santa Claus is coming to town... (or in this case, private equity)
By Claire Boyd and Hiroshi Narushima
Once again there has been some recent press about private equity groups focussing on the resource sector setting up in Perth. At a time when interest in the junior sector is at an all-time low, this provides a welcome visit from Santa Claus.
He’s making a list, and checking it twice.
Here’s what the private equity firms are traditionally seeking:
(a) investments that can support gearing that will supercharge their equity returns;
(b) businesses which generate reliable and predictable cashflow that will service that debt;
(c) opportunities to make operational changes (such as to cut costs and improve efficiencies) or to implement strategic initiatives;
(d) a strong management team to execute on the business plan; and
(e) a profitable exit often within a time horizon of 5 to 7 years or less.
Unlike that traditional private equity model, we expect that resource sector private equity funds will not require debt leverage because all the leverage they need to achieve their target returns will be in the operational success of the asset they are seeking to develop or improve. Rather than the usual private equity requirement for steady cashflows to service debt, the converse is true where the deep pockets of private equity are able to ride out the commodity price cycle to properly fund quality projects.
So be good, for goodness sake!
Because here’s what private equity might bring to the table.
Firstly, and most importantly from the company’s perspective, they bring the much needed cash funding.
Secondly, private equity will invest in experienced management that they believe can deliver operationally. This may be existing management or a new management team brought in by the private equity firm. The key executives will be given the opportunity to invest alongside private equity through a management incentive plan which will often require the participants to at least part fund their subscription out of their own pockets so that they have skin in the game. The ability of management to realise any upside from the incentive plan will be aligned with the exit event for the private equity investor. Once a highly incentivised management team is in place, private equity firms tend to supervise their investment through the Board and leave it to management to deliver results.
Finally, there will need to be an exit event within a time horizon that aligns with the fundraising lifecycle of the private equity investor. There will be pressure to realise returns to their investors and have runs on the board in time for the private equity firm to point to their track record to help raise the next fund. In the context of the resource sector, this does not necessarily mean that a greenfield project has been taken through to production within that investment time horizon. A private equity investor may consider that it can achieve an exit event through a trade sale or IPO at a time where they have sufficiently developed and de-risked an asset to be able to take the asset to market.
You better not pout
But you should ask the right questions. The key things to ask private equity (outside of the key terms of the investment) include:
- their track record of investment in your commodity space or stage of development;
- their management style – how actively will they be involved in operational decisions;
- what is their investment thesis and plan for the business and how does that align with the views of management;
- their sources of funding over the life of their investment – how long does the fund have left to run and how much unutilised capital commitments do they have; and
- what are the terms of their management incentive plan, including whether the equity be held on capital account so management can access concessional rates of tax, will the subscription be self-funded or through a loan, will the loan be limited recourse to the equity, what are the conditions to vesting, among others?
At times like this, private equity can be your best friend. They can provide badly needed cash funding and sector specific expertise. They can also incentivise management to deliver on the business plan.
So, be sure to ask the right questions and find out who’s naughty or nice.
Penny-wise, twenty cent foolish
By Adam Totaro and Julie Athanasoff
On 30 September 2014 ASX released an update to Guidance Note 12 (GN12), which amongst other things, has implications on the application of Listing Rule 2.1 condition 2 (20 cent rule) applied by ASX to entities seeking a back door listing on ASX.
Previously, all entities seeking to re-comply with the ASX admission requirements via a back door listing have been required to offer securities as part of any associated transaction at a minimum issue or sale price of 20 cents each. In order to comply with this requirement, entities are frequently required to reorganise their capital structure, usually in the form of a share consolidation, such that the existing securities on issue have an implied value of at least 20 cents.
In the update to GN12, ASX has acknowledged that practical issues might arise where entities are required to comply with the 20 cent rule. ASX has confirmed that it will now consider requests for waivers from the 20 cent rule where to comply will impose structure, timing and other impediments to the completion of the proposed transaction and provided:
- The issue price of the securities being offered is not less than 2 cents and is approved by shareholders; and
- ASX is otherwise satisfied with the pro-forma capital structure of the entity
Where an entity is not proposing to undertake a capital raising as part of a back door listing, ASX acknowledges that the 20 cent rule has no application and has confirmed that if it has any concerns about the likely trading price of securities upon readmission, it will address those concerns on a case by case basis.
Notionally, the relaxation of the 20 cent rule should have no bearing on the value of an entity’s existing issued capital in the context of a back door listing and may save time and money for market participants. It may also preserve a level of transparency for existing shareholders in assessing the impact of any associated capital raising on their interest and the implied value being offered to new shareholders. At a theoretical level, it may also promote liquidity and trading in an entity’s securities post-transaction, particularly at trading levels below 10 cents.
Whilst a minor reform, the relaxation of the application of the 20 cent rule is a positive initiative by ASX and has the potential to ease the regulatory burden of market participants seeking a back door listing.
Why a surge in convertible notes?
By Sarah Turner, Eugene Tse and Samer Aljanabi
In the current economic climate, many companies, including those in the resources space are seeking injections of cash. Whilst many companies are finding it difficult to raise equity through traditional means such as placements, rights issues or share purchase plans, convertible notes have become a much more popular form of capital raising in the past 12 months.
So what has changed? During the mining boom, there was no shortage of deep pocketed investors looking to sink their money into shares in the next big thing. These days, an investor’s propensity for risk is significantly less. Convertible notes are attractive to investors because they have features of both debt and equity. An investor can subscribe for a convertible note, earn interest on it, and collect the principal at maturity or, if the company is performing well and they like the stock, they can convert the debt into shares in the company.
Convertible notes can take many different forms. They can bear interest or be interest free, they can be secured or unsecured, conversion can be at the issuer or the investor’s election (or both may elect to convert), the principal may be repayable at maturity or the note may be redeemed earlier for cash. The list goes on.
Given the increasing prevalence of convertible notes, we thought it would be useful to provide a brief overview of the key legal issues a company needs to consider in a convertible notes issue:
How do investors make their money?
Does the note structure you have chosen reward investors by accruing interest at penalty rates when the company defaults, or does it incentivise them to support the company by providing returns based on time invested or the achievement of project milestones?
Convertible notes are securities under the Corporations Act 2001 (Cth) (Act). This means that they either need to be offered under a prospectus or offered under a disclosure exemption, for example to sophisticated or professional investors. Given the time and cost of preparing a prospectus, the latter is far more common.
If convertible notes are offered without a prospectus, the secondary trading provisions of the Act will apply to any shares issued on conversion. To enable the shares to be freely tradeable, the company can either rely on ASIC Class Order 10/322 and provide disclosure at the time the convertible notes are issued, or issue a cleansing notice or cleansing prospectus each time a convertible note is converted to shares.
A cleansing notice (or prospectus) is required to contain any information a company is withholding from the market in reliance on a continuous disclosure carve out. This can be hard to manage in practice, particularly if the convertible note is structured so that the investor can choose when to convert and can convert multiple times.
Listing Rules Capacity
ASX Listing Rule 7.1 broadly provides that a listed company can issue (or agree to issue) equity securities up to 15% of its issued capital in any 12 month period without shareholder approval. This is commonly referred to as a company’s ‘15% capacity’. An equity security includes a convertible note, so when considering entering into an agreement for the issue of convertible notes, a company should ensure it has sufficient capacity to issue the notes, or if it doesn’t, the agreement to issue the note must be subject to shareholder approval, or the note must be issued as a pure debt instrument, with no conversion rights unless and until shareholders approve the right of conversion.
Investors will often want their convertible note to be secured over the assets of a company. The documentation for this can be complex, particularly if the company has other secured creditors in place.
A secured convertible note may also trigger a requirement for the company to seek shareholder approval under Listing Rule 10.1, for example, if the investor is a related party and the security is to be granted over a substantial asset of the company
The takeover provisions of the Act broadly provide that subject to certain exceptions, a person cannot increase their relevant interest in a company’s shares to above 19.99%, or from a starting position above 20%. The issue of convertible notes will not trigger these provisions, but if it is possible the issue of shares on conversion of the notes in the future may trigger the takeovers threshold, the parties will need to consider this. Common ways to deal with this issue include to make conversion subject to shareholder approval if necessary, or simply provide that if the takeovers threshold will be breached, conversion will not occur and the note must be repaid in cash. If the parties seek certainty that the convertible note will be able to convert, shareholder approval can be sought at the time the notes are issued.
Convertible note issues to directors
An issue of convertible notes to a director will require shareholder approval under Listing Rule 10.11 (there are no relevant exceptions to this), and also under the related party provisions of the Act unless a relevant exception applies.
An exception which may be relevant is where the independent directors determine the convertible notes issue is being made on arm’s length terms to the director, or on terms less favourable for the director then if the issue had been made on arm’s length. In making this determination, the directors should have regard to the company’s circumstances including its need for funds, its capital raising options and whether it could issue convertible notes on the same terms to non-related parties.
If approval is required under the Act, the notice of meeting will need to include prescribed information including a valuation of the financial benefit being provided to the director, and the notice will also need to be sent to ASIC for review.
In general, a non-US foreign investor subscribing for convertible notes in an Australian company valued above $248 million will need to seek FIRB approval prior to the issue of notes if the conversion of the convertible note may potentially result in the foreign investor (together with any associates) acquiring an interest in 15% or more of the company (or if several foreign investors and their associates acquiring an interest in 40% or more of the company). Further, generally speaking, if the investor is a foreign governmental entity, or if the Australian company is an Australian urban land corporation, FIRB approval is required regardless of the size of the investment or the value of the Australian company.
What are you looking at? WA Court of Appeal considers the interpretation of 'Tenement'
By Tim O'Leary, Cassandra Hay and George Salter
The Western Australia Court of Appeal recently delivered its decision in Technomin Australia Pty Ltd v Xstrata Nickel Australasia Operations Pty Ltd, a case which deals with the proper interpretation of a definition of ‘Tenement’ in a royalty contract and the rules of contractual interpretation. This case is of interest to investors in the mining industry for two reasons. First, it gives helpful insight into the definition of ‘Tenement’ used in this case. Second (the slightly duller reason, perhaps of more interest to lawyers than anyone else), it helps us to better understand principles of contractual interpretation. In this case, the question of interpretation was critical – it meant the difference between a royalty being payable, or not...
Terms of the Royalty Deed
The dispute stemmed from the interpretation of the term ‘Tenement’ in a gross production royalty deed (Deed). Technomin had been assigned a right to receive royalty payments under the Deed, which would be payable by Xstrata. The royalty payments were to be calculated by reference to minerals ‘from the Project attributable to [the royalty payor’s] proportionate share or interest (as varied from time to time) in any Tenement or in the Project’.
The ‘Project’ was defined to mean the ‘exploitation of the Tenements’.
The definition of ‘Tenement’ in the Deed was as follows:
“Tenement” means the Kathleen Valley Tenements and the Mount Harris Tenements and PL36/1142 at Violet Range and any extension or variation or addition or replacement or substitution of any of them (whether or not also affecting other tenements or land outside the Area)’ (emphasis added).
The Deed did not define the term ‘Area’, however the parties accepted that it had the same meaning as the definition of Tenements in the related Deed of Assignment and Assumption (that is, ‘the area affected by the Tenements’).
The Xstrata Mining Lease
A mining lease was subsequently applied for and granted in respect of the area the subject of P36/1142 (which tenement was referred to in the above definition of Tenement) and a number of additional tenements (Xstrata Mining Lease). Around 1999, the ‘Cosmos Mine’ was established on the Xstrata Mining Lease, from which nickel and other minerals have been obtained and sold. The meaning of the words italicised above in the definition of ‘Tenement’ was of critical importance to the parties, because the Cosmos Mine and its operations are located outside of the area that was formerly the subject of P36/1142. That is, no minerals have been mined from that area, and so if the definition of ‘Tenement’ did not extend beyond P36/1142 to the additional tenements that comprise the Xstrata Mining Lease, no royalty would be payable in respect of the nickel and other minerals from the Cosmos Mine.
The central issue became whether the definition of ‘Tenement’ was limited only to the original area as contemplated by the Deed, or whether ‘Tenement’ also included the additional area that made up the remainder of the Xstrata Mining Lease (that is, whether ‘Tenement’ covered the area of the Cosmos Mine and operations).
Technomin, as the royalty interest holder, argued that the definition of ‘Tenement’ captured the area of the Cosmos Mine and operations, and therefore that the royalty payments had been triggered.
At first instance, the trial judge rejected Technomin’s argument. The trial judge accepted Xstrata’s submission that the words in parentheses in the definition are words of clarification (that is, that the term captures the area the subject of the listed tenements notwithstanding extension, variation etc) rather than amplification (which would have the effect of expanding the definition to include the entire area of extensions, variations etc). The trial judge considered the circumstances surrounding the making of the Deed when interpreting the Deed and decided that Technomin’s interpretation was commercially unreasonable.
It was the trial judge’s reliance upon surrounding circumstances that provided – amongst other things, a basis of appeal, in that Technomin argued that the definition in the Deed was not ambiguous and therefore that the trial judge should not have considered the surrounding circumstances when interpreting the Deed.
When can the ‘surrounding circumstances’ to a contract be considered?
The recent history of the issue of when surrounding circumstances can be considered can be summarised as follows:
- The High Court held that evidence of surrounding circumstances was only admissible if the language of the contract is ambiguous or susceptible of more than one meaning (sometimes called a ‘gateway’ requirement) (Codelfa Construction Pty Ltd v State Rail Authority (1982)).
- A number of (intermediate) state appellate courts in Australia made decisions that assumed evidence of surrounding circumstances was always admissible, regardless of whether the language of the contract was ambiguous or susceptible of more than one meaning.
- The High Court reaffirmed the decision in Codelfa that the ‘gateway’ requirement applies, that is, that there must be ambiguity, or language susceptible of more than one meaning, before evidence of surrounding circumstances could be admissible (Western Export Services Inc v Jireh International Pty Ltd (2011)).
- The High Court appeared to take a turn away from Codelfa and Jireh, with the majority of the High Court considering surrounding circumstances to interpret a contract without finding expressly any ambiguity in the contract. Unfortunately, the High Court did not take the opportunity to comment on the validity of the approach taken by State courts that surrounding circumstances could always be considered (Electricity Generation Corporation t/as Verve Energy v Woodside Energy Ltd (2014)).
The Technomin decision in the Court of Appeal
In Technomin, President McLure of the Western Australian Court of Appeal drily expressed her surprise that trial courts – being charged with the responsibility of regularly resolving contractual disputes – had not so far managed to give any certainty to the principles of contractual construction.
In this case, the Court found that the definition of ‘Tenement’ in the Deed was both ambiguous and susceptible of more than one meaning, and that the Court could therefore look to surrounding circumstances to aid in its interpretation. Upon examination of the surrounding circumstances, the Court was satisfied that the correct interpretation was that, for the purposes of the royalty provision in the Deed, the definition of ‘Tenement’ was limited to the original area, and did not extend to the remaining area of the Xstrata Mining Lease.
Commercial considerations were also a noteworthy feature of the decision. President McLure took the view that the purpose of the extended definition of ‘Tenement’ is to protect the royalty holder’s position by ensuring that any changes to the original tenements would not diminish its rights; its purpose is not to effect an enlargement of the royalty right. She noted that the latter construction ‘results in an uncommercial windfall’ to the royalty holder.
Interestingly, while the Court held that there is a ‘gateway’ requirement when interpreting contracts (which requirement was met in this case because the language of the Deed was ambiguous), it is permissible to have regard to some pre-contractual surrounding circumstances for construction purposes without having to satisfy the ‘gateway’ requirement (for example, when implying a term in fact).