Caroline Donally, Director Denham Capital

Interview by Frik Els (Mining.com)

Director of $1 billion fund discusses Denham's unique approach, the vibrant parts of the M&A market and what juniors should do to attract capital.

In 2014 the number of mergers and acquisitions in the mining and metals industry doubled from the year before.

Was hardly a bumper year though. At $21 billion it pales against the heady pre-financial crisis days when mining M&A came within shouting distance of the $100 billion mark.

Mining has never been able to attract much outside capital.  Then and now the vast majority of deals are miners buying mines.

Then Mick Davis showed what was possible; cobbling together almost $6 billion in private money over a short time (spending it is taking longer). Suddenly everyone was talking of private equity billions being pumped into the scorched earth that the sector had become.

So far it's turned out to be wishful thinking, but the idea of white knights galloping to save the industry also obscures the transformation private equity is bringing about in the sector. And has been for a lot longer than is generally perceived.

Caroline Donally, director of Denham Capital, tells MINING.com that the roots of the private equity firm's mining business can be traced back more than a decade.

Denham Capital started out in the oil and gas and power sectors, but after a couple of coal deals were inked in 2004-2005, a dedicated mining arm was established. In 2008  Denham Mining  made its first investment.

Those coal deal have been realized and today Denham has seven active investments in the mining sector. Denham has $7.9 billion in invested and committed funds, with mining making up more than $1 billion of the total.

But what sets Denham Capital apart is not that it's been active in mining for a long time, it's the unique approach to investing.

The fund backs management teams not specific assets or projects. These management teams are multidisciplinary with the ability to advance many projects at the same time.

"We look for the right people to start a business with a specific strategy or business plan in mind. In some instance our teams do not even have any projects when we commit capital to them. The first thing they'd do is hire offices, print business cards and hunt for assets," says Donally who is based out of Denham's Houston office.

The selection process can be lengthy. "Getting to know people takes time. We typically think of our investment on a five to seven year time frame. We need to be highly comfortable with the people to work together for that long."

It is also a two-way street says Donally: "The teams that we back need to be willing and comfortable to work with us for that length of time. Understanding their thinking, how they consider assets, where they see value, and how they would go about acquiring are all criteria that have to be considered."

What makes the Denham approach particularly suited for mining is the fact that management teams have certainty of funding. "They are not spending their time looking for money, having to go on roadshows and raise funds every six months. They can actually focus on looking for assets and develop their business," says Donally. Staying private also helps keep costs low and shields teams from the ups and downs of public markets.

Blue skies for explorers won't come soon

Denham typically puts up $150 million to $200 million which the management team can then carve up and top up. "Once we back a team, they can do much smaller deals, within their capital commitments. There are also ways for teams to raise other funds through debt financing and other structures to increase the amount of capital they have."

Another key success factor  of this approach is that managements teams have to have skin in the game and aligned interests says Donally: "It's a well understood model in the oil and gas space but less so in mining. Management teams invest alongside us. When it comes to an exit a certain portion is carved out for the management team as an incentive."

That additional management equity incentive can be as much as 20% depending on the value of the exit. Compare that to listed juniors where insider ownership tends to be diluted over time as capital is raised to advance projects.

The exit can be anywhere on the curve from preliminary economic assessment to an in-production property, says Donally, but she adds that "the days when you could spend two-three years developing an exploration asset and somebody will buy it from you is probably over. But there's also no reason it won't come back."

Donally says the M&A action is particularly vibrant for larger producing assets: "We have seen quite a few quality, cash producing assets change hands. And just from talking to people in the market for each of those there were five if not ten bidders who were valid sensible bidders looking at those assets."

Denham Capital Mining is mostly active in the Southern Hemisphere with teams focused in South America, Africa and in Australia. "In 2008 we saw most potential in Brazil where we backed our first team," says Donally. That was amid the global financial crisis, which meant cheap assets could be picked up during the crash which, particularly in the commodity sector at the time, was followed by a rapid pickup.

Donally said Denham looked at Australia around four years ago, but considered it too expensive. "When we saw markets turning and valuations dropping it made more sense," says Donally. An office was open in Perth in 2013 and since then the region has only been getting cheaper, in part due to the falling Australian dollar."

"Our portfolio companies are mostly in acquisition mode right now," says Donally.

Denham's mining portfolio companies have done a few deals in Latin America. Copper and gold of course, but also iron ore (at a time iron ore was just entering its boom period) and rare earth. "Australia is scouring the market as it's relatively new, while our African team is mostly advancing projects but is also looking at new opportunities," says Donally.

The South Africa based team in operation since 2011 has $200 million to $300 million to potentially draw on and have looked at a wide range of exploration projects from manganese to tin apart from copper and gold in West and Central Africa.

Donally is seeing opportunity beyond Denham Mining's current footprint, particularly North America: "It appears buyers are becoming more interested in assets in North America. When we see M&A activity pick up in a region it attracts our attention."

Don't expect explosive growth in the sector

Donally does believe metal and mining markets are close to bottoming and doesn't see them falling much further, but neither is a major rebound in the offing: "There's still a lot of rationalization that needs to happen and I think there are still too many junior miners that are not progressing their projects. That's going to take a few years to wash through the system."

"We consider hundreds of projects. Perhaps one in 30 or one in 40 may go somewhere," says Donally. So with the odds stacked against them what advice does Donally have for juniors struggling to attract new capital to take projects further?

"What works for Denham may not necessarily work for other private equity funds. For me that seems to be one of the confusing things about private equity and mining. There are niches that private equity funds fulfil. Not all private equity is the same.

"It's question of trying to find the right type of private equity fund. People try two or three and then get despondent. Perhaps they're approaching a fund that's not focussed on what they are.

"And most importantly don't take a piecemeal approach. We want to know what your end-goal is; we don't want to hear about the $5 million you need to move your project one step further."