Investing in mining related infrastructure - What investors and contractors should know

Major-Projects-Infra-7.jpg
23 April 2012

Australia’s vast mining and resources sector has an unquenchable thirst for infrastructure. Billions of dollars needs to be invested in roads, railways and port facilities to support the sector’s export chain. The Major Mining Industry Projects Reports indicate that there are 102 minerals and energy projects at an advanced stage of development with committed capital expenditure of over $230 billion , and there are 302 projects considered to be at a less advanced stage of development, with an estimated capital cost exceeding $224 billion. It seems clear that government cannot and will not meet the level of infrastructure investment required. Increasingly, mining companies are finding themselves stepping in to fund and build railways and port facilities.

Options for financing infrastructure

When it comes to the private sector funding its own infrastructure assets, there are a range of financing structures and options available.

Major resources players, the likes of BHP and Rio Tinto, have the funds to build and operate their own infrastructure. However, this is not feasible for the vast majority of companies operating in the sector.

Over the last decade, there has been an explosion in the numbers of Australian junior and mid-tier miners, as well as substantial investments from China and India in the resources sector.  These smaller entities are hard pressed to raise the huge amounts of capital required for mining projects and associated infrastructure.

Accordingly, many mining companies are, by necessity, looking at a range of innovative financing options. Some have established Special Purpose Vehicles or participated in multi-party consortiums to acquire interests in mining infrastructure companies such as Port Waratah Coal Services and Abbot Point Coal Terminal.

While the idea of users of an infrastructure asset pooling their resources to develop the asset is logical, the reality is multi-user funded infrastructure involves myriad complexities.  Competing user priorities, tax considerations and issues over control can lead to serious problems between investors and impede development.

Contractors – a new source of finance?

Increasingly, contractors bidding for mining infrastructure projects are also being invited to contribute equity to secure a favourable outcome for their bids.

Before agreeing to invest equity into any project, contractors should undertake proper due diligence into the financial feasibility of the company as well as the project to ensure that

  1. risks to the contractor’s investment are fully appreciated; and
  2. an acceptable rate of return can be achieved, having regard to the total equity investment as well as the likely return on the construction contract. 

Of course, in the event of insolvency, any equity investment will rank behind all creditors.

Form of contribution

An important investment consideration is the form of contribution – will it be equity or an alternate form of debt?

The equity contribution frequently takes the form of equity or quasi-equity instruments such as preference shares, convertible preference shares, redeemable preference shares, or convertible debt.

However, it may also be possible for the contractor’s “equity” contribution to take the form of a debt instrument.  In such case, it is important to consider the debt subordination arrangements and priority arrangements among the various parties providing debt finance to the project.

Debt subordination is distinct from priority issues and ranking of security granted by the project company over its assets.  Subordinated debt falls behind the claims of senior creditors and potentially other creditors, although it will rank ahead of shareholders’ equity.

Managing risks in the equity investment and exit strategy

Contractors are understandably focussed on delivering a sound infrastructure project and being able to achieve a successful (i.e. speedy, trouble-free and lucrative) exit. Where a contractor is engaged as the mining services contractor for a defined term or life of mine, generally it will not wish to be a long-term owner.

A contractor’s financial exposure to the mining company or project (including on-going and contingent liabilities and obligations) can be managed by disposing of, or reducing its ownership of, shares in the mining company or project. This can be done in a number of ways including buy-back arrangements and call and put options. Each investment approach will have its own separate tax and stamp duty considerations (including any “land rich” duty related issues), and these should be addressed at the outset.

Risk allocation under EPC infrastructure contracts.

Notwithstanding the contribution of equity or debt into a project by a contractor, the relevant contract may still contain a risk allocation profile that is ‘owner friendly’, so as to maintain greater certainty and comfort for the owners in terms of time and costs certainty.  This may not necessarily be acceptable from the contractor’s internal risk management perspective, and the risk/reward profile of such an investment may not be commercially acceptable.

Financing resources infrastructure through PPPs

Historically, governments have made use of public private partnerships in financing and delivering public infrastructure.  PPPs are now also being considered overseas for mining infrastructure[1].

The PPP model has come along way in the last decade however it is important to have regard to the following key issues:

  1. Understanding the security package over the project and the mining company, and evaluating the priority that the financiers providing funds for the project will have.
  2. Evaluating and putting in place arrangements to ensure that the project is able to generate enough cashflow to service all debt (including any junior debt provided by equity and/or contractor(s)).  Project sponsors will seek to utilise as much debt as the project cashflows (i.e. from offtake/sales contracts) permit (with appropriate headroom for overruns and other contingencies) in order to realise an attractive return.  It may be important that the investor contractor is able to have recourse to those cashflows as security for any debt it provides (subject, of course, to the prior ranking claims of senior debt providers).

Final considerations

Ultimately, there are a number of considerations to be taken into account in constructing a workable financing package for a project, such as:

  • The rights of financiers at different levels in the debt capital structure (e.g. senior debt, mezzanine debt and subordinated debt).
  • Projected cashflow.
  • The legal and tax implications of each type of equity or debt or quasi-equity/debt instrument.
  • The existing structure of the project company and any restraints on the future structure.
  • The risk/reward profile of the project company and its shareholders (including the investor contractor) and financiers.

[1] Exploiting Natural Resources for Financing Infrastructure Development – Policy Options for Africa, AU Conference of Ministers Responsible for Mineral Resources Development, December 2011, Addis Ababa, Ethiopia




The content of this publication is for reference purposes only. It is current at the date of publication. This content does not constitute legal advice and should not be relied upon as such. Legal advice about your specific circumstances should always be obtained before taking any action based on this publication.


Contacts

Andrew Chew

Partner. Sydney
+61 2 9210 6607

Profile

Rommel Harding-Farrenberg

Partner. Sydney
+61 2 9210 6366

Profile