Investment in junior companies: laying the foundations for economic development in Africa

Junior miners provide a high risk/high reward opportunity in the early-stage exploration and development niche. Larger mining companies, while still active in this sector, tend to have an acquisitive strategy and a low appetite for early-stage exploration risk. The majors look to the juniors to provide a pipeline of projects. Motivated by these exit possibilities and therefore the investment opportunities provided by junior companies, African Lion (AFL) has been actively investing in the mining sector in Africa. It has developed an investment approach based on knowledge of the sector and a focus on investing in the early stages of the cycle – where valuations are more compelling – and exiting towards the top of the project cycle. In addition to the opportunities they offer investors, junior resource companies can provide a catalyst for growth in Africa. With a footprint across the continent, they are often at the vanguard of development initiatives. Companies from emerging economies are a growing feature of the African mining industry. While this increases competition for Western companies active in the sector, the arrival of emergent investors will revitalize the sector. This could benefit private investors, such as AFL, and contribute to the economic growth of African countries.

Positioning of the junior resource companies in Africa

Junior resource companies play a vital role in unlocking value in high-risk exploration and mining projects in Africa. By investing in exploration, they support the opening of mines that feed the pipeline of projects contributing to developing the sector. Without this, the number of projects would be limited. Junior companies are frequently managed by technically highly qualified geological personnel schooled in larger mining companies from many countries. Junior companies raise risk equity funding largely from the mining-focussed North American, European and Australian equity markets. Here and elsewhere, they can also access pools of private capital. Funding for juniors is generally both cyclical and commodity-focussed, with frequent dips in exploration (and therefore on-the-ground activities) related to broader market conditions. It is easier for resource companies (and particularly juniors) to access risk capital at the peak of the mining cycle. This is particularly the case for ‘hot' commodities, where market demand for new opportunities is high. Recent examples include the uranium boom from 2003 to 2007. Currently, there is a strong appetite for gold-mining companies, and African-focussed explorers and developers are benefitting from this. The strategy of junior companies generally follows alternate paths: evolving from explorer to developer to producer, or taking a project to a stage where it (or the company) can be sold to a project developer. Junior companies are capable of being opportunistic in advancing early-stage projects, while larger companies tend to be impeded by high establishment costs and a need to set up technical and administrative networks. Consequently, they might instead seek to selectively back junior companies with equity financing or specific projectlevel investment. However, where project scale has been demonstrated (or specific synergies identified), a full takeover might also be considered. The major companies frequently make strategic decisions to focus on specific commodities, countries or even continents, often avoiding the less ‘fashionable' frontier or problem countries (e.g. Zimbabwe, Sudan, Eritrea), where they are usually not prepared to commit. This has led them in some instances to abandon exploration programs, sometimes resulting in the removal of exploration teams from projects with good exploration results or potential. Such projects could be acquired or possibly picked up by juniors at no cost. Notwithstanding this, in terms of global exploration spend, Africa has continued to attract approximately 15% of world exploration spend from 2005 to 2009 (Metals Economics Group – MEG, 2009). The lower profile of junior companies often curbs unrealistic expectations in structuring project deals, as tends to occur with larger mining companies. This can result in shorter deal conclusion times. Junior companies are also able to offset risk by carefully selecting local partners and providing them with appropriate incentives.

The AFL approach to investment

AFL has been a private equity investor in Africa since 1999, when the first fund was established. Figure 1 shows the timeline for all three AFL funds. The most recent AFL3 was established in 2008 with a committed capital of USD 79 million. The funds have a 5-10 year investment horizon backed by a support group of shareholders comprising , Australian listed investment company Lion Selection; Commonwealth Development Corporation; European Investment Bank; Proparco; a specialist fund Botswana Insurance Fund Management; and commercial banks Rand Merchant Bank and Investec (both from South Africa) complete the shareholder mix. This group of investors has remained largely unchanged since 1999, supporting the creation of the three funds. The currently active fund, AFL, has invested in Morocco, Democratic Republic of Congo (DRC), Uganda, Tanzania. Liberia, Ivory Coast, Ghana and Tunisia. Complementing the manager's experience, the fund shareholder base has a very strong African focus and enormous experience across the continent. AFL's management team understands the need to benefit maximally from these relationships in order to review and assess investments and to add specific-country knowledge when appropriate. Shareholders have also taken the opportunity to co-invest via debt and equity in selected fund investments. All founding shareholders have the opportunity, and are encouraged by the manager to be represented on the fund investment committee, thereby adding value to the investment process. This ‘value add' comes from a broad range of country-specific, technical and commercial experience across a range of commodities and countries. Shareholders also refer opportunities to the manager. AFL has successfully invested in early-stage companies (grassroots exploration); however, given the paucity of technical information at this stage, very few are investment grade. A practical consideration is the number of companies that can actively be managed. As early stage investments are generally smaller, the challenge is to find a balance between small and large investments while maintaining a portfolio of 10-12 companies. Many of the investments made by the AFL funds have thus been at an advanced exploration stage or at an early stage of project advancement (Figure 2). At this stage, exploration has already defined a potential project. Through incremental investment and the introduction of appropriate board and/or management skills, the manager aims to add value and help the company progress to he next level. This next level might be project development, partnering or sale. AFL can invest in listed or private companies. In most cases of private company investment, the manager has supported an initial public offering strategy and helped to introduce banking and broking relationships in the various listing jurisdictions. With some exceptions, the fund will look to realise its investments close to, or at commercial mine production, with a target of 5-10 times return on the initial investment. The AFL team has both technical (geological and mining engineering) and corporate (banking and broking) skill and experience. The team has evolved an investment process that requires a high level of people, technical and valuation due diligence, combined with a comprehensive risk analysis. Of these, the key element is the quality of the teams being backed, with the objective of minimising reputational risk to fund shareholders and the manager. The manager also assesses economic, geological, operating and market risk. As part of the country review, the manager generally visits the project and meetings are held with key stakeholders. A country due diligence is run in parallel with the company review, to understand the regulatory environment, security, political and event risks, and to meet with government and other key groups (e.g. accountants, lawyers, the stock exchange). This is particularly important at a time of increasing pressure for legislative changes in the mining industry globally. The manager and all shareholders in the AFL fund are committed to ensuring best practices by investee companies in the areas of health, safety, environment and social development. These all warrant that they will comply with AFL's Environmental and Social Management System (ESMS), incorporating World Bank/IFC performance standards. The manager aims to move companies beyond compliance towards best practice in all areas of social and environmental management, and where appropriate, introduces skills and relationships to help companies grow. Investee companies must comply with all the laws and regulations of their country of residence and any country where they operate. They must also provide annual  reports to the fund on these issues. The fund has a nominated ESMS office that ensures adherence to fund policy. Additionally, investee companies provide information on significant shareholders as part of their anti-money-laundering diligence. The AFL investment model also strongly encourages companies to identify good quality local partners at the earliest possible stage. Empowerment of local partners is aimed at providing long-term development support and aligning the interests of all parties involved in project development. One example of employment benefits is Gallery Gold Ltd2 in Botswana, a USD 5.6 million equity investment (corresponding to 45% of shares) by the first two funds in 2000. At the time of the AFL initial investment, there were 10 employees, and at exit in 2007, approximately 350 workers were employed during the early production stage of the gold mine. The company built roads, school and hospital infrastructure, and continues to operate in 2010.

Emerging players and the way forward in mining

The junior mining sector in Africa provides an enormous investment opportunity for private investors and can provide co-investment opportunities for fund shareholders. Chinese groups with national/provincial government backing have been increasingly active in the sector.3 While they initially focussed on larger companies, projects and offtake agreements, they are increasingly investing in smaller resource companies and projects. Investment in countries such as Zimbabwe, where many Western mining companies are unable or reluctant to invest, has proved fertile ground for thesegroups. Additionally, South American and Indian  companies are spreading their reach into the African continent. This is beginning to change junior company dynamics and represents a competitive threat to Western-based juniors across Africa. AFL anticipates that there will be a significant flow of funds into exploration from China, India and South America, with increased risk appetite. The next generation of junior explorers may very well be Chinese and Indian vehicles, funded by institutional and venture capital from within these countries.

References

MEG , 2009. World Exploration Trend, Prospectors and Developers Association of Canada International Convention, report.