Digging Out of Trouble in a Cross-Border Deal?
For an Australian company running a base metal mine in Latin America through a Latin American operating subsidiary, it felt like a perfect storm. Historically, commodity prices fluctuate, but during the global financial crisis of 2007–2009, base metal prices fell precipitously. The company’s Latin American subsidiary faced claims from customers whose contracts called for advance payments with rebates if market prices dipped – as they had. The company needed a cash infusion to keep operating but, remember, this was in the middle of a financial meltdown: credit was hard to find.
These were external forces, outside the company’s control. But the subsidiary also had failed to communicate its cash squeeze to its stakeholders, which created an information vacuum that quickly was filled with concerns. Customers worried about their contracts; employees worried about their wages; lenders worried about the subsidiary’s ability to meet its debt obligations. Unsurprisingly, the lenders sought an independent business review, and the results confirmed their worst fears: the mine was in danger of insolvency.
The review led the company to appoint an administrator; the lenders appointed an Australia-based receiver from FTI Consulting to guard their interests and, hopefully, keep the mine open.
The receivers immediately began talks with the Latin American operating subsidiary’s unsecured creditors to discuss an informal restructuring. But as talks progressed, employee groups staked a claim to about $2 million in unpaid wages they argued were owed to them by the mining operation. After two months, and no restructuring options available due to the still plummeting base metal prices, lawyers acting for the employees escalated their claims, multiplying them by a factor of four. Riots erupted during the conflict over workers’ wages and local suppliers’ unpaid invoices. The claims against the mining operation grew so large that an informal restructuring was deemed impossible, and the Latin American subsidiary had to enter local bankruptcy proceedings.
The losses ultimately stretched from Latin America to Australia. And the worst part for the mining company and all its stakeholders is that the crisis, and all the value destroyed, could have been avoided.
Mining Firms Caught in a Financial Vice
The challenges the Latin American base metal mine faced were not unique. This past decade has been a particularly difficult time for multinational mining firms. They can face serious consequences, even in good markets, when they fail to act decisively.
During the global financial crisis, credit to support existing or new mining operations was in short supply. At the same time, commodity prices and currency exchange rates whipsawed, creating uncertainty about revenues used to fund operations. Then, as the financial crisis eased, commodity prices rose as demand from China spurred miners to increase production. But when China’s economy cooled, and demand for coal and iron fell, prices fell once again.
Today, many mining firms have improved their balance sheets by deleveraging, but high-cost producers and new projects still find it difficult to attract capital.
Those high-cost producers with significant debt are left with some difficult choices. To meet their financial obligations, they can try to raise equity at deeply discounted prices. They can sell off their highly-leveraged assets. They can enter joint ventures to get other firms to take on their operations and debt.
Or, they can file for bankruptcy.
These will always be difficult choices, but they will be somewhat less difficult – and have a greater chance of a successful outcome – if they are not made in the middle of a crisis.
Some mining executives believe they can weather a difficult patch by keeping calm and waiting for the market to improve. And, sometimes, they can. But it would be wiser for multinational mining companies to set up contingency plans for dealing with cross-border financial problems before there’s a squeeze. Not having a plan in place can make a manageable crisis unmanageable. The best decisions are rarely made under pressure. The time to communicate with lenders, for example, is when a company’s executives can see that a cash shortfall is looming, not after it arrives. Lenders are better able to listen to plans about addressing cash shortfalls when a company is still meeting its obligations; once it stops, lender patience evaporates rapidly.
This need for contingency planning is particularly pressing for multinational firms with operations in the developing world, where the need to obtain and maintain a social license to operate (that is, the understanding that the mine benefits everyone in the community, not simply its owners and investors) is hard won and easily lost. Unlike in the United States, the United Kingdom, Canada and Australia, the courts in nations where many mining operations are located often are not inclined to favor large corporations over local employees and suppliers. For that reason, appealing to the courts is rarely an attractive option for multinationals. In addition, courts in developing markets may take many years to resolve disputes without regard to the business implications of delay.
These factors in developing markets make it smart to avoid courts and also demonstrate the importance of proactive, clear communications with stakeholders. Both financial institutions and local community and labor groups need to understand the nature and extent of a mining operation’s challenges before they reach a critical stage. That awareness can create an environment in which it becomes possible to gain support for plans to restructure loans, for example, and to reach agreements with local suppliers and labor groups on payment schedules that can enable a mine to continue operating and creating value.
Failing to manage a situation before it becomes a crisis can invite conflicts that lead to greater losses. Lenders can become alienated and withhold funds needed to keep operations going. The demands of labor groups only rise in a hostile environment, and suppliers who see lenders withdraw support will stop deliveries. Once this happens, a firm can lose its social license to operate in the community, and nothing good ever comes from that.
Knowing When to Ask for Help
Active engagement can lead to a better outcome than the Latin American base metal mine operators experienced.
For example, another Australia-based mining services company owned a subsidiary that built processing facilities for operations in Latin America. When the subsidiary faced overruns on several projects, its leaders realized its fixed-price contract terms would not cover its costs. As the overruns mounted, the subsidiary reached out to its head office and asked for help.
The head office hired FTI Consulting to review the company’s options for managing the Latin American unit’s financial crunch. FTI Consulting suggested that a Special Purpose Vehicle (SPV) directly responsible for the Latin American unit (which itself was a subsidiary of a publicly held Australian firm) should come under the control of an external administrator in Australia to reduce the risk that financial problems from Latin America would come back to bite the publicly held Australian firm.
In the end, the SPV brought in an administrator who acted as a mediator between local creditors in Latin America and the publicly held company in Australia. The parties agreed on an informal debt-for-equity restructuring with the Latin American operations’ major creditors that minimized stakeholder losses while avoiding a costly court battle.
The leaders of the SPV had a big problem. But their decision to seek outside expert help in an expeditious fashion, before everything fell apart, brought what could have been a crisis under control.
Five Actions for Effective Cross-Border Crisis Management
A deeper look at the mining services firm’s actions shows how and why it succeeded. The company took five actions to mitigate the risks of its financial crisis and exerted as much control as possible over the outcome. Specifically, the firm:
- Assessed the situation. The holding company in charge of the mining services firm reviewed the unit’s financial condition and assessed how it was likely to improve. The review led to the appointment of an external administrator who could act as an honest broker with creditors, local suppliers, labor groups and other stakeholders.
- Alerted its creditors about the problem. The holding company explained to its creditors both its internal review and its decision to appoint an external administrator to manage the situation in Latin America. This demonstrated the firm’s commitment to transparency. It showed that it took its financial problems seriously and was seeking help to manage them. This built confidence among key shareholders who therefore were receptive to appeals to share additional equity as part of a solution to the crisis.
- Informed local stakeholders about efforts to address the problem. The fact that the external administrator communicated with all stakeholders – project owners, various legal advisors, the Australian Embassy and company employees in Latin America – and not just shareholders also conveyed the company’s seriousness and, in effect, secured the company’s social license to operate. This created a sturdy platform for a solution.
After three months of negotiation with 100 different claimants to the projects in Latin America, the firm settled all claims, and in some cases reached compromises on terms acceptable to all parties. For example, the administrator divided claims into small, medium and large categories depending on the amount owed. Settlements offered full cash payments to small creditors. Medium creditors were offered 50 cents on the dollar, and large creditors could receive 50 percent cash or the option to convert 100 percent of the amounts owed to equity.
- Maintained a strategic communications program. The company kept key stakeholders, including the shareholder company’s listed shareholders and employees throughout the group, updated about its progress in Latin America. Information was shared through a combination of stock exchange releases, internal memorandums and one-on-one meetings, ensuring consistent messaging.
- Limited the mining service company’s financial exposure. By acting quickly, leaders of the mining services company contained the financial damage. Without this effort, the burden of meeting its financial obligations could have fallen to the parent company in Australia, hurting its standing with investors. And the success of the restructuring kept the facilities in Latin America in business.
Talking About Restructuring Is Hard to Do
While this kind of proactive engagement strategy may appear straightforward, many firms in the mining industry are loath to implement it.
One barrier is the very human tendency to believe that challenges can be overcome without external help. The troubles that most often lead to restructuring in cross-border mining operations – volatility in commodity prices, cost overruns, economic downturns – are financial management problems. As noted, commodities are always volatile, and mining executives may feel that they can weather any one storm as they’ve weathered previous ones. The risk of this attitude is that some storms can build until they become Category 5s, creating damage that is beyond repair.
Because these issues in cross-border mining almost always involve external parties, such as lenders, and very visible stakeholders, including employees, subcontractors and local communities, it should be a matter of due diligence to seek outside expertise and advice. Perhaps that advice will confirm management’s outlook. But the risks of not seeking outside help far outweigh the cost of engaging it.
A second challenge to proactive engagement is implementing the response. Companies must determine the specific cause, or causes, of their financial problem and then focus on two tracks simultaneously: handling their communications about the situation and managing the fallout from the crisis. The mining services firm with a crisis in Latin America discussed its problems with stakeholders and developed a plan to settle with creditors based on their individual circumstances and relationships with the firm. It’s not enough to talk. Companies need to act, too.
Getting Ahead of a Crisis
Companies involved in the mining industry – those that operate mines and the many firms that provide services to them – need to remember that they operate in an environment in which they must maintain their social license to operate while managing the effects of financial conditions, including fluctuating prices and macroeconomic swings. Although these economic factors are beyond their control, they should have contingency plans to deal with them when they arise, as they inevitably do.
Those plans should include engaging external experts to assess a gathering storm before it becomes a crisis and being able to communicate with stakeholders about unfolding conditions and the company’s plans for dealing with them. To manage a mining company effectively in times of financial crisis, it not only looks good to seek outside help, it is also cost effective.
Senior Managing Director, Co-Leader of Asia Mining and Mining Services