MLPs in Mining – the Path Less Travelled
While financing in the first half of 2014 has been a quantum leap healthier than in the truly dire days of 2013, the reactivation (if I dare call it that) is certainly not rambunctious and it has not concluded anything that we would call innovative. However we might note that Royalty funds and those that use the Silver Wheaton-type model of advances against production seem to have a strongly funded position to make those the more predominant (possibly) on this go around of the mining cycle.
However miners being creatures of habit those that have had success with one mode of financing in the past do not tend to want to break ranks and be innovative. Having said that, equity financings for battered producers are far more punishing than for explorers. Explorers are, to be brutal, selling part of a promise and a promise is infinitely dilutable. Producers (and near-producers) on the other hand are selling part of something much more tangible and in most cases something heavily marked down by two years of market miseries.
In light of the battered state of Canadian markets the temptation is to look to the US markets. This is particularly alluring when the mining asset is located in the US. The drawbacks are primarily the perception of heightened legal jeopardy (e.g. class actions) and the lack of a sophisticated analytical or institutional investment community for mining stocks. Compliance costs can also be very high in the US. These are not drawbacks though for larger mining enterprises that wish to play “in the Major Leagues”.
…and Less Considered
However for the smaller miner one option, the Master Limited Partnership (MLP), is seldom considered probably because it is almost always ONLY an option for those operating in the US and the skillset of those bankers or advisors outside the US on the topic of Master Limited Partnerships is limited. Too often Canadian miners, even those with US-based properties that would be ripe for an MLP type funding resort to some of the more tried and true forms of financing and ultimately come to grief. Veris Gold (the old Yukon-Nevada) with its Jerritt Canyon mine and roaster in Nevada presents as a good example of a company that pursued a bank-organised financing and loans from a Canadian fund manager rather than thinking outside the box.
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A MLP is a limited partnership that is publicly traded on a securities exchange. It combines the tax benefits of a limited partnership with the liquidity of publicly traded securities. This would be an attractive option to restructure a producing company into. As the alluvial tin operation could be a short timeline to production this is a real option for the management to consider.
MLPs are limited by United States Code to only apply to enterprises that engage in certain businesses, mostly pertaining to the use of natural resources (and their transportation). To qualify for MLP status, a partnership must generate at least 90% of its income from what the Internal Revenue Service (IRS) deems “qualifying” sources. For many MLPs, these include all manner of activities related to the production, processing or transportation of natural resources.
In practice, MLPs pay their investors through quarterly required distributions, the amount of which is stated in the contract between the limited partners (the investors) and the general partner (the managers or GP). Typically, the higher the quarterly distributions paid to limited partners, the higher the management fee paid to the general partner. Failure to pay the quarterly required distributions may constitute an event of default.
Because MLPs are classified as partnerships, they avoid corporate income tax at both state and federal levels. Additionally, limited partners may also record a pro-rated share of the MLP’s depreciation on their own tax forms to reduce liability. This is the primary benefit of MLPs and gives MLPs relatively cheap funding.
The tax implications of MLPs for individual investors are complex. While distributions from MLPs are taxed at the marginal rate of the limited partner, there may be no tax advantage to claiming the pro-rated share of the MLP’s depreciation when the investments is held in a tax deferred account. To encourage tax-deferred investors, many MLPs set up corporation holding companies of limited partner claims which can issue common equity.
A general partner in an MLP often begins with a small stake of about 2% in the partnership, but is given incentive distributions from net income after the quarterly required distributions. Since these distributions are usually paid in the form of increased equity claims the general partner may attain an increased share of the partnership’s ownership.
If Coal Miners can do it…
To illustrate the case, I went in search of some mining MLPs and suspected I would not find many but at least there would be some variety. Alas though, I was right on the former and wrong on the latter as it seems that only coal companies (and in the US, at that) have embraced this model. However, I cannot see any reason why it should not find traction amongst any metal miners with a reasonable residual mine life (5 years or more) or of any producer of DSO, such as iron ore, manganese, bauxite or chromite.
In this age of dismal returns on many fixed income instruments, MLPs can give good returns. The yields and distributions can be as high as 8%. We found a list of the main US coal plays in the MLP space:
Alliance Resource Partners, L.P. (NASDAQ: ARLP) is located in the mining regions in the Illinois Basin, Central Appalachia, and Northern Appalachia. It has nine mining fields and have approximately 700mn tons of coal reserves. It is a producer of high sulphur coal, which many feel will see higher demand as new and better scrubbers are installed at electric utilities.
Foresight Energy L.P.(NYSE: FELP), which IPOed in May 2014, is a leading producer of thermal coal with over 3 billion tons of coal reserves in the Illinois Basin which we have developed with four mining complexes. It recently completed a five-year, $1.7 billion capital expenditure program constructing these complexes and related transportation infrastructure.
Natural Resource Partners L.P. (NYSE: NRP) is different in that it sub-leases its land and mineral rights (with estimated reserves of 2.1 billion tons of coal) on a royalty-producing basis. It therefore is not a miner and thus is somewhat like a variant upon the royalty model as practiced by Franco-Nevada though also it is different.
Oxford Resource Partners, L.P. (NYSE: OXF) has its producing assets in Northern Appalachia and the Illinois Basin. Oxford sells to large utilities under long term contracts. The predecessor to Oxford Resource Partners, Oxford Mining Company, was formed in 1985. In 1989 the company transitioned to an independent coal producer, and in August 2007 the partnership was formed. Oxford IPOed its limited partner interests in July 2010.
Rhino Resource Partners L.P. (NYSE: RNO) has coal mining operations in the Illinois basin and Central and Northern Appalachia. Proven reserves stood at 325 million tons. The “shares” were brought public in September of 2010.
The Fatal Flaw
As I have often noted a Canadian mining exec with cashflow is like a corpse grasping a fistful of dollars. Rigor mortis sets in and there is no separating that cash, particularly if it involves sending a dividend to long-waiting shareholders. First Majestic is our poster-child for companies that think they know better how to handle cash than shareholders.
And in this observation we have the fatal flaw in the introduction of MLPs to the Canadian mining funding scene. Managements feel like they know better how to “manage” earnings than shareholders do. History has shown otherwise. Money burns a hole in the pockets of mining managements. What a far better company Kinross would be if it had distributed earnings to shareholders as a dividend than splurging on sequential (over-priced) lemons!
For MLPs to prosper in the broader mining markets (meaning more than just coal), there would have to be a change in mindset that would involve letting loose the grip on earnings and trusting that shareholders should also share in the returns of the mine, rather than just management, for MLPs are the ultimate in revenue-sharing with the oft-forgotten shareholders in the resources space.
If Canadian mining company managements latched onto possibilities that they might be the general partners in a MLP then they might be dissuaded from their age-old issue with dividends of “what’s in it for us?”.
It’s sometimes said that there is “nothing new under the sun” but this is only technically true. Sometimes there are solutions (or at least other options) staring one in the face that go untried because of their novelty value. MLPs though are not virgin territory for the oil & gas sector, but they are largely untested by miners. Unjustly so..
Most of the breed of Nevada-based gold producers could have resorted to MLPs over the last decade if they had bothered to put some thought into it. However with competing sources of money not as copious as they once were it time for the mining industry to break out of tired old models that either don’t work anymore or are so defective that they only prove useful when there is a high-tide in the mining space. MLPs should definitely be on the agenda of producers and wannabe producers.
Christopher Ecclestone is a Principal and mining strategist at Hallgarten & Company in London. Prior to founding Hallgarten & Company in New York in 2003 ... <Read more about Christopher Ecclestone>