Private equity firm Denham Capital has invested in four mining ventures in South America and Africa since 2008, and is close to signing a fifth deal, this one with a team in Australia.
And the Boston-based firm — which has US$7.9 billion in invested and committed capital in three sectors: oil and gas, power and renewables, and metals and minerals — is looking to make more investments in mining.
But Denham’s approach to the mining business is very different from other private equity firms, which typically are project and cash-flow focused, says Caroline Donally, a director of the firm’s metals and minerals group.
“For us, everything is about the management team,” Donally told an audience at this year’s Prospectors and Developers Association of Canada convention in March, during a session on alternative financing.
“We are team-focused and we are business plan-focused,” she said. “So it’s very rare that you hear people from Denham actually talk about projects, we always talk about teams and business plans.”
Basically, Denham provides venture capital for mining entrepreneurs to execute a business plan. Those mining entrepreneurs have a track record of success in a certain commodity or region, and often have deep local knowledge that gives them a tremendous advantage in understanding the local social and political landscape.
Those entrepreneurs seek to capitalize on their experience and knowledge with a business plan that outlines a commodity and/or region of focus, a target for the number of projects that will be considered, how far they will be advanced before looking for an exit, and the amount of money needed to fund the plan.
Denham’s “backer management team model” is novel to mining, but it’s based on a model private equity already uses when investing in oil and gas.
“The model of backing a management team before they have any projects is exactly how the oil and gas private equity business in the U.S. works,” Donally says.
Usually, the mining entrepreneur who will become the CEO of the new company hand-picks his or her own team, which starts as a bare-bones four- to five-person team. As the business grows, the team is filled out.
Because the people are so important in Denham’s model, and they may be taking Denham into commodities or regions that are new to the firm, deals can take a lot longer than raising capital in the public markets would.
“We want to get to know and understand the teams, how they think, how they operate, and how they think about spending capital over time to generate the best returns,” Donally says. “That process of getting to know and trust one another is not something which happens overnight. So it can be a fairly lengthy process upfront.”
While junior mining companies typically have several projects, but only really advance one at a time, Donally says Denham is looking for teams that can carry out a “one-team, many projects” model.
“We’re looking for multi-disciplinary teams who are able to develop numerous projects at the same time. So typically there’s an element of project churn in that the team will go out and assess a project, discard and start the next one, but we are looking for teams who are able to progress with many projects at the same time.”
Some business plans may include bringing one or more projects into small-scale production in order to bring in cash flow.
For example, Denham’s venture with Stellar Mining, a team that Denham backed with $175 million, was put together to look for polymetallic projects in Peru, where many such projects are owned by families. Stellar has so far secured seven projects, several of which are small-to medium-sized projects that it is looking to bring into production in the next couple of years, as well as two projects that have the potential to be very large discoveries.
It usually takes five to seven years for a company to carry out its business plan, Donally notes.
“Once all the strategy has been fully executed, the business is put up for sale — either through a listing or a sale of the entire biz through a sale of the component parts — whatever approach will make the most money at that time.”
‘No investor roadshows’
One of the big advantages Denham offers its partners is certainty of funding.
“There’s no investor roadshows, there’s minimal time on compliance and corporate affairs, so for us we see great value in giving management the ability to go out and execute on their business plan rather than spending their time trying to raise capital,” Donally says.
Before a deal is signed, Denham and the company management will figure out how much money is needed to execute the company’s business plan.
“On day one, when entrepreneurs sign up with Denham, they know that the money they need to execute the full scale of the business plan is available as and when needed.”
Denham has signed deals in the $150-$200 million range with its mining teams.
While all of this may sound like a dream come true to junior miners who are finding the public markets closed to explorationists, Donally notes that Denham’s model doesn’t appeal to everyone.
“It’s a certain type of entrepreneur with whom this resonates,” she said in an interview, adding that for some mining entrepreneurs that are used to the Canadian listed space, Denham’s approach may be too foreign.
“Those types of groups, when we come into contact with them, the private equity model that we follow at Denham is often a step too far — it’s too private. So they might be thinking: ‘We’ll stay private for a short amount of time and then we’ll list once we’ve got to a certain point,’ which is quite different to our approach.”
Another thing Denham asks for is that management “back themselves” by investing some of their own money in the venture.
“The skin in the game for us is absolutely critical,” Donally says. “It ensures that our incentives are aligned with those of the management team and on day one, we all want to know that we’re heading down the same path together.”
The way that incentives are structures is another way management’s interests are aligned with Denham’s and Denham’s investors.
“Everybody is paid as cash comes out of the system,” Donally says. “So on an exit, when the projects are sold or the business is sold, that is when everybody’s incentive kicks in.”
On an exit, cash first goes back to Denham and the management team, which both get back their equity contribution. As more money is earned, Denham and management both get a return on their equity (as do Denham’s investors), but management also gets a percentage of the money earned (5% for example) as an incentive. That percentage increases the more money is made.
“You can think of it almost as reverse dilution in that more money is made, more money gets returned to the management team and that is how we think about incentives,” Donally explains. “We want everybody to be aligned, to be paid at the same time and if management is doing a tremendous job and has turned $100 million into $500 million, well quite frankly, 25% of that is a great incentive for a management team and for us at Denham that would be a fantastic outcome.”
By contrast, in public companies, CEOs own less and less of the companies they lead the larger those companies get.
“We want our management teams to be incentivized to make as much money as they possibly can for both themselves and for their investors,” she said. “Hence we follow a model where the management incentive goes in the opposite direction to a typical dilution model whi
ch you would see in a listed business.”
Denham’s mining team has so far focused on the Southern Hemisphere, but it’s now looking to see what it can do with its backer management team model in the United States and Canada.
Denham is also looking for projects that can be assessed and perhaps picked up by one its teams.
“As a firm, we like the base metals, we like the fundamentals behind them, we like the fact that they’re actually used for something and they’re consumed in a process or infrastructure or whatever it might be.”
While the capital commitments required to advance iron ore projects in Canada are likely too large for Denham to handle, it is interested in base metals and other commodities such as tungsten, tin, manganese and others “where we could find the right team to back who had the skills and the experience in those commodities.”