Interesting article on Blackrock Inc's new take on direct investment in Commodities.
By Peter Ker, Sydney Morning Herald, 1 August 2012
There was a sign of things to come in London this week, and it had nothing to do with the waning fortunes of Australia's swimming team.
Across town in the offices of BlackRock Inc, a fresh way of doing business was being unveiled, and Australia's mining and resources sector might want to take note.
Already the world's biggest investor in resources stocks with an estimated $36 billion sunk into the sector, BlackRock announced that it was investing $110 million in an iron ore company.
Nothing unusual there, except that BlackRock was not buying shares in the miner - London Mining - but rather securing a 2 per cent royalty on all future iron ore sales from the company's Marampa mine in Sierra Leone.
The mine is already producing more than 1 million tonnes of iron ore each year, and the funding injection from BlackRock will help expand that nine-fold in coming years.
In a rare sortie before the media, BlackRock's top fund manager Evy Hambro revealed the company had been reviewing the way it invests for some time, and royalty arrangements had become more attractive as sources of funding had dried up for mining companies.
"It's an attractive deal to BlackRock because BlackRock can borrow at well below the cost of debt that is available to mid-tier to junior miners and earn a return on investment that's well above that level," he told reporters in London.
"In today's financial environment, the banks' ability to lend has been vastly reduced," Hambro went on. "Bank capital is scarce and when available, more expensive."
He said the new model gave BlackRock exposure to iron ore without direct exposure to the sort of rampant cost inflation that has become the norm in the mining sector, because the royalty is set on sales revenue not overall profits.
Nor would BlackRock be beholden to the executives whose annual whims decide dividend returns, and Mr Hambro indicated that this investment would not be the last of its type.
"We continue to evaluate a number of other opportunities that are similar in nature to this royalty," he said.
For those that have watched BlackRock in recent years, it will come as little surprise that the investment giant is looking at fresh ways to invest its billions.
The company has made no secret of its frustrations with the big diversified miners, which always seem to have yet another growth project to fund rather than returning a bigger slice of profits to shareholders.
When private lobbying got them nowhere, BlackRock last year resorted to questioning in public the likes of BHP Billiton over their growth strategies and approaches to shareholder returns.
BlackRock has since delivered on their warnings, reducing their stake in several big miners, including BHP and Australia's biggest listed gold producer, Newcrest Mining.
While the $110 million punt on London Mining is smaller beer than the billions BlackRock has invested in BHP, Hambro's indication that it plans more royalty-based may give hope to mid-tier Australian miners.
These miners are often caught between the current scarcity of finance and the market's sudden reluctance to invest in resource stocks.
Such deals have proved successful in Australia in the past: back in 2006, Manhattan-based investor Leucadia National bought a royalty note on production at certain iron ore mines being developed by a tiny aspirant called Fortescue Metals Group led by one Andrew Forrest.
Fortescue famously went on to become one of the world's biggest iron ore producers, and while the terms of that royalty note are now subject to a legal dispute, the deal has still been wildly successful for both parties.
Royalty and off-take focused companies in North America like "Silver Wheaton" and "Sandstorm" have this week indicated that they too believe the conditions are primed for royalty-type deals to take centre-stage. Tim Schroeders, the Melbourne-based fund manager of Pengana Capital, agreed there is a lot of merit in the concept.
"It's an interesting model as you are exposing yourself to operational hiccups but not necessarily cost over-runs or expenditure increases, because you are taking a royalty on revenues," he said.
"It's pleasing there is this sort of innovation occurring from one of the biggest global investors in mining (BlackRock) so it's a good outcome for all parties concerned I would think," Mr Schroeders said.
"It makes a lot of sense," he adds. "I've no doubt we will see more of it."
Disclosure: I am long BHP.