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Renegotiating the minor-major relationship

Renegotiating

Savannah will carry out reconnaissance and scout drilling on sites
already identified as holding high potential resources.

A new mineral sands joint venture between Rio Tinto and Savannah Resources in Mozambique has been described by Savannah CEO David Archer as "a new approach in the mining industry for collaboration between majors and juniors". With the major offering the minor the opportunity to up its stake from 10% to 51% proving the project's potential, could this open up new opportunities for companies to work together?
The recently announced partnership between Savannah Resources and Rio Tinto is anything but a marriage of equals; in the mining sector, they don't come much smaller than London's AIM-listed Savannah, with a market cap of just over £5m and a share price just poking up above the 2p point, especially compared to the juggernaut that is Rio Tinto, with its cap of £44.5bn and a share price of 2,391p.

However, the deal struck between these two vastly different-sized companies - borne out of both operators owning prospects along the same trend in Mozambique - is, according to Savannah, a unique arrangement. "This deal represents a new approach in the mining industry for collaboration between majors and juniors," explained its CEO David Archer. "It's standard for juniors to do exploration and then sell to a major. But in this particular case, Rio has created a high quality body of technical work on Mutamba."

Mining firms as one in Mozambique
Located roughly 40km away from the Maxixe port in Mozambique, the operation will draw together the four mining prospects of Mutamba, Dongane, Jangamo and Chilubane, all of which lie along the same trend, in order to develop them as one into a world-class heavy mineral sands deposit. With potential deposits of more than 12 billion tonnes of HMS at 4.5% in the Mutumba prospect alone, the project seems an endeavour only a major could pursue. However, defying convention, in this case it is the major handing over responsibility to the minor.

Having previously carried out more than 80,000m of exploratory drilling within its Mutumba, Dongane and Chilubane sites, Rio Tinto has identified eight separate mineralised bodies with significant potential. However, hit hard by the slump in iron ore prices, Rio Tinto has decided that rather than simply sell off the assets, it will leverage its ownership and resources to enable Savannah to take over operations.
Under the innovative contract arrangement, a joint venture between the two has been established with an initial ownership split of 90% Rio Tinto and 10% Savannah. However, as time progresses and specified metrics are met, Savannah has the opportunity for a majority stake of 51%.

Minor must prove its worth to take majority stake

minor

As time progresses and specified metrics are met,
Savannah has the opportunity for a majority stake of 51%.

With its initial 10% stake, Savannah will carry out reconnaissance and scout drilling on sites already identified as holding high potential resources and conduct a full scoping study to establish the viability of developing cost-effective mining operation at the site. Once this is completed, which Savannah estimates will take around half a year, and Rio Tinto is satisfied of its viability, Savannah's stake in the project increases to 20%.
In order to increase its stake to 31%, Savannah will then carry out further drilling on the site and more comprehensive studies, including mineralogy and metallurgy tests, develop a preliminary plant and process design and initiate a series of studies on environmental impact, community benefits and infrastructure requirements.
For the final stage of the feasibility process, Savannah will be required to complete a comprehensive assessment and plan that would enable the creation of a fully operational site. This will include taking multiple bulk excavation samples, a definitive process flow sheet and fully costed assessment of both the process plant and infrastructure requirements. Upon delivering the full feasibility study to satisfaction, its share in the project would increase to 51%, giving it majority ownership as the project moves to the construction stage.
Beyond the specific terms of the contract, due to its uniqueness in the market, it's important to understand what each party gets out of it.

A mining marriage of convenience
For Rio Tinto, it would be straightforward to simply wash its hands of the project and put it on the market for sale. However, against a backdrop of a strong buyers' market for assets and previously proven but, as yet, undelivered potential, the deal offers the ability to gradually relinquish overall control while maintaining an interest in a project that may prove profitable in the long term.

It should be noted that Rio Tinto will hold first refusal rights. By including its assets alongside Savannah's, it expands the scope of operations for a company already operating with a solid understanding of the region - in both business and operational terms - while assisting it through the inclusion of its existing on site infrastructure into the joint venture. In essence, Rio Tinto possesses the capability to develop the site itself but is not sufficiently incentivised or motivated to invest its own efforts and resources in delivering. Instead, it has passed that incentive and motivation to Savannah in return for the access and support network that only a major could offer.

In the case of Savannah, the deal offers the opportunity to develop, and potentially own, a major development of a scale that would otherwise be beyond its reach. With a partner as deep pocketed and connected as Rio Tinto, it can draw on its physical on-site infrastructure as well as its business connections and industrial clout in order to rapidly advance the development. A key element of this is written into the agreement, with Rio Tinto agreeing to handle 100% of the sales of minerals extracted through the project - unless both parties mutually agree to revise the agreement. Overall, with the asset Savannah contributed to the project constituting less than a tenth of the overall resource potential, the deal enables the company to significantly increase its operations in the market without taking on potentially crippling risks.

A marker for increased contractual collaboration?
Once the deal was announced, it was welcomed as a major advance for Savannah, its shares increasing by 85% and its alliance with a company as substantial as Rio Tinto significantly increasing its profile across the industry. But, as the details have been digested in more detail and the share spike has dampened, concerns have been raised over why Rio Tinto would hand over an asset with such supposed potential resources.
"Rio Tinto doesn't usually say more or less goodbye to an exploration target of 7-12 billion tonnes of HMS grading 3-4.5% with the benefit of 80,000 metres of past drilling without a good reason," says Roger Bade, a mining analyst at Whitman Howard. "Whether it is a view on the prospectivity of this particular deposit, the outlook for the HMS market and its continued presence, or a view on Mozambique, remains to be seen."
Also urging caution, broker RFC Ambrian said that, due to its early stage of development, it was "difficult to make a valuation" on the full scope of the project, but concluded that, given the potential payoff and the low risk in the near term for Savannah, it should be seen as a "speculative buy".

As with all innovations, from products to contracting arrangements, the value of the deal to both Rio Tinto and Savannah Resources can only be assessed a lot further down the line, but with the major looking to reduce its primary involvement in the project and the minor looking to take a step up while minimising its risks, it certainly seems a worthwhile exercise to try.

With its gradual process of passing ownership of one to the other as goals are met, the potential earnings should evolve in step with the learning so that any risk transferred is balanced out by potential reward.
Should the project fail, the results would not be any worse than those of conventional arrangements between majors and minors, but success could well set the course for a new way for risk and reward to be shared across the different tiers of industry.

 

 
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