LAUSANNE, Switzerland Private equity firms, which have been showing an increased interest in investing in the mining industry, will have a hard time even if they are betting on recovery in the longer term, the bosses of Anglo American (AAL.L) and Glencore Xstrata (GLEN.L) said on Tuesday.
Private equity firms such as Warburg Pincus have hired executives from the mining industry to start investing in the sector and some top industry veterans such as Vale's (VALE5.SA) former chief executive Roger Agnelli and Mick Davies, head of Xstrata before its takeover by Glencore, have also lined up funding for new ventures.
X2, the investment vehicle run by Davies for example, said on Monday it now has $3.75 billion (2.25 billion pounds) backing his plans to create a new medium-sized diversified mining company.
But the chief executives of the two biggest diversified miners said choppy commodity markets and unpredictable returns will make it hard for the highly geared private equity firms to pay interest on their debt.
"Now there are a lot of private equity guys starting companies, a lot of guys who left the industry and started private equity groups. It's never worked in the past," Glencore's chief executive Ivan Glasenberg said at the FT Commodities Summit.
Private equity firms specialise in borrowing money to buy distressed companies or assets in the hope of making a return when they sell them after a few years.
But the high level of gearing also means companies need to realise high level of return to pay the interest.
This model, however, might not succeed in the cyclical and volatile mining sector, the executives said.
"The problem with the commodities space if you have a high gearing is that you are not running Boots pharmaceutical where you have a pretty constant earnings base," Glasenberg said.
"(In mining) you just don't know your earning base. When you hit bad times, like we did recently, it goes down (quickly). How are you going to feed your debt?"
Another difficulty for private equity firms or funds looking to buy mining assets is that although large mining companies have recently identified some assets they wish to divest, they are not in a rush to sell unless they get a price that meets their expectations.
"At the end of the day (private equity firms) will be making pointed bets. There is still a lot of risk associated with those bets. The assets that are being sold are probably not the best assets in the portfolio," Anglo American's chief executive Mark Cutifani said.
"You are taking narrow bets on potentially difficult commodities. You have to be very good to be successful. And into this market that is a bit choppy, it gets a lot tougher."
(Editing by Greg Mahlich)