Junior zinc miner Zincox and its local partner Ansan Wikfs is set to complete the $120 million bond financing of its Jabali zinc mine in Yemen imminently. The project financing was the first in Yemen, and has beaten the much-hyped and long-awaited Yemen LNG transaction to market. It also eschews most of the essential ingredients of an emerging markets mining deal, including hedging, political risk, insurance, multilateral support, a full engineering procurement and construction contract, and bank lenders altogether.

If it had closed nine months ago, the use of hedge funds as debt investors on a greenfield project financing might have been dismissed as a product of frothy credit markets. The deal, however, was assembled in August 2007, and signed with a change in participants, but not in terms, early this year. Junior miners that are prepared to pay for the flexibility of such a financing will find the structure worth replicating.

ZincOx, which is listed on London's Alternative Investment Market, is building three zinc processing projects in the US and Turkey, which recycle waste dust from steel furnaces to produce zinc oxide. Jabali is its primary mine development prospect, and was located through a document search of suitable resources, since its deposit has been identified since the 1960s.

ZincOx' management specialise in newer methods of recovering zinc oxide from difficult sources. Many of them hail from another mining company, Reunion, which developed the Skorpion zinc mine in Namibia before its joint venture partner AngloAmerican, bought the project in 1999. Management settled on the Jabali site in 1997.

Anglo had passed on the Jabali resource, believing that its body of zinc would be difficult to commercially exploit with standard solvent methods. ZincOx applies methods more commonly found in copper, uranium and gold mining to zinc ore bodies. The technology is relatively untested, the host country has no experience of large-scale mining, let along mine financing, and the zinc oxide market is relatively illiquid.

All of these considerations made an approach to the commercial bank market difficult, though ZincOx management considered that avenue. But, as is chairman Andrew Woollett notes, "the cost of political risk insurance on a bank financing for a Yemeni project, even if it could be found, would be very high." Export credit agencies and multilaterals require offtake arrangements that would have squeezed most of the potential benefits of the project out of the sponsors.

Yemen does not have a dedicated mining law, and one of the biggest challenges for the sponsor was moving its right to the deposit from an exploration license to a mineral development agreement. This was accomplished through a dedicated law named after the project, and provides the sponsor with as much certainty as Yemen is likely to offer a sponsor.

ZincOx' local partner, with a 48% stake, is Ansan Wikfs, a conglomerate active in Yemen and Egypt, whose interests include Coca-Cola and Mercedes dealerships and, crucially, some offshore oil and gas development. It signed an agreement with a predecessor of Anglo in 1996, and became partners with ZincOx and Anglo in 2005 after the completion of a 2005 feasibility study. In late 2006, however, Anglo sold its 20% stake in the venture to Ansan, while Ansan also bought up another 8% from ZincOx, taking its total share to 48%.

Through a ZincOx board member, the developer approached Exotix, a London-based debt boutique that specialises in illiquid, distressed, and plain unusual debt securities, particularly in emerging markets. It has worked on deals that encompass risks from Cuba, Iraq and Serbia. According to Woollett, "we heard that they'd worked on a salt mine financing in Djibouti, and we thought that they could do something similar for us on Jabali."

Of the mine's $217 million cost, $37 million would be Ansan equity, while ZincOx would fund a further $40 million in equity through its own resources and through the $31 million in deferred proceeds of the sale of a zinc property in Kazakhstan called Shaimerden, The receipt of this payment was one of the principal conditions precedent to the closing of the debt financing.

The sponsors did not have a fixed-price engineering procurement and construction (EPC) contract, so much as an EPC management contract, where the contractor receives incentives for minimising costs and brining in the project on time. Non-traditional investors, and Exotix' hedge-fund client list can clearly be classed as non-traditional, paid less attention to these arrangements, after being satisfied with the technical due diligence, and more to the yield on the debt investment.

Negotiations with this small lender group took place on a one-on-one basis, and lenders' eagerness to gain some exposure to the price of zinc led the sponsor to attach instruments, separately tradeable but issued with each bond, that provide returns based on high zinc prices. The instruments, called Zinc Indexed Price Payment Obligations, or ZIPPOs, provide for a coupon calculated as $0.16 per dollar above $1,300 that the price of each tonne of zinc from the mine reaches. The six-year bonds carry a more conventional, if rather expensive, coupon of 11%.

The zinc oxide market is a difficult one for a new entrant to crack, since buyers are a mixture of ceramics makers and rubber producers, all of which demand that producers demonstrate a track record before committing to a seller in large numbers. But since using ZincOx's solvent technology is likely to result in much lower costs than the dominant method of production – burning zinc – the mine will have a compelling cost advantage.

The financing was ready to go in August, but lost several key investors as credit markets turned. The depth of potential interest in such assets is demonstrated by the fact that these could be replaced in a matter of months. Such investors could be marshalled behind any number of resources projects in less well-known jurisdictions. While Yemen LNG is will not need to follow it, junior miners elsewhere will take note.

Jabal Salab Company (Yemen) Limited
Status: Signed 21 January 2008, set to fund imminently
Size: $216 million
Location: Yemen
Description: 800,000 tonnes per year zinc oxide mine
Sponsors: ZincOx Resources (52%), Ansan Wikfs (48%)
Debt: $120 million
Arranger: Exotix
Maturity: 2013
Lender legal adviser: Herbert Smith
Borrower legal adviser: Eversheds
Technical adviser: Saint Barbara LLP
Environmental impact assessment: Scott Wilson