Lonmin enters last chance saloon with $407m rights issue

Disclosure: I have no financial interest in any  company mentioned in this article.

Lonmin’s decision to raise $407m (£270m) through a 46-for-1 rights issue means two things:

1. Shareholders who choose not to take part will be diluted out of existence — the number of new shares mean dilution will be 97.5%.
2. If Lonmin cannot make this work, shareholders are toast; the company is likely to go into administration and the shares to 0p.
3. The only people guaranteed to make a profit out of this are the banks underwriting the offer. They’ll be collecting a cool $38m in fees. That’s more than 10%. Nice work if you can get it.

Lonmin’s spectacular 95% discount to its stated book value has been a potent reminder of the writedowns and dilutive re-financing we all knew must be in the pipeline.

Since the rights issue was announced yesterday, Lonmin shares have continued to fall. As I write they are down by 35% on Tuesday and by 43% so far this week. Many shareholders have obviously decided that faced with a choice between a big loss and funding Lonmin’s third major rights issue since 2009, they will sell.

Here’s a summary of what the rights issue will mean. All these figures are estimates based on my calculations. Naturally they may contain errors and will rapidly become out-dated — please do your own research before making any investment or trading decisions:

• Rights issue price: c.27bn new shares at 1p
• Ex-rights price (based on last seen 10p share price): 1.2p
• Estimated value of nil paid rights: 0.2p (i.e. 9.2p per existing share)
• Estimated price/book ratio post-rights issue: 0.2

These numbers will change continually until the shares go ex-rights. If Lonmin shares continue to fall, the ex-rights price and the potential value of the nil-paid rights will fall further. In my view there is no reason to consider an investment until after the rights issue, when the flood of new shares hits the market.

Mucho problemo

On the face of it, Lonmin has a stronger balance sheet than heavily-indebted Petropavlovsk, which also carried out a massively dilutive rights issue earlier this year. Lonmin’s net debt isn’t excessive but the firm’s other problems make it potentially much more risky than Petropavlovsk, in my view.

The obvious issue is that the firm’s reported platinum group metals (PGM) basket price fell from $1,013/oz in 2014 to just $849/oz in 2015. In 2011, it was $1,300/oz. Can Lonmin restructure its operations in order to generate free cash flow at the current price? Perhaps, but the firm faces a wide range of obstacles.

This article by Reuters columnist Andy Critchlow does a good job of explaining the issues, but in brief Lonmin must deal with a weak and uncertain platinum market, labour-intensive, aging mines with a highly-unionised workforce, and the difficult political and social environment in South Africa.

After all, it’s only 3 years since 34 Lonmin workers at the firm’s Marikana mine were shot by police. The company was not found to have broken any laws, but was criticised by a subsequent judicial inquiry for not doing enough to prevent the outbreak of violence.

In my view, investors need to consider the nature of the problems that led to this tragedy, which would be inconceivable in most other parts of the world:

• Is South Africa a safe investment environment?
• Do you want to fund a company which has for many years been happy to profit from workers whose poverty and inequality drives them to such extremes?

Lonmin has been a toxic investment since at least 2012, in my view. I believe there’s still a fair chance the firm could go bust leaving shareholders with nothing. However, I will look again at the investment opportunity after the rights issue takes place.

Disclaimer: This article is provided for information only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.