Category Archives: Mining

A share tip circled in a newspaper share listing

South32 Ltd is worth more than I expected

A share tip circled in a newspaper share listingDisclosure: I own shares in BHP Billiton and South32.

Back in January, ahead of the spin-off of South32 Ltd (LON:S32) from BHP Billiton plc (LON:BLT), I wrote How much is BHP Billiton spin-off South32 worth to shareholders?.

That article is currently the most popular post on this site, so I thought I’d look back at my three valuations and compare them to how the market has valued South32 shares, which started trading towards the end of May.

Price-to-sales ratio

My prediction: I suggested that based on its peer group, South32 might trade with a price-to-sales ratio of 1. This would equate to a share price of 115p.

The reality: As I write, South32 shares trade on a P/S ratio of 0.85 and a share price of 105p. If the P/S ratio rose to 1, the share price would be 123p.

Conclusion: I was pretty close.

Book value

My prediction: Based on the figures provided by BHP before the spin-off, my calculations suggested that South32 could have a book value of $11.3bn, which would equate to 140p per share.

The reality: The pro-forma balance sheet in the South32 UK prospectus suggests a net asset value of $12.95bn. This equates to 158p per share, so I wasn’t far off. However, the shares currently trade at a slightly larger discount to book value than I expected, on a price-to-book ratio of 0.7.

Note: users of Stockopedia and other data services might see the firm’s book value stated as $16.7bn, giving a per share figure of $3.14 or about 204p. This figure is listed in the same prospectus document as “Invested capital attributable to members of South32” based on the new firm’s historical accounts. It appears to be stated before the adjustments made in the demerger. I’ve chosen the more conservative pro-forma figure, but I’m not entirely sure which is more accurate. DYOR as usual. We’ll get a more accurate idea when South32 publishes its first set of accounts as an independent company. Year-end is June 30, so probably in Aug/Sep.

Conclusion: Based on the pro-forma figures, my estimate of book value per share wasn’t far off, but the market is being a little more cautious than I expected.

Price-to-earnings ratio

My prediction: I suggested that South32 could start trading with pro-forma earnings per share of around 9 cents, or roughly 6p.

The reality: I was partly right. The trailing twelve month (TTM) figures give earnings of 9.4 cents per share, in-line with my calculations. I suggested the shares could trade on a P/E of 10, giving a share price of just 60p per share.

This was my worst-case scenario and has been proved partly right: South32 is trading on a P/E of 11, but it’s a forecast P/E, based on this year’s forecast earnings of about 9p per share.

Conclusion: Analysts have crunched the numbers and expect South32’s full-year earnings to be better than I expected.

As my estimate came from simply extrapolating the BHP EBIT figures, the analysts’ techniques and information should be better than mine. In this case I’m happy to have been proved wrong too cautious.

Buy or sell South32?

In my original article, I suggested that South32 shares could be received very cautiously by the market. As it’s happened, I think they’ve had a fairly positive reception, helped by a strong earnings outlook than I estimated.

At 105p, selling South32 would give a 7% yield on BHP shares purchased at 1,500p, or 5.25% on shares purchased at 2,000p. If you’re not interested in holding a small portion of South32, then selling will effectively give you a tidy special dividend.

I’m going to hold for a little longer, however, as I think some modest upside might be possible.

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.

An open-cast coal mine

Why I’ve added Hargreaves Services plc to my value portfolio

An open-cast coal mine

Coal is not exactly the flavour of the month. Will this prove terminal for Hargreaves?

Disclosure: I own shares in Hargreaves Services.

Stock markets are forward-looking. At least that’s the theory.

That’s why coal firm Hargreaves Services plc (LON:HSP) is trading on just 3.7 times its 2014 earnings, with a 7% yield.

The firm’s earning power is expected to crater over the next couple of years and the shares trade on nearly 8 times 2016 forecast earnings.

However, the problem with predicting the future is that you’re often wrong.

I’m not suggesting that Hargreaves’ core business of mining and trading coal is not in decline. I believe it is. The group’s focus on simplification and debt reduction” are an implicit admission of this, as is its focus on cash generation and shareholder returns.

Despite this, I’m not convinced the end is nigh. Not quite yet.

Traditional Ben Graham-style value investing involves looking at historical numbers, rather than forecasts. On this basis, Hargreaves is extremely cheap. These numbers are taken from my investment spreadsheet, which I fill out and refer to before deciding to buy (or sell) a company:

TTM P/E TTM yield PE10 P/B P/TB Current Ratio Dividend cover FCF dividend cover Cash interest cover Net gearing 10yr eps growth 10-yr divi growth
3.70 6.90% 5.0 0.81 0.86 2.1 3.5 3.9 8.5 26.50% 29.50% 17.70%

Source: Annual reports, Stockopedia, my calculations

The strength of Hargreaves’ balance sheet and cash flow are impressive. I’m also impressed by management’s ability to remain objective and focused on financial efficiency and shareholder returns.

I think that to some extent, these advantages discount the risks facing the firm in the short/medium term. Should Hargreaves firm be able to tread water for a while, I believe the shares could generate a reasonable total return.

As a result, I recently added some to my value portfolio.

Hargreaves’ financial year ends in May, but the firm didn’t publish its results until September last year. I may have to wait until then to learn how well timed my initial buy was, as the company appears to have foregone its year-end trading update this year.

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.

Iron ore

African Minerals Limited: Chinese partner takes control of debts

Iron oreFinal update 26/03/2015: Shares in African Minerals will be delisted at 0p on 31 March following the appointment of administrators today. Sadly for shareholders, my original prediction of wipeout was correct.

Updated 06/03/2015: African Mineral has gone into administration and the firm’s AIM NOMAD has resigned. AML accepts it has lost control of its main assets, and the shares will be delisted if another NOMAD cannot be found in a month. Game over, I fear.

[Updated 03/03/2015 — see end of article]

In November, when shares in African Minerals Limited (LON:AMI) were suspended, I warned that the firm’s debts meant there was only one likely outcome for shareholders: a complete loss.

So far, that prediction is looking accurate. After admitting that it was in default on its debts on 10 February and warning that even a successful refinancing would be likely to leave little or no value for shareholders, on Friday (27 Feb), the firm issued another update revealing how things could go from here — and raising some new questions about what on earth is going on in Sierra Leone.

Chinese move in for the kill?

AML’s money problems have been exacerbated by the fact that its Chinese backer, Shandong Steel Hong Kong Resources Ltd, a subsidiary of Shandong Iron and Steel Group (SISG), has refused to release some of the funds it had previously offered. It’s not clear what the full story behind this is — I suspect blame is, at least, equally divided, if not weighted towards AML — but that’s now irrelevant, at least for AML shareholders.

On Friday, AML announced that the lenders of its pre-export facility, a $250m finance facility,had transferred their interests in the facility to a new lender, Shandong Steel Hong Kong Zengli Limited, which is another subsidiary of SISG.

I’m sure you can see how this is going: SISG now owns around one-third of AML’s debt, in addition to owning a 25% stake in the project.

Here’s what I believe will happen next: AML’s pre-export facility, on which it has been in default since November, is secured using AML’s shares in two key subsidiaries, Tonkolili Iron Ore Ltd and African Railway & Port Services Ltd. As their names suggest, these are the two key operating companies which actually own the mine assets in Sierra Leone. 

What I believe will happen now is that some of AML’s shares in Tonkolili Iron Ore Ltd and African Railway & Port Services Ltd, used as security for the pre-export facility, will be seized by the new lender, SISG subsidiary Shandong Steel Hong Kong Zengli Limited, in order to address the current arrears.

Given that AML still has a problematic $400m bond on which it is also in arrears, you might expect this latest development to speed up the firm’s move towards administration and winding up.

However…

Can’t go into administration

Friday’s announcement also included a second piece of news: AML has been issued with an interim injunction prevenuting it from unilaterally taking any steps that will lead to the dissolution, liquidation, winding up or placing into administration of any of the defendant companies.”

The injunction is valid until 2 March 2015 (today, as I write) and appears to relate to “shareholders agreements” between various AML subsidiaries and SSHK, the SISG subsidiary that is a 25% shareholder in the project.

We don’t know the story behind this, but a hearing is scheduled for today for “the hearing and determination of the application”.

I’ll update this article as and when more information becomes available.

Update 03/03/2015: As I predicted above, the new lender of the pre-export facility, which is a subsidiary of AML backer SISG, has made moves to take control of Tonkolili Iron Ore Ltd and African Railway & Port Services Ltd, shares in which were used as security for the loan.

According to today’s update, SISG is trying to take 100% control in one fell swoop, through its two subsidiaries:

The Lender has taken control of the Holding Companies by appointing new directors who have a voting majority, and has taken steps to take control of AML’s 75% shareholding in the operating companies by appointing replacement directors to those companies. The Lender’s sister company, Shandong Steel Hong Kong Resources Limited (both ultimately owned by Shandong Iron and Steel Group), owns the 25% in the operating companies not held by AML.

AML says it is seeking legal advice on the effectiveness of these action, but as far as I can see, SISG has AML over a barrel.

We’re still waiting to learn more about the injuction preventing AML from going into administration.

Disclosure: This article is provided for information only and is not intended as investment advice. The author has a short position in African Minerals Limited. Do your own research or seek qualified professional advice before making any trading decisions.

A tunnel in a deep mine

Petropavlovsk PLC rights issue explained: why are the shares down 65% and what are the nil-paid rights worth?

If you’re a Petropavlovsk PLC (LON:POG) shareholder, you have noticed the value of your shares fall from around 15p to 5p when markets opened today.

What’s happened?

Yesterday (26 Feb) Petropavlovsk shareholders voted to approve a rights issue, which will raise $235m that will be used to repay some of the firm’s $1bn net debt.

The rights issue is a 157 for 10 issue at 5p per share, which means that for every 10 shares you already own, you have the right to buy 157 newly-issued Petropavlovsk shares at a price of 5p per share.

The reason the existing shares fell in value today is that the nil-paid rights were admitted to trading and the existing shares started to trade ‘ex-rights’ — i.e. buyers of the shares from today do not have the right to buy new shares in the rights issue.

What are my choices?

In a rights issue, you have the right, but not the obligation, to buy new shares. So there are two choices:

1. Take up your rights

If you are happy to put new money into Petropavlovsk in order to maintain the size of your shareholding (as a percentage of the total share count) then you can buy some or all of the shares you are entitled to.

Your have the right to buy 157 new shares at 5p for every 10 Petropavlovsk shares you own. You don’t have to buy the full allocation, however — you can just buy part of it if you wish.

For every right you don’t take up, you will be entitled to receive payment for the value of your ‘nil paid right’ — the unusued right to buy a new share, which someone else can then buy instead.

2. Sell your nil-paid rights

Nil-paid rights are, as the name suggest, rights for which you have not paid. However, these do have a value and if you don’t want to take them up yourself to buy new shares, you can sell them. (This is normally handled automatically by your broker if you don’t take up your nil-paid rights within the specified timeframe — phone and ask them if you’re unsure of the details.)

My calculations suggest that the value of each nil-paid right in this rights issue is approximately 0.6p.

That equates to around 9.4p for each Petropavlovsk share.

[Update 05/03/15: The price value I suggested above for the nil-paid rights was correct in theory and indeed was true in practice on the day the nil-paid rights were admitted to trading, when POG shares were trading at around 5.6p.

However, investors have proved unwilling to pay that much for the nil-paid rights, which are now worth around 0.13p (POG shares are currently trading for around 5.13p).

How it works: Remember, buying a nil-paid right gives you the right to buy a share at the rights issue price, in this case 5p. Therefore while the rights issue is underway, the value of one nil-paid right plus the cost of the rights issue price should equal the current share price.]

Here’s a quick explanation of how I calculated these figures:

Petropavlovsk shares closed at about 15p on the day before the rights issue started.The price of the rights issue shares is 5p.

Value of 10 old shares @ £0.15 = £1.50

Value of 157 new shares @ £0.05 = £7.85

The ex-rights share price is simply the average of the new and old share prices:

Ex-rights share price = (£7.85+£1.50)/167 = £0.056 or 5.6p

The value of each nil-paid right is the difference between the ex-rights price and the rights issue price:

Value of nil-paid rights = 5.6p – 5p = 0.6p per right or 9.4p per Petropavlovsk share (each old share gives rise to 15.7 nil-paid rights)

What next?

If you’re a Petropavlovsk shareholder, you now need to decide whether to take part in the rights issue and buy some new shares, or whether to simply sell your nil-paid rights.

If you don’t take up your rights, most brokers will usually sell your nil-paid rights for you automatically, but it may be worth checking this with your broker, to ensure you don’t miss out.

I hope this is of some use — fell free to leave a comment below if you have any questions.

Disclaimer: This article is provided for information only and is not intended as investment advice. The author has no financial interest in any company mentioned. Do your own research or seek qualified professional advice before making any investment decisions.

Scales of justice

Petropavlovsk PLC refinancing: what’s happening, and how can you vote?

Scales of justiceFinal update 26/02/2015: Peter Hambro’s publicity campaign to persuade private investors to vote succeeded, and the resolutions needed to undertake the 157 for 10 rights issue, and bond exchange were passed at a general meeting today.

The rights issue shares are being issued at 5p. For anyone who isn’t clear on the dilution implications this has for existing shareholders, I explain what will happen now — and why your shares are almost worthless — here.

Debt-ridden Russia-based gold miner Petropavlovsk PLC (LON:POG) has been much in the headlines this week.

This high profile has mainly been due to founder Peter Hambro’s press campaign to encourage private shareholders to vote in favour of the firm’s restructuring proposal — and to the efforts of Sapinda Holdings, a privately-held fund which now commands a 10.7% voting stake in the Petropavlovsk, and is trying to gain backing for an alternative restructuring deal.

In this article, I’ll make a comment on the Sapinda proposal (updated 24/02/2015, see below) — which has been rejected by Petropavlovsk and is not available for shareholders to vote on — and I will look at the actual mechanics of how private shareholders can vote at company general meetings.

Much as I disagree with most of what Peter Hambro has to say — his attempt to blame short sellers for his problems is laughable — he is right to point out that many shareholders are not even aware of the need to vote, let alone how they might accomplish this feat.

Sapinda vs Petropavlovsk

As I explained in this article, Petropavlovsk’s current refinancing deal is essentially designed to wipe out existing shareholders, unless they are willing to stump up more money that will principally be used to make bondholders whole — that is, prevent them taking a loss on the $310m of bonds which are due for repayment in this month (February 2015).

Sapinda’s position appears to be that this is unduly harsh on shareholders, who will be very heavily diluted if they don’t choose to take part in the rights issue. To address this, Sapinda’s proposal appears to be that bondholders should take a partial loss on some bonds, in order to preserve more value for shareholders.

The details of this proposal aren’t entirely clear (update 24/02/2015: the situation has changed, see below), but while it will undoubtedly be attractive to some shareholders, it does seem a little odd — I’d always accepted that it was normal for shareholders to be wiped out before bondholders could be forced to take a loss. Frankly, I can’t see much chance of the firm’s bondholders accepting such a deal.

It’s possible that Sapinda’s plan is to derail the refinancing vote and force Petropavlovsk into administration — a near cert if the rights issue isn’t approved. After this, Sapinda might be able to buy up Petropavlovsk’s debt at distressed prices and take control of the company in this way.

We don’t know — yet — and shareholders should remember that this isn’t up for the vote next Thursday — the only deal on the table that’s certain to prevent the firm going into administration is the one that’s on offer from Petropavlovsk.

Update 24/02/2015: Sapinda released full details of a modified proposal today, saying that it will back Petropavlovsk’s refinancing proposals if the firm agrees to certain of its conditions, principally that Sapinda and current shareholders will be able to participate in a further $100m placing at 3p following the restructuring (remember, the planned rights issue, which would still take place, is at 5p per share).

However, without commenting on the proposal, Petropavlovsk bondholders went ahead and voted convincingly to back the original debt-for-equity swap and rights issue today. Sapinda then issued a further statement expressing its disappointment that “The bondholders are resorting to threats, rather than analysis.”

Sapinda’s proposal appears to be structured so as to prevent shareholders facing quite such a total wipe-out as they do at present — although for shareholders who paid 100p+ plus for their shares, the difference may be academic.

As I write, after the close on Tuesday, there is still time for things to change, but at the moment it still looks like the original plan, which Sapinda opposes, will still be going ahead unless shareholders vote against it on Thursday (26/02/2015).

How to vote

Petropavlovsk needs 75% of shareholders to vote in favour of the restructuring for the deal to go through.

Given that Sapinda says it controls 10.6% of the votes and will vote against the restructuring, and that around a third of Petropavlovsk shares are held by private investors, this is a rare occasion where private shareholders’ votes could actually be significant.

The problem is that almost all private investors hold their shares through nominee accounts, and can’t vote directly as the shares are technically owned by their brokers. Voting isn’t always simple — or even possible, in some cases.

I have accounts with two popular retail brokers, AJ Bell Youinvest (formerly SIPPDeal) and TD Direct Investing. Generally speaking, I’m happy with both, but when it comes to voting at general meetings, there’s a big difference between them.

Here’s how voting works for Youinvest customers:

AJ Bell Youinvest voting

You can’t vote online with AJ Bell Youinvest — you have to request it through customer services.

Not great — although I understand that the firm is in the process of updating the secure areas of its website. Perhaps new functionality will be added later this year.

Now here’s how it should be done — voting at general meetings is simplicity itself for TD Direct customers:

Voting for TD Direct Investing customers

Select the ‘Voting & Information’ option on the eServices menu

You will be shown a list of currently schedule meetings at which you can vote:

List of general meetings at which you can vote

Finally, simply click on the ‘Vote’ link for the meeting at which you wish to vote, and you will be shown a list of the resolutions on which shareholders are being asked to vote, with the choice to vote for, against or to abstain from each resolution.

Voting is likely to work differently at each of the big brokers, so if you’re not sure then it’s worth logging in to your online account or telephoning your broker to find out more now, before it’s too late.

This vote could matter

Petropavlovsk’s general meeting, at which shareholders will vote on whether to approve the rights issue that’s key to the deal going through, is next Thursday, 26 February.

Mr Hambro has gone to some lengths to convince investors that the firm will go into administration immediately if this refinancing deal isn’t approved, so Petropavlovsk shares could potentially be suspended immediately following the meeting.

Remember: voting for the refinancing does not commit you to any investment — if the deal goes through, you can choose to take part in the rights issue and buy new shares, or you can sell your rights into the market  — most brokers will do this automatically if you don’t take up your rights.

There’s no reason to have no opinion — you may as well vote either way and know that you have played your part in the final decision.

Disclaimer: This article is provided for information only and is not intended as investment advice. The author has no financial interest in any company mentioned. Do your own research or seek qualified professional advice before making any investment decisions.

An open-cast coal mine

How much is BHP Billiton spin-off South32 worth to shareholders?

An open-cast coal mineUpdate 11 June 2015: Now that the dust has settled, I’ve taken a look at the South32’s actual valuation and pro-forma accounts and compared it to my original estimates in the article below. Click here for my new article.

Update 19 May 2015: After two days, South32 shares are trading towards the upper end of my valuation range, which is encouraging.

The promised 40% dividend payout ratio is encouraging, too.

However, it’s early days. We’ll have to wait until we see the first set of accounts from the firm before forming a more detailed view. I will probably hold my South32 shares until at least that time.

In August last year, BHP Billiton plc (LON:BLT) announced that it would spin-off a selection of its non-core assets into a new company, the shares in which would be distributed to BHP shareholders.

Investors had been hoping for a cash return or share buyback, and were not overwhelmed by this idea: BHP shares fell by nearly 8% in the 10 days that followed.

The assets to be disposed of — described by the firm as “a selection of its high-quality aluminium, coal, manganese, nickel and silver assets” were essentially Billiton assets which BHP acquired when it merged with Billiton.

It’s certainly true that these assets aren’t especially profitable, at the moment, but they do have reasonable scale, and I think the market may have underestimated the medium-term value in these assets.

What are they worth?

Disclaimer: There are lots of approximations involved here. This is just for fun — don’t take it too seriously or use it as the basis for any investment decisions.

The demerger is expected to take place in the first half of 2015, and the new firm has now been given a (predictably naff) name — South32 — which appears to refer to the fact that all of the firm’s assets are in the southern hemisphere: South Africa, Latin America and Australia.

As I’m a BHP shareholder, I decided to make an attempt at estimating the likely value of the demerged assets, and hence the value of the shareholder return I will receive.

I’ve taken the list of assets BHP has provided for South32, and used the firm’s final results from last year to generate the following numbers:

Asset Revenue ($m) Underlying EBIT ($m) Net operating assets ($m)
Aluminium & alumina 3,287 48 6,244
Cannington silver 1,079 412 234
Energy Coal South Africa 1,279 (170) 989
Illawarra metalurgical coal 886 (39) 1,384
Cerro Matoso nickel 595 10 860
Manganese business 2,096 476 1,613
Total 9,222 737 11,324

Source: BHP Billiton results y/e 30 June 2014

Here are the highlights:

  • Revenue: $9.2bn
  • Adjusted operating profit/EBIT: $737m
  • Adjusted operating margin: 8.0%
  • Net operating assets: $11.3bn

The question now is how to value such a business. Clearly caution is required, despite the new entity’s 8% operating margin and meaningful revenues.

I’m going to suggest three possible valuations:

  1. Price to sales ratio of 1: to put this in context, Anglo American currently has a P/S of 0.8, but Rio and BHP have a P/S of around 1.6. South32 should have “minimal net debt” according to BHP, so it should be in a slightly stronger position than Anglo — a P/S of 1 seems reasonable.If South32 had a P/S ratio of 1, this would equate to $1.73 (approx 115p) per BHP share.
  2. BHP has promised that South32 will have a strong balance sheet, so perhaps the market will be more generous and value it at its net asset value of approximately $11.3bn. Again, this is a little more than Anglo American, but significantly less than Rio and BHP.If South32 had a price to book ratio of 1, this would equate to $2.12 (approx 140p) per BHP share.
  3. Finally, I had a stab at valuing South32 on a P/E basis. This required me to estimate how South32’s operating profit might translate into post-tax earnings. Last year, BHP’s profits after tax were 65% of its operating profits, so I used this as a basis for the calculation.Crunching the numbers gives earnings per BHP share for South32 of 9 cents (approx 6p). BHP, Rio and Anglo are all valued on around 10 times forecast earnings at the moment, so using a P/E of 10 as a guide, South32 could be worth 60p per BHP share.

I’ve calculated the value of South32 per BHP share because the shares in South32 will be distributed pro-rata to BHP shareholders, so it’s logical to look at this like a special dividend.

Although methods 1. and 2. (P/S of 1 and P/B of 1) gave similar results, averaging 128p per BHP share, valuing South32 on a P/E of 10 gave a dramatically lower value of just 60p per share.

If you think abou it, this is logical, — the reason BHP is hiving off these assets is that they are underperforming. The question is whether they can be turned around, and how long this might take.

South32 listing price

In my view, South32 shares are likely to be cautiously received by the market.

There may be some forced selling by institutional investors whose remit doesn’t allow them to hold the shares, so I wouldn’t be surprised if they dropped to around 50p when they are listed.

Selling the shares at 50p would equate to a 3.6% special dividend — not to shabby, assuming the market doesn’t write down BHP shares following the demerger.

However, I suspect that patient investors may snap up South32 shares and enjoy a considerably larger reward, over a 2/3 year timescale, perhaps. As things stand at the moment, that’s certainly my plan — I don’t intend to sell straight away and will see how the new company performs, first.

Commodity outlook

Finally, just a note to emphasise that it’s worth looking at South32 in the context of commodity prices.

Aluminium and silver are very cheap at the moment, but this situation won’t last forever. Manganese appears to be very profitable, and the price of nickel rose strongly last year, so this business could also do better in 2014/15 than it did last year.

Disclaimer: This article is provided for information only and is not intended as investment advice. The author owns shares in BHP Billiton and Rio Tinto. Do your own research or seek qualified professional advice before making any investment decisions.

A tunnel in a deep mine

Petropavlovsk PLC: a textbook example of shareholders bailing out bondholders

A tunnel in a gold mineBack in August, I published an article on the Motley Fool website entitled “3 Reasons Why Petropavlovsk PLC Shareholders May Be Left With Nothing.

The point of the article was to highlight that all of the available cash flow from Petropavlovsk PLC (LON:POG) operations was being used to fund interest payments on its c.$1bn of debt — and that shareholders would eventually have to stump up cash or cede an equity share in order to fund a debt restructuring.

The end result, which we’ve now almost reached, is that the firm’s existing shares will become worthless. The whole situation is a textbook example of the risk that excessive debt levels poses to equity investors — and today’s refinancing news confirms I was right to view the stock this way.

At the time of my original article, Petropavlovsk’s share price was around 37p. Since then, it’s made steady progress downwards to its current level of 11.7p, which gives the firm a market cap of just £22m.

Refinancing deal

This morning’s c.30% plunge was triggered by news that the firm has agreed a refinancing deal for the $310.5m of bonds that are due to be repaid in February 2015. The firm cannot possibly repay these out of cash flow or existing resources, so shareholders will stump up $235m through a heavily discounted rights issue, at 5p per share. The remaining $100m will come from a new, five-year, convertible bond issue.

Here’s what this means for shareholders: most, if not all of that $235m will be used to repay debt, not to improve the business. Even after this has taken place, net debt will still be around $700m, so repayments will still be arduous and leave no room for a dividend, especially if the gold price fails to recover (or falls further still).

Selling the rights issue shares at 5p — a 66% discount to yesterday’s closing price — is a clear sign of distress.

Massive dilution

Note the difference between today’s market cap (c.$35m) and the rights issue ($235m): this difference, combined with the discounted price of the rights issue shares, means that Petropavlovsk’s share count will increase by 23 times following the rights issue.

Any shareholder not choosing to participate in the rights issue will be diluted out of existence: your share of the refinanced business will be 23 times smaller than it is at present.

The fact that the new $100m bond issue is convertible means that even more dilution is likely in the future, if the business recovers and the share price rises, some of these bonds will be converted to shares. On the other hand, if Petropavlovsk fails to recover, don’t rule out another refinancing. Either way, shareholders will be diluted.

Bondholders are not taking a loss

Shareholders should note that this is a textbook example of the superiority of debt funding.

The firm’s bondholders are not taking a loss: they will receive around 66% of their money on time, and the remaining third within five years.

This is all perfectly correct

In case you’re in any doubt, this is not a scandal — it’s perfectly correct!

When a company runs into trouble, debt holders rank above equity holders in terms of recovering their investment. It is perfectly normal for shareholders to be diluted or wiped out, in order to fund debt repayments and make bondholders whole.

That’s why investing in poorly-funded and heavily-indebted companies is a huge risk: because as a shareholder, you’re a sitting duck, waiting to be sacrificed to feed hungry debtholders.

Disclaimer: This article is provided for information only and is not intended as investment advice. The author has no financial interest in any company mentioned in the article. Do your own research or seek qualified professional advice before making any investment decisions.

Iron ore

African Minerals Limited shareholders: destination wipeout

Iron ore

Update 2 Mar 2015: I’ve published a new article on the latest developments at African Minerals here.

Update 10 Feb 2015: African Minerals issued an RNS today warning shareholders that it was on the verge of defaulting on $17m of bond coupon payments (due 10 Feb).

The firm also said that whether or not it manages to reach a refinancing deal, it is highly likely that the outcome would leave little or no value for AML’s shareholders”. As I warned in my original article below, this is one of the hazards of investing in underfunded, highly-indebted firms.

Original article (published 21 Nov 2014):

Back in October, I took at look at the latest (perhaps last) interim results from African Minerals Limited (LON:AMI) in an article for the Motley Fool.

My conclusion was that despite an apparently impressive 58% rise in production, the operating loss and balance sheet told the true story, and shareholders were very likely to face excessive dilution or simple wipeout.

So convinced was I, that I opened a small short position on the stock, once sufficient time had passed after the article’s publication to meet the Motley Fool’s disclosure rules.

Yesterday morning African Minerals’ stock was suspended pending an announcement, and once the markets had shut and attention had shifted to the commute home, the firm released its latest financing update (here), at 5.36pm.

There’s no more money

Unsurprisingly, African Minerals’ Chinese backer, Shangdong Iron and Steel Group (SISG) has decided not to release the final $102m of funding it had promised. And indeed, why would it? With the iron ore price down to $70 and showing signs of heading further south, SISG can either wait until the outlook improves, or demand a more generous share of Tonkolili in return for keeping it afloat.

As for debt, I explained in my Fool article that African has too much debt already, and it appears as if the firm’s bankers, Standard Chartered, agree. Last night’s announcement confirms that the bank has failed in its mission to structure a new debt facility for African Minerals.

What next?

To sum up: African Minerals can’t get the remaining $102m that came as part of a 25% farm-out deal of its Tonkolili mine. The firm can’t borrow any more money, either.

There’s only one way left to raise more funds: wipe out shareholders. This could take place in one of three ways, I suppose:

  1. Disposing of a further share of the Tonkolili mine at a bargain basement price, probably to SISG. I suspect this is the most likely outcome. This would dilute shareholders’ stake in the mine, devaluing their shares still further.
  2. Carry out an equity raise at a brutal discount to the already low share price — again, existing shareholders would see the value of their shares decimated. However, this would probably be hard to pull off, even at a crazily large discount.
  3. Let African Minerals Limited go bankrupt, sending the shares to 0p, before flogging the underlying operating companies at a bargain price to a private buyer. This is simply a more ruthless and perhaps more likely version of (1), above. It would not be a great surprise to me if AML boss Frank Timis ends up owning Tonkolili — another of his firms, Timis Corp, recently purchased the London Mining’s nearby Marampa Mine out of administration, with the intention of enjoying cost efficiencies by sharing existing AML infrastructure… Mr Timis is also known to enjoy good relations with the Sierra Leone government.

The shares remain suspended, so for long and short holders alike, the die is cast: now we wait.

Disclosure: This article is provided for information only and is not intended as investment advice. The author has a short position in African Minerals Limited. Do your own research or seek qualified professional advice before making any trading decisions.

A tunnel in a deep mine

Things Aren’t Getting Better At Petropavlovsk PLC

A tunnel in a gold mineIf you want to see what happens when a leveraged bet on commodity prices goes wrong, look no further than Petropavlovsk PLC (LON:POG).

Peter Hambro’s Russian gold miner is hemmed in on all sides by the constraints imposed by its mountainous debts — with the added spice of having to deal with the capital-raising restrictions of current western sanctions against Russia.

The firm’s share price can fairly be described as option money, but so it should be: Petropavlovsk’s directors now work for the firm’s lenders, not its shareholders — a situation I can’t see changing anytime soon.

In a new article for the Motley Fool today, I took a closer look at the (horrendous) numbers in today’s half-year results and what they could mean for shareholders.

Disclaimer: This article is provided for information only and is not intended as investment advice. The author may own shares in the companies mentioned in the article. Do your own research or seek qualified professional advice before making any investment decisions.

An open-cast coal mine

Proposed BHP demerger should be good for shareholders

An open-cast coal mineIn a new article for the Motley Fool today, I’ve taken a look at the proposed demerger of BHP’s Billiton assets, in the form of the giant miner’s aluminium, manganese, nickel and selected coal operations.

I reckon that it should work well for shareholders in the short and medium terms, as I explain in today’s article.

Update 19/08/2014: Details of the spin-off were announced today, and while the assets to be disposed of were as expected — aluminium, manganese, nickel, silver/lead plus some coal — the deal was not as expected.

There’s to be no cash return or buyback, instead BHP shareholders will be issued pro-rata with 100% of the stock of the new company, which will be listed Down Under with a secondary listing in Johannesburg plus ADRs. That’s gone down like a lead balloon here in Blighty, where neither private nor institutional shareholders are overjoyed at the idea of being given foreign shares to hold or sell, according to their mandate and/or preferences.

To add insult to injury, BHP’s full-year results, also published today, missed expectations slightly — although they were healthy enough. More details in my write-up for the Motley Fool.

Disclaimer: This article is provided for information only and is not intended as investment advice. The author may own shares in the companies mentioned in the article. Do your own research or seek qualified professional advice before making any purchase decisions.