As I mentioned in the November magazine, with the outlook for other mining commodities cloudy and funding for their projects problematic (Paragon Diamonds is in trouble because finding funds has been more difficult than it thought – interested investors will find more up-to-date information on the BBs than we can provide here) it seems sensible for investors to look at coal to power companies where the coal price as a commodity is less relevant than the local long term electricity price. Their host countries’ desperate need for power ought to ensure that the four companies we highlighted can secure reasonable terms, and would be regarded by major funding institutions for funding as quasi-utilities. But equity will still be needed and their owners are still quoted companies, so we continue to try to work out whether the present large discrepancy between their market caps and the value of their projects must (mustn’t it?!) give scope for shareholders to benefit at some stage.
The theory obviously applies to any company with an as yet unfunded project, such as development stage miners.
But my closer look at Kibo Mining (KIBO) (I discuss the other three here), and attempt to assess what value there might be for present shareholders in the run up to ‘financial close’, discovered how difficult it is to arrive at an absolute conclusion. I stated that while – in the absence of key details, not least the terms likely from project lenders and institutional investors – it was difficult to pin down an absolute value ‘now’ for the shares and therefore for their potential after a fundraising.
Here, however, I look at a rough and ready (some might say ‘Heath Robinson’) method that should at least enable a comparison of the best ‘speculative’ value of each company as of now. It is slightly more than back-of-an-envelope, but not as laborious as flogging through full cash flow forecasts (even if available from consultants’ technical reports) and constructing financing models. It is a very easy calculation (after working out how to do it).
But while it should give a theoretical ‘ranking’ between the owning companies, it won’t give an absolute valuation because, as we explained in our piece last month concentrating on Kibo, the key to the fundraising price is what return the institutions will expect on any equity they subscribe to, which obviously varies according to the project’s location and other perceived risks. According to the sparse literature we have found, some institutions demand a return of more than 20% p.a. for developing countries, and as my results later show, the raise price is highly sensitive to this ‘hurdle’ return rate.
Nevertheless, it is this institutional fundraising price that will place a medium-term value on the shares, unlike the ‘target prices’ that, as I explained last month, even if valid would never be approached in practice. So for that reason it is worth trying to estimate even if the shares meanwhile will be affected by factors such as perceptions of the risks and the projects’ timings, newsflow, and the owners’ (i.e. present shareholders’) need to raise on-going working capital before the major project fundraising.
Nor will my estimate take into account any other assets the companies might own. (As for Kibo – I don’t think its exploration assets are worth much in today’s environment. More likely their spending need is a liability.)
The method
As I hope I have shown, it would be completely wrong to divide the announced project NPVs by the current shares in issue and expect that to give a valid ranking between them. It is the unpleasant fact that the institutions demand a fairly high return – which is the basis for my method here – that explains why during 2013 even before the recent funding drought, mining shares were valued at less than 1/3rd the theoretical NPV/share based on NPVs touted by brokers’ analysts.
What is needed instead is a ‘value per share’ once the necessary funding – via shares, loans, and whatever – has been made. Vitally, to compare like with like, one has to ensure that the returns as would be seen by an institutional investor in the equity shares at the funding price, and the loan terms, are the same for each company, which allows for the different capital structures and sizes of projects in relation to the owning companies. Of course, if private investors can be persuaded to put up all the equity, they would probably expect a far lower return than would an institution. But 30% of capital expenditures in the range $750m-$1,500m would be an impossible morsel for the private investor market to swallow.
My method involves assuming a return that an institution will expect (I take 21% and 15% to show sensitivity to its effect) on shares to meet 30% of the total funding (usually the project capex); deducting the PVs of other financing repayments and costs from the gross PV; and dividing by the shares in issue after the major fundraising, to show a theoretical post-funding value per share (PV is gross value after funding) – compared with the present share price. It is a crude but feasible way to compare projects at a relatively early stage, but is obviously dependent on the accuracy (which varies) of each company’s published project economics.
The results
Notice the substantial difference between the results for institutional hurdle rates of 15% and 20%. And bear in mind that I think at least 20% will be required.
Neglecting Ncondezi Energy (NCCL) (was Ncondezi Power) Oracle Coalfields (ORCP) looks by far the best value, with the most scope from now to a capital raise price, with Edenville Energy (EDL) not far behind, whereas Kibo has the least. Kibo’s market cap is already near to the potential market cap of the equity alone (although most of the project value could be in the form of loans) for its coal mine, which could be because it has attracted more private investor interest than the others, and/or its other exploration assets might be giving it a (I think undeserved) premium.
Unsurprisingly, Ncondezi also comes out ‘top value’ – but only because, as I have mentioned, its shares are extremely depressed by fears that this ‘project owning’ company might be going bust!
Other factors might also be affecting each share while, if the project turns out different in scale than the one I have assumed (so that my NPVs and IRRs are different from what has been published) my figures will have been skewed, which is why short thumbnails below should help investors to further refine any decision.
Not least important is the timetable for the projects, which will depend on the host country’s plans for plugging the new generators into its transmission networks. For the two Tanzanian companies, Edenville and Kibo, whose projects are of different sizes and in different locations, and where coal will be competing with gas, news about timescales might emerge from the ‘Powering Africa – Tanzania’ conference on December 3rd.
Oracle Coalfields seems to me to have been the most honest with shareholders up to now, always reminding them of the significant funding task for its Pakistan project whereby the £1bn capital cost will need a 30% equity contribution, with the rest expected from China – perhaps in the form of securitisation of the power output, which ought to be cheaper than a straight project loan.
Edenville, similarly, though proceeding too slowly up to now in the view of some shareholders, has never promised too much, but is now in discussions with power plant builders as well as on the point of receiving a mining permit.
Kibo, in my view, has been economical with the truth – issuing streams of RNSs which for more than a year have added nothing that enables shareholders to assess what might, or might not, be in it for them. Instead it quotes cherry picked figures from the technical studies highlighting juicy-looking NPVs and IRRs without the necessary context or other detail to judge them and hardly any warning that a substantial equity raise will be needed. (Its cherry-picked figures are for its coal mine alone – I discusssed Kibo’s options as between that and the much less profitable, if larger, integrated power project, in the November issue.)
Having been in discussion with SEPCO, Standard Bank, and using other technical consultants for the past year, Kibo has promised ‘financial close’ by Q1 2016, even though the most crucial element – a Bankable Feasibility Study for the integrated coal mine and power station – is only promised for the end of 2015, after which it usually takes a considerable time for all the funding sources and terms to be found and agreed. With China involved, however, some new types of funding might be wheeled in.
The method described here has assumed conventional project loan funding for 70% of the capex. Different formats will modify the figures. However, as a rough guide for investors as to the potential for each company, I think this method is useful. I would welcome other opinions.
But Please Note: I am not ‘recommending’ any of these shares. They remain subject to all sorts of unforeseen events.