Has Sibanye’s Froneman over-reached in SA deal of year? Mark Ingham thinks not

After weighing the evidence, my impression is Sibanye’s CEO Neal Froneman got caught up in the chase with his group’s proposed $2.7bn acquisition of US palladium miner Stillwater. Independent investment analyst Mark Ingham thinks otherwise. Existing and potential investors in Sibanye shares would do well to listen to this podcast before deciding whether to support the enterprise transforming deal. – Alec Hogg

Big corporate deals need big kahunas and with his bid for Stillwater, Sibanye Gold’s Chief Executive Neal Froneman has once again, shown us that he does not lack testicular fortitude. I’m a sceptic though, and for a number of reasons, think that Froneman has overreached. Independent analyst Mark Ingham sees these things very differently which, as you’ll hear, makes for a really interesting discussion.

Yes. I think this is an interesting new chapter unfolding Alec, in the life of Sibanye. It’s certainly at the forefront of the gold mining industry in South Africa – doing some interesting stuff over the last couple of years including, as you know, breaking out from the focus on gold into platinum. I think this potential acquisition of Stillwater Mining Company in the United States takes it further along that journey. It’s not a slam dunk by any means. There are a number of hurdles that still need to be crossed before they acquire the business. In fact, this being the United States, some law firms are already getting into the act and questioning whether in fact, the deal value is as good as it could be but that aside, they’ve done due diligence. They’ve been onsite and they’re very well acquainted with the asset and importantly, the people associated with that asset.

All things being equal (and assuming the finances stack up – that the gold price and the platinum price are at a reasonable level), this could be quite a game changer for Sibanye.

That’s kind of the overall thing and I don’t think anyone could argue the point you’ve made now, but Neal Froneman is known as Pacman in the mining industry because he likes to buy things. He started negotiating this transaction at a time when the Sibanye share price was very different to where it is right now. Is there a concern that we’re once again, getting ‘deal time fever’ like rugby players get ‘try line fever’? They’ve just got to go through with it even though it doesn’t really stack up as attractively as the deal would have been when the Sibanye share price was much higher?

Yes, Alec. I think the currency from an acquiring point of view, has diminished and I think that was one of the attractions. If you go back eight or nine months when the share price was heading to R60 plus the economics; as you correctly point out, would have been rather different as is the nature of the mining industry and the ebb and flow of the gold price. Timing isn’t always on your side. The asset has come along at probably, a very good time but the pricing unfortunately, given where we’ve seen the gold/platinum price in the last few months, hasn’t. Therefore, the dilutionary effect from the issuing of more shares, given the fact that your share price is down and therefore, the number of shares to be issued has to go up, means that you have to take a much closer look at the economics of the deal. I’ve run through the figures and I think they’re probably going to have to raise about $1bn.

You’re probably looking at them raising that at about R20 per share. There will be a circular issued with far more financial detail around this in the next short while. You’ve got 924 million shares in issue, currently. You may have to issue a good 600/700 million above that whereas if the share price had been closer to 50 (issuing stock at 50), you’d probably have to issue less than 300 million. There is quite a dilutionary impact potentially and therefore, you have to look at the degree to which this asset could contribute in earning over the next year or two, or three.

Just to hold that there for a second, Mark: if you take the deal in its entirety today, it’s almost like Sibanye, which exists in the current form, after their transaction will only be one-third the value of the enlarged group. It’s increasing the value of the group by two-thirds but it certainly isn’t increasing the production, profitability or the output by two-thirds and that, I think, is what critics of this deal are worrying about because the company to be acquired…their share price has gone up while Sibanye’s share price has gone down so something that might have made sense in the past, now many people in the mining industry are saying, “No, Neal. This is one step too far.”

Yes. I think that this deal (and given the pricing dynamics Alec, that you correctly referred to), has divided opinion. The transaction would lift PGM Production quite materially from just over one million ounces per year to potentially two million ounces once the blitz project/expansion project in the US comes on stream. Effectively, you’re doubling the production of platinum group metals over the next while. Certainly, that has good attraction to shareholders, I would argue. Certainly, in the numbers I’ve run; by the 2030’s, the value will be at 90%. That will include metals and is assuming this deal goes through. Of course, that’s if you include Rustenburg and Aquarius in the mix too, so it will take on a very different shape to where we are at the moment. One attraction is the intrinsic profitability. The cash cost of production in this business is about $450 per ounce.

In round numbers, that’s roughly half of what the current Sibanye cash cost situation is. You’ve got all-in sustaining costs of about $600 per ounce so when you compare the cash operating costs in platinum in South Africa at about $700, there’s certainly a very good cash cost attraction to this asset. It’s very mechanized. It’s very efficient. It’s got high grades and it’s got long-lived assets, too. In the short term, I would fully agree with you. I think the pricing dynamics insofar as the equity, raises concern as far as the additional shares necessary could be a concern. Indeed, that balancing between your debt EBITDA and the degree to which you can keep your covenants in check is a very fine balance. There’s not a lot of room for error as we stand at the moment. With the numbers that I’ve run, the deal is probably doable at these levels and the company probably would remain within the debt covenants that it currently has.

For example the net debt-to-EBITDA of the group at the moment is about 0.7 times and your net debt (if you include the Bernstein Expansion Project) is around $450m. If you assume additional net debt on the Stillwater acquisition, assuming that they raise $1bn; that means about 1.2 billion in debt and that’s in Dollars. Bear in mind that Stillwater has cash as well so your net debt-to-EBITDA would still be under 1.5 times, which is within the target range that Neal and his team have actually set out. Yes, it’s tight but it is doable, based on those assumptions.

Mining shaft

Okay. All fine, except that we’re going into a rising interest rate cycle. We know the Federal Reserve, for only the second time since 2008, has raised interest rates in December. Janet Yellen says another three increases in interest rates are coming next year. If Donald Trump has his way, it could be more than three, given the money he wants to spend. The markets are looking at these things very nervously. This is not the time one would presume to go out and borrow US Dollars, just as the interest rate cycle is turning. Isn’t that almost an existential threat to Sibanye, if they get this one wrong?

Alec, that’s very true and certainly, some scenarios would have to have been gone through. Not just with the due diligence but in terms of the financing package. They formed the United States merger subsidiary. They then obtained a bridge loan already from banks, in the amount of $2.7bn, which is a very substantial amount of money and they have the backstop granted as well. They are looking at a future bond issue, with lock in funding at a relatively stable rate in relation to the current interest rate cycle. Correctly, as you point out, a rising interest rate cycle. This will be offshore funding. It will be backed by the Stillwater assets and the Stillwater cash flow, too. In terms of the rising interest rate cycle… Let’s assume Alec, for argument’s sake that we have a further three interest rises in the next year or so… Let’s call it 0.25 each time.

In terms of funding costs in the United States, that’s still extremely attractive relative to the cost of funding in South Africa. Again, bearing in mind that the interest servicing cost, together with the debt, is being serviced by cash flows out of the United States. It’s also being funded by cash flows at a very competitive cost of production, relative to South Africa. I think that gives you a little bit of fat in it, relative to what your situation would be if you were borrowing a similar quantum in South Africa and having to service that in South Africa. Bear in mind that once you start getting close to R450,000 per kg (on gold, for argument’s sake or indeed, plats) you’re starting to – at best – break even in South Africa. We’re currently looking at just over R500,000 per kg. It wasn’t long ago when the gold price was slightly higher and we were looking at over R600,000 per kg so I would fully agree with you.

In the South African context, it would be highly questionable and I think the appetite for it (from shareholders) would certainly not be there. I think that given the quality of the asset and the location of the asset, the risk profile of that asset (bearing in mind that the politics in the United States are rather different to what we have here at the moment) … The attractiveness of the US mining still remains pretty good, relative to SA. Probably, the team are taking a calculated, but very carefully measured, approach to this deal. As I mentioned at the outset, it’s not a shoo-in as it stands at the moment. We are getting shareholder support. A couple of their very sizeable shareholders have already given support to it and I think that does indicate that there is a reasonable appetite, given what’s been presented to the shareholders for the deal at this stage.

However, if we had to see the platinum price drift further/lower, then once again, people would start to question. At this stage, the dynamics as far as the cash flow figures that I’ve run, are probably slightly in its favour.

Again, you’ve mentioned the platinum price but this is really more of a palladium play, isn’t it – 78% palladium – and palladium has been on a rip this year. Up 56% since January. If that is not sustained… These are just the risk factors which, when one looks at it from a neutral observer’s perspective… Froneman had Sibanye’s assets outside of South Africa where they weren’t exposed to AMCU labour unrests literally bringing the mines to a standstill by external factors. You’d look at this and say, “What the devil is he doing?” However, given that he has those issues at home to take care of, perhaps that pushed him in this direction.

Joseph Mathunjwa (R), president of South Africa’s Association of Mineworkers and Construction Union (AMCU). REUTERS/Siphiwe Sibeko

I think so, Alec. You’re well aware that the Fraser Institute recently came out with its annual survey and it ranked South Africa relatively poorly for investment attractiveness. We ranked 11th in Africa, which is hard to believe, and 66th in the world. In fact, even Russia scored better than SA. Indeed, I think the political and regulatory issues in South Africa are not conducive to expansion of the mining industry. There is tremendous potential in the domestic mining industry, provided that common sense prevails. Pending legislation, it’s also a catalyst for companies like Sibanye, casting their nets abroad. The pricing differential between palladium and platinum (bearing in mind that they’re all part of the platinum group and have to be seen in the context of that); that gap between the two pricings has closed in the last while. It’s certainly narrowed considerably and I think that has been a further attraction for the deal.

Demand for palladium particularly, has been increasing in the catalyst industry and other uses, too. Despite that, we need to remind ourselves again that even if the palladium price does slip back relative to platinum (within the platinum group minerals complex), it would still mean that given the very competitive cash costs of producing in that particular region and given the very attractive yields that you’re getting out of the mine, it still makes sense. You’d have to see the price of palladium come back quite dramatically for the economics to be questioned. I think the likelihood of that happening is probably not there at this stage. Then again, I think this company (Sibanye) and indeed, any mining company looking at risking capital to the degree that we’re looking at here, has to run very sensitive scenarios – assuming various outcomes on pricing, currency, and demand.

On that basis, the group feels that this deal is worth it but as I say, there are a number of hurdles yet to cross. I think what’s quite interesting though, is that they’ve managed to get the financing structure in place concretely. They’ve got US Merger Subsidiary up and running so they’ve done a lot of homework here Alec, in preparation for getting this potential deal off the ground.

They’ve got City and HSBC who’d put up the cash so from that perspective, it’s a done deal (in essence). When you look at it in the long terms, Neal Froneman and Sibanye are either going to be seen as having done a masterstroke or having risked the company unnecessarily as a whole on this transaction. It’s a massive transaction in every type of context. For instance, if the South African mining industry were to grind to a halt through labour legislation, bad governance, and continued interference from a Mining Minister who has quite a lot of questions against his name then Froneman would look like an absolute superstar. However, if there is a rejuvenation of the South African mining industry, the question has to be “Why give away two-thirds of your company on something that’s a great asset in America but is certainly not worth two thirds (on paper, anyway) of what you see in Sibanye?” I guess that’s the big story, isn’t it? The future of South Africa.

It will be. I think there’s been a slight strategic change in tack Alec, which speaks to your point precisely, in the last number of months. Sibanye was going to be a consolidator in the domestic landscape. The approach that they took to platinum particularly spoke to that. At more distressed levels, they felt that they had the chequebook and the capability to give these assets a new lease on life and I still believe that will be the case. Mining teaches us that the only certainty about your predictions is that they’ll be wrong. Hence, the scenarios that you have to go through and you’re right, Alec. Is this a question of betting the farm? Yes. If we were still at R60 per share… If the platinum price for instance, was at over R1000… If the gold price was at R1250 for argument’s sake then certainly, I think the debate would perhaps not be as querying as we are finding at the moment.

I think analysts particularly, have to take a very critical eye on this and I think Neal and his team are fully aware of that. I think it’s quite interesting that the PIC, which is one of the larger investors and indeed, probably the largest single investor in South Africa, have given it their support. We do need 75% shareholder support, and so that is the real litmus test – the fact that the PIC is supportive of the deal and Gold One (the Chinese backers of Sibanye) are also supportive. The fact that they are supportive does not, ipso facto, mean that other institutional shareholders will come to the party too. A lot of those and indeed, fund managers, are sharpening their pencils at the moment, looking at the risk/reward scenarios. Certainly, by the first quarter or so of 2017, we’ll know one way or the other, which way this will go.

It’s quite interesting that just in the last few days Alec, we’ve seen pricing on metals edge up after a period of relative weakness and that may speak to people rethinking the politics in the US at the moment and perhaps getting a little bit less enthusiastic over industrial expansion and infrastructure, etcetera. The market dynamics for palladium and platinum are looking quite good. If you look, going forward, at the supply/demand equation, it is looking relatively good insofar as that demand/supply balance is concerned, which probably also speaks to their pricing model.

I guess markets are made by different opinions. The opinion that I’d be coming from is very negative on this one. In fact, it would be my short of the year. If there was one stock that I would be able to sell with the confidence that it will be lower in a year’s time, this would be the one. Of course, you never make those statements in a mining industry because ‘what’s the gold price going to do’? What’s the platinum price going to do? I remember a long time ago, learning that the man who predicts the gold price has only one description – fool. Let me not call it the short of the year or anything along those lines, but I think you’ve unpacked it really well, Mark. I have a natural aversion to intense risk and in this case, it is the entrepreneurial Neal Froneman at his best. He is taking a huge bet and if it comes off, he’ll be a hero.

If it doesn’t come off… Well, that’s what happened with Uranium One if you recall, which he also had once before. He did something similar. Closing off, isn’t there a danger that he’s repeating the mistakes that he made at that time, in the uranium market?

Alec, the mining industry (particularly) doesn’t take any prisoners. It’s a very hard taskmaster. A certain amount of learning has occurred. I think that you do have a board of directors here at Sibanye. This has to go through the board of directors. It’s got to go through proper due diligence. It has to be assessed in that light. If the board feels that there is merit to it – having weighed up all the pros and cons and indeed, all the subject matter that we’re talking about now, both positive and negative – then I think from a governance point of view, they’ve gone through the right process. Yes, we don’t know where the net position will be for the market in the next few years but on the basis of market outlook, the net market balance is moving from surplus to small deficit. That will be positive for the pricing. I think ultimately, it’s the quality of the asset that really attracted them.

Again, no asset is worth paying over the top for and in fact, back to that legal issue that I referred to at the outset; there are a few legal firms in the US circling at the moment, investigating whether the Stillwater board of directors have perhaps failed to get the best possible deal. Litigation isn’t out of the question, or some arm-twisting for a higher price. It could potentially be the defining deal of 2017. It’s still possible that this may be derailed because of legal aspects. There are various covenants that are built into the legalese around the agreement. There is a breakup fee. It’s a relatively modest breakup fee by United States’ standards but it’s still a fairly chunky $33m, which Sibanye would be required to pay for a breakup. They’d also have to pay up to $10m in costs. It’s not out of the question that the legal aspect…

If, for instance, the pricing dynamics didn’t go in its favour, the legal aspect may very well be the one catalyst preventing this deal going through. In that case, they would wash their hands of it and walk way (maybe to come back and fight another day). Again, they’ve also secured bridge funding and the other hurdle they’d need to get through is the shareholder support. Yes, there are a number of negatives. There are a number of risks. There are a number of unknowns. If this comes off, it will be the defining moment of Neal Froneman’s career. If not, I think it will be back to brass tacks again.

Mark Ingham is an independent analyst and this special podcast was brought to you by EasyEquities.