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 Goldâs Chief Executive Neal Froneman has once again, shown us that he does not lack testicular fortitude. Iâm 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 youâll hear, makes for a really interesting discussion.
Yes. I think this is an interesting new chapter unfolding Alec, in the life of Sibanye. Itâs certainly at the forefront of the gold mining industry in South Africa â 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. Itâs 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, theyâve done due diligence. Theyâve been onsite and theyâre very well acquainted with the asset and importantly, the people associated with that asset.
All things being equal (and assuming the finances stack up â that the gold price and the platinum price are at a reasonable level), this could be quite a game changer for Sibanye.
Thatâs kind of the overall thing and I donât think anyone could argue the point youâve 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 weâre once again, getting âdeal time feverâ like rugby players get âtry line feverâ? Theyâve just got to go through with it even though it doesnât 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 isnât always on your side. The asset has come along at probably, a very good time but the pricing unfortunately, given where weâve seen the gold/platinum price in the last few months, hasnât. 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. Iâve run through the figures and I think theyâre probably going to have to raise about $1bn.
Youâre 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. Youâve 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), youâd 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, itâs almost like Sibanye, which exists in the current form, after their transaction will only be one-third the value of the enlarged group. Itâs increasing the value of the group by two-thirds but it certainly isnât 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 acquiredâŚtheir share price has gone up while Sibanyeâs share price has gone down so something that might have made sense in the past, now many people in the mining industry are saying, âNo, Neal. This is one step too far.â
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, youâre 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 Iâve run; by the 2030âs, the value will be at 90%. That will include metals and is assuming this deal goes through. Of course, thatâs 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, thatâs roughly half of what the current Sibanye cash cost situation is. Youâve 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, thereâs certainly a very good cash cost attraction to this asset. Itâs very mechanized. Itâs very efficient. Itâs got high grades and itâs 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. Thereâs not a lot of room for error as we stand at the moment. With the numbers that Iâve 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 thatâs 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, itâs tight but it is doable, based on those assumptions.
Okay. All fine, except that weâre 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. Isnât that almost an existential threat to Sibanye, if they get this one wrong?
Alec, thatâs 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⌠Letâs assume Alec, for argumentâs sake that we have a further three interest rises in the next year or so⌠Letâs call it 0.25 each time.
In terms of funding costs in the United States, thatâs 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. Itâs 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 argumentâs sake or indeed, plats) youâre starting to â at best â break even in South Africa. Weâre currently looking at just over R500,000 per kg. It wasnât 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, itâs 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 whatâs 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 Iâve run, are probably slightly in its favour.
Again, youâve mentioned the platinum price but this is really more of a palladium play, isnât it â 78% palladium â 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 observerâs perspective⌠Froneman had Sibanyeâs assets outside of South Africa where they werenât exposed to AMCU labour unrests literally bringing the mines to a standstill by external factors. Youâd look at this and say, âWhat the devil is he doing?â However, given that he has those issues at home to take care of, perhaps that pushed him in this direction.
I think so, Alec. Youâre 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, itâs also a catalyst for companies like Sibanye, casting their nets abroad. The pricing differential between palladium and platinum (bearing in mind that theyâre 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. Itâs 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 youâre getting out of the mine, it still makes sense. Youâd 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 weâre looking at here, has to run very sensitive scenarios â 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 whatâs quite interesting though, is that theyâve managed to get the financing structure in place concretely. Theyâve got US Merger Subsidiary up and running so theyâve done a lot of homework here Alec, in preparation for getting this potential deal off the ground.
Theyâve got City and HSBC whoâd put up the cash so from that perspective, itâs 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. Itâs 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 âWhy give away two-thirds of your company on something thatâs a great asset in America but is certainly not worth two thirds (on paper, anyway) of what you see in Sibanye?â I guess thatâs the big story, isnât it? The future of South Africa.
It will be. I think thereâs 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 theyâll be wrong. Hence, the scenarios that you have to go through and youâre 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 argumentâs 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 itâs 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 â 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, weâll know one way or the other, which way this will go.
Itâs quite interesting that just in the last few days Alec, weâve 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 Iâd 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 yearâs time, this would be the one. Of course, you never make those statements in a mining industry because âwhatâs the gold price going to doâ? Whatâs 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 â fool. Let me not call it the short of the year or anything along those lines, but I think youâve 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, heâll be a hero.
If it doesnât come off⌠Well, thatâs what happened with Uranium One if you recall, which he also had once before. He did something similar. Closing off, isnât there a danger that heâs repeating the mistakes that he made at that time, in the uranium market?
Alec, the mining industry (particularly) doesnât take any prisoners. Itâs 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. Itâs 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 â having weighed up all the pros and cons and indeed, all the subject matter that weâre talking about now, both positive and negative â then I think from a governance point of view, theyâve gone through the right process. Yes, we donât 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, itâs 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 isnât out of the question, or some arm-twisting for a higher price. It could potentially be the defining deal of 2017. Itâs 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. Itâs a relatively modest breakup fee by United Statesâ standards but itâs still a fairly chunky $33m, which Sibanye would be required to pay for a breakup. Theyâd also have to pay up to $10m in costs. Itâs not out of the question that the legal aspectâŚ
If, for instance, the pricing dynamics didnât 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, theyâve also secured bridge funding and the other hurdle theyâd 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 Fronemanâs 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.
