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Value not writ in Stone

9 September 2009

Publication: Fin24.com
Author: Marc Hasenfuss

Amidst a paucity of project finance and dulled investor appetite, it hardly seems advisable to bring a capital hungry exploration company to market.

Perhaps we should be more trusting of companies which list in tough times (unlike those that make capital of market froth to take advantage of inflated values). But it could hardly be surprising that Sephaku Holdings, a black-controlled exploration company which listed on the JSE in August, was given a bit of a cold shoulder.

Sephaku – which, thankfully, looks more formidable than some of the junior exploration twaddle we’ve seen listed in recent years – saw its shares briefly traded at 640c before drifting down to 450c.

The trading volumes are small, and perhaps some “early bird” investors are cashing in portions of their holdings. This would not be surprising because between late 2006 and early 2007 about 28 million shares were issued to existing shareholders, staff and new subscribers at prices ranging between 25 cents per share to 80c/share.

In April 2007 13 million shares were issued to new subscribers at 200c/share, and 10 million shares were issued a year later at 250c/share in a rights issue. In June 2009 4.7 million Sephaku shares were issued at 300c/share in a rights issue.

In other words, even at the current share price – which gives Sephaku a not-insubstantial market capitalisation of R700m – there is easy money for the taking for early bird investors.

One can’t really begrudge anyone making a bit of quick dosh, especially in these challenging economic times when folks may be pressured to loosen up a bit of extra cash flow.

I’d suspect these small(ish) sellers will continue feeding shares into the market over the next few weeks, which begs the question of whether longer term investors might start considering Sephaku as a higher risk value play.

Last week Sephaku advised shareholders that net asset value (NAV) per share would be the adopted measure for future trading statements.

That’s fair since earnings for an exploration (stage) company is relatively meaningless – at least in comparison with more critical issues like available cash resources.

Ambitious cement projects

Sephaku’s pre-listing statement shows a NAV of 280c/share and a tangible NAV of 250c/share for the year to end-February 2009.

That value is mostly underpinned by a cash pile of about R270m, with not too much value “officially” being lumped onto the value of Sephaku’s ambitious cement projects as well as its smaller gold and fluorspar initiatives.

While Sephaku has adopted NAV as the yardstick of performance, the historical NAV figures are really quite irrelevant. The 2009 NAV – outside the cash pile – merely reflects the exploration costs incurred at the various projects rather than their future potential.

Now page 17 of the pre-listing statement gives some inkling of the potential value of these projects, based on the Competent Person’s Report (in this case the well-known Venmyn outfit).

The breakdown of Sephaku’s portfolio of exploration and development assets accords a value of R3.5bn to the cement projects, which comprise a limestone mine and cement plant (the Itsoseng Project), a cement grinding and milling plant (the Delmas Milling project) and a waste ash processing plant (the Fly Ash Classification Project at Eskom’s Kendal Power Station).

The 100% fluorspar project and 30%-owned Tuang gold mining project are accorded values of between R75m to R120m and R51m to R186m respectively.

But for now, let’s set aside the gold and fluorspar and rather concentrate on the cement project.

As things stand, Sephaku holds 80% of the cement project but intends reducing its holding down to about 55% by placing shares with new investors in a bid to raise at least R550m (but perhaps as much as R700m to R800m) for the project.

These funds are important with Sephaku having already placed a $273m (R2bn) order for the turnkey cement plant erection and implementation with China’s Sinoma Industries. Clearly Sephaku wants its cement plant up and running by the end of 2011 and in full production by mid-2012.

Paper tiger?

If we work on the premise that Sephaku will shortly be reducing its shareholding in cement, the inferred value of the company’s 55% stake in the project is worth over R1.9bn. This equates to more than 1 200c/share, nearly three time the current share price.

For the record, Sephaku’s fluorspar and gold mining interests would collectively add another 100c/share to the collective value.

On paper Sephaku looks like a bargain. But the value suggested in the pre-listing statement is based on professional opinion around future potential. There is no historic cash flows, operating track record or production profile.

Sephaku clearly thinks the cement project can spin cash in the future. The company paid R420m in September 2008 to acquire shares in the cement company from various minority shareholders – including more than a handful of Sephaku directors. The transaction was settled by issuing 37.8 million shares at 1 111c/share – a massive premium by today’s price (but certainly not in a pre-Lehman Brothers period).

My gut feel is that serious market players will stay aloof until Sephaku pulls off the fund-raising for the cement project.

Presumably, Sephaku would have preferred to list with the cement project funding in place. In this regard one suspects ongoing negotiations are probably around the price at which scrip in the cement project will be placed with new investors (a matter that certainly won’t be helped by small sellers dumping their stock at 450c).

Sephaku kicked off capital-raising for the cement project in 2008 already, when R350m of roughly R900m needed to start up production was raised from Dangote Industries (now a strategic investor, holding 19.8% of the cement project).

While Sephaku is trying to twist the arms of new investors, the company is also negotiating with a consortium of commercial and development banks to provide the necessary project debt.

At the current price the market is putting a value of about R450m to R500m on the cement project, which is not much more than Dangote paid for its 19.8% stake a year ago.

If Sephaku confirms its equity and debt funding within the next couple of months, market watchers taking advantage of the recent bouts of desperate selling may well be grinning gleefully.

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