Northam bets farm on the platinum price
There’s the present cost of BEE to Northam Platinum, and there is the potentially company-wrecking cost of things going wrong in the future if the platinum market doesn’t perform the way that the company hopes it will.
The upshot of Nor t ha m Platinum’s R6.6bn black economic empowerment (BEE) deal, unveiled on 22 October, is that the platinum group metals (PGM) producer and its major shareholders have bet the farm on the platinum price.
Northam issued 22% new shares to a BEE entity called the Zambezi Platinum Consortium for R4.6bn to which the Public Investment Corporation (PIC) added R2bn worth of shares it already held in Northam.
In order to pay for the new shares from Northam, and the existing stake the PIC is selling, the consortium is to issue preference shares to the tune of R6.6bn. The preference shares will be separately listed on the JSE and be underwritten by Coronation Asset Management and the PIC. (In fact, the PIC is swapping its shares in Northam for preference shares.) This means that investors will have the two entry points into Northam: ordinary shares and the preference shares that the Zambezi Platinum Consortium must repay in 10 years’ time, at a coupon rate of 3.5% above prime, which at the time of the deal announcement, was a return of 12.75%.
The choice, which investors with an interest in the platinum industry will have to make, is whether to take the embedded return on the preference share or choose direct exposure to Northam, which as part of the BEE deal, has netted itself R4bn for expansion.
The preference shares are largely (but not entirely) risk-free because they embed a return. It’s possible then that Northam preference shares may rise and fall with, say, interest rate adjustments made by the South African Reserve Bank. The yield on the preference shares is quite high if one considers how platinum shares have performed over, say, the last f ive years: Northam, for instance, is 60% down in that period.
The benefit of owning Northam, however, is that the R4bn it receives in net cash from selling its 22% stake (R600m is fees and other items), will be put towards production expansion either internally or by merger and acquisition. In fact, Northam CEO Paul Dunne said in an interview with Finweek that the firm could probably increase its financial firepower to R7bn including bank debt.
This means that Northam Platinum could generate considerable capital growth in its share provided it spends t he cash well – on properly value accretive transactions – and perhaps more importantly, the platinum price is supportive.
“We take the view that the platinum market is close to a cyclical bottom,” sa i d Neill Young, an analyst for Coronation Fund Managers. “We think this is a good time for Northam to act as a consolidator,” he added.
The expectation is that over the next ten years, t he platinum price will respond positively to a recovery in the European autocatalyst market, as well as jewellery marketing efforts in places such as China.
Perhaps more importantly still is the view that SA’s platinum industry has learned from its past mistakes, that discipline in new growth projects is followed, and that high-cost production from ageing shafts is knocked out of the system.
“There’s quite a lot of moving parts in this transaction,” said Michael Kavanagh, an analyst for Noah Capital. “What’s clear is that Northam is taking a tremendous bet on the market. It’s also likely that now Northam is closely leveraged to the platinum price such that it will respond sharply to changes in the dollar price of the metal.”
Said Dunne: “The industry is at a point of inf lexion and we would like to participate in the restructuring of the industry. We are positioning ourselves to do that.”
He has suggested in the past that Northam could double output to 1m ounces, a target that Young said should not be “a fixation”.
For preference shareholders, the risk is that Northam doesn’t deal well in the market, or that the platinum price doesn’t perform as well as either Dunne, Coronation or the PIC expect and it, therefore, cannot fund the BEE consortium to repurchase the preference shares it has issued.
According to Kavanagh, this would put incredible pressure on Northam’s balance sheet and may see instead an unbundling of Northam shares to preference shareholders.
Said Seten Naidoo, an analyst with Standard Bank Group Securities: “We believe these types of deals create signif icant pressure on companies further down the line, which the market starts pricing into the stock materially ahead of time when the tide t urns against producers.
“In our opinion, this would only be value accretive should Northam perform in line with it s goals of expanding significantly while having commodity prices in its favour, thereby making the significant burden due in 10 years negligible.”