Ann: Trading Update, page-57

I don't think i misunderstood dilution risk at all; to the contrary, i think i understand it very well, because i've put together a model (which i shared with everyone here) that steps through potential dilution scenarios and what these scenarios imply in terms of likely shareholder returns vis-a-vis today's share price and the future profitability of MRM. Admittedly that model was 80/20 and omitted some critical detail (for example, ability of existing MRM shareholders to participate in the likely event the equity raise has a retail rights issue component), but it's very instructive.

My baseline dilution scenario for MRM is basically this:

- Raise $75m at $0.20. Leaves ~750m shares on issue post raise and net debt of ~$290-$300m, given net debt probably goes from $342 at FY16 to $370m at 1HFY17.
- I plug in a target return from this scenario to back into a targeted future equity value. For me, i'd want a minimum of 50% p.a. returns to invest into MRM today, given how risky this situation is. Therefore, i want ($0.29*(1+50%)^2.5), where 2.5 is the hold period assuming i exit my investment post release of 30 June 2019 financial results (because i think that's roughly when MRM will be back somewhere close to normal profitability). So, i would want the share price at 30 June 2019 to be $0.60 to justify an investment in MRM today at $0.29.
- On 750m shares on issue post dilution, at that equity price ($0.60), i am targeting a market cap of $450m. Add net debt post equity raise of $300m, and i am targeting a FY19 EV of $750m.
- To justify a $750m EV, this business probably has to be generating ~110-$120m EBITDA in FY19, capped at a 6x-7x multiple (which i think is roughly right for a business of this quality - a 4/10 business).
- I have no confidence that MRM will be back doing $120m+ EBITDA by FY19 (given they are probably running near breakeven EBITDA in this half), nor do i have confidence around the equity raise scenario , so i therefore think that this proposition is too risky and uncertain.

I personally don't find it particularly helpful to speculate whether the share price moves up or down post equity raise, because that will only become clear once the terms of the equity raise are revealed. The more they raise, the bigger the discount will have to be, the greater the dilution will be, and the less likely it is that the share price recovers to pre-equity raise levels - this can be empirically observed by looking at the share price charts of the very many over-levered companies that were forced to do deeply discounted equity raisings at the height of the GFC in 2008-2009 (take a look, for example, at many of the REITs who did big, dilutive equity raises). To talk banker talk and be a little technical, the more dilutive the equity raise is, the lower the theoretical ex-rights price ("TERP") of the stock will be, and the further underwater existing holders will be (unless they can average down into a rights issue structure). To put this into context with MRM, if they did the equity raise as i've laid it out, the TERP would be [(373*$0.29)+(377*$0.2)] = ~$0.24 - now, post the equity raise, yes, i suspect the stock probably hangs around the TERP or maybe climbs up slightly if the insolvency risk is removed, but that doesn't put you back to par with an investment at $0.29 today.