vwap calculation - finance facility fee - good luck, page-7

Hi 2ic, point taken, I apologise again.

I’ll carry on where I left off in my previous comment, which was about to explain why I believe that a capital raising of $200mil at sub 50c is “as good as off the table”.

Why is this discussion important?
1) I feel that the share price has been heavily influenced by an ongoing assumption that a large on market capital raising is on the cards.

2) as soon as an investor can rationalise that a capital raising at sub 60c (or even 60c) will in most likelihood never be the superior option for management to pursue, the sooner it will become evident that a 60c share price is not sustainable.

In my opinion a market price of 85c-90c is where the price deserves to be given the current market information and state of play. Why 90c? because:

- if a takeover comes in and two or three parties fight over the asset (and it’s an asset worth fighting over, let’s keep in mind the industry’s supply/demand dynamics as forecast by ALL the research houses, which is why I suspect the big boys are playing it so coy) then the upside is $1.80-$2.20.

- If a low ball takeover happens then it's $1.20.

- If a partner is found at 50% discount to NPV then it’s $1.50+,

- If a fire sale deal needs to be done I simply can’t see ILU passing it up at 90c.

- And if it is trading at 90c (which to my mind is not just wishful thinking but a fair bet based on the upside downside scenario) and a capital raising is the only option then it can be sprung on the market by putting the stock into trading halt and pitching it at 70c, or maybe it will need to be 50c, and then the upside is 80c-$1 after that is finished, but before that can be completed then watch ILU come out to prevent that from happening because ILU won’t want this strategic asset secured in a competitor’s hands, and then it 90c.

So why is a capital raising to fund the remaining capital requirements "off the table"?

My simple answer is that a raising will simply be too dilutive to existing shareholders (including management) and therefore even the unattractive alternative of selling the asset at a “give away prices” (one which a buyer couldn't refuse) will generate a better outcome for existing shareholders, and therefore if push comes to shove then that’s what will be pursued. Incidentally I don’t believe that this will need to be the case. SFX has an asset in a market which has steady to slightly increasing demand and a falling supply profile.

In order for this statement to make any sense we really need to rethink your value proposition of Thunderbird and dilute any ideas that may have sunk in about the asset being marginal as a result of the recent capex increases and based on the upfront capital that an investor would need to invest to fund the project.

So let’s move onto that topic.

Did the announcements in October - December regarding changes in capex and other capital requirements negatively impact the “real value” of the project?

No, I don’t believe they did, why?

1) the capex increase due to the owner operated infrastructure decision will result in savings of $7,500,000. This is equates to an NPV saving of about $114mil (assuming a 2% inflation on the annual figure of $7,500,000), or $90mil if the savings figure is not adjusted for inflation.

2) the capex increases of stage 1 and 2 which equate to an estimated $74mil in my model will have a negative effect on the company value, however as detailed below the sensitivity of the “real value” of a long mine life project is not highly sensitive to capex increases in the same way as that of a short or medium project is (this comes back to the point of shifting away from looking through the NPV looking glass).

3) capital requirement to fund the company through the 1.5-2 years of construction. These cost were always bound to be there, they are not a new cost and apply to any entity which is bringing into production a large project which requires construction. This has no negative effect on the value of the project or on the NPV.

4) capital guarantees required by Taurus. This is a contingency which given an EPC contract is in place for 80% of the stage 1 construction, which has recently been revised to give satisfaction to the EPC contractor, should not be assumed to be a capex requirement and has no effect on the NPV value or real value of the project.

IS THUNDERBIRD MARGINAL?
If we look at your assessment tabled on March 3rd it’s understandable that investors may have started to question whether optimism towards an investment in SFX is still valid (on the basis that the asset is worth a lot more to a Corporate than current prices).

I didn’t like the assessment of the project value in that post because I thought it was inappropriate on several counts, primarily because it uses the NPV as the main benchmark of value, and then compounding that issue proceeds to adjust the NPV by increases in capex and other capital requirements in a way which I didn’t agree with.

Just for the sake of NPV adjustments (although I’m not condoning NPV as a representation of real value) here is what I put forward:

Let me know which parts you don’t like and we’ll go from there.

NPV adjustment

2017 BFS NPV 8 620mil
increases in capex (stage 1) 50mil -49mil

increases in capex (stage 2) 45mil -25mil

owner operator infrastructure 90-65mil +25mil

Taurus overrun contingency 50mil 0mil

increased in pricing compared +62mil

with 2017 BFS. Av 14% increase
assumed 10% increase in NPV

adjusted BFS NPV8 633mil

exploration assets +40mil
corporate costs (build) -89mil -79mil

corporate cost (build) tax credits +26.7mil +23mil

corporate cost (LOM) -100mil

(assuming it already includes tax credits)

NPV 8 (adjusted for corporate asset/liabilities) 579mil

*note I added in the exploration assets because I feel that a buyer will want to include those assets in any deal done.

Capital requirements

Stage 1 463mil

Corporate costs 89mil

Taurus capital guarantee 50mil

Taurus debt funding -247mil

$0.65 capital raising -20mil

NAIF Funding -95mil
2017 BFS contingency -24mil

Net capital required stage1 216mil


One on the biggest issues I had with your assessment was the section which looks at the return on investment for JVCo’s buy-in. With the stroke of a key your numbers makes it seem like the investment potential is “terrible”. No wonder we are still thinking a deal will not get done (and therefore a capital raising is a real possibility), who on earth would want to stick their money into this project with such ordinary “terrible” returns?

In actuality, if a party buys in at a 50% discount to post tax NPV8 they are getting a fully compounded 14.6% (fully franked) return over the enormous timeframe of 42 years. IRR’s, just like NPV are heavily influenced by the life of the project and getting a IRR of 25%+ for that period of time is not at all common when buying a fully developed “shovel ready” project.

Even buying in at NPV is arguably not a bad investment, that’s essentially what an NPV is suggesting, that this is the present value you should pay for the asset. In this particular case the only cost of getting almost double the 8% (fully franked) return is having to pay an upfront capex component (which incidentally is internally fully funded, essentially meaning it will cost the buyer no more than the investment risk and the opportunity cost of not being able to use the secured part of your balance sheet for other investment purposes).

This equates to a pre-tax IRR of over 20% for a 42 year LOM.


let’s work off a 33.33% sale as you did.

NPV valuation (33.33% of 579mil) $193mil

apply buy-in discount of 50% $96.5mil

purchase cost $96.5mil

stage 1 funding requirements $154.5mil

(33.33% of 463mil)

corporate costs(33.33% 89mil) $29.6mil

Taurus contingency $16.6mil

TOTAL capex contribution $200.7mil

(JVCo will debt fund their capex requirement using their own balance sheet as collateral. The above capital requirement of $200.7mil are included in the adjusted NPV calculation and have therefore been accounted for in the negative cash flow calculations in the NPV model. The loans are essentially self funded and will be paid down as specified in the NPV model.)

JVCo

Purchase cost $96.5mil
Debt Funding $200.7mil

TOTAL Capital invested $297.2mil

NPV value $193mil
debt cashflows (loan repayments) $200.7mil

NPV return $393.7mil

Thunderbird is not a project that can be meaningfully be valued by using on NPV’s . This is primarily because of the long life and the way that earnings in years 20+ are not given appropriate weighting. In 10 years time the project will have an NPV of over $1billion and in 10 years after that it will still have an NPV of over 1 billion.

It also has a much greater strategic value, not only to a player like ILU, but also to any company which ends up with this cashflow positive asset, it could be viewed as a company maker.

Thunderbird is a project that can be a stand-alone underpinning asset for a growing resource company, it can easily be the company’s base asset onto which more and more earnings can be added using it’s cashflow. BHP started somewhere, Rio started somewhere, and once a company gets established it’s then on the lookout for more and more investments using its positive cashflow and balance sheet to grow shareholder’s return on investment.

What I mentioned in the previous paragraph is assuming that the asset stays as a stand-alone company, however if you add this sort of asset into a company such as ILU which already has a strong business with a balance sheet to support the operation then the strategic value is even greater.

On top of that, if we look at the value of this strategic asset for a company like Iluka whose earnings profile is currently vulnerable due to existing assets being expended then the acquisition of supporting assets such as TB is much more than just a new income stream and would instead serve as being an underpinning asset for the whole company structure and setting it in play for another 20+ years of growth.

INCREASING RESOURCE BEYOND 42 YEARS

Another important point about using the NPV number as a benchmark for value is that it underestimates that there will be increases in the size of the resource as time and needs progresses - it’s quite obvious that the tenements contain more high grade mineral sands which sit outside of the current resource. But for now the company need not put money into proofing up a resource beyond 42 years, it can be done, but what would it prove? what would it add? it is now self evident that the tenements are mineral sands rich and that there will be plenty of addition stock feed to satisfy a longer mine life and/or support higher levels of production.

HIGHER LEVELS OF PRODUCTION

Speaking of higher levels of production, let’s also not under appreciate that with more available capital (as would be the case with a company with a solid balance sheet), the project can be easily redesigned to condense the revenues which are currently spread over 42 years into half that time, this will have a whopping effect on the NPV numbers.

What's on the table in the NPV calculations is what is determined to be the optimal mix in order to meet certain requirements ie, a small resource company getting a project into production optimally, however it is no way indicative of the real worth of the asset when it comes to selling the project.

To further demonstrate the short comings of thinking that an NPV number represents the value of an asset regardless of its profile (especially one with high positive cash flows, early capex payoff, and a long life) then consider this: what will the NPV of Thunderbird be after 6 years of production when most of stage 1 capex has been repaid from positive cashflows and there is no longer a capex component to be paid off from the future cashflows?

answer: the project will then have a NPV of over $1.2 billion dollars 6 years after production starts, and in ten years from then it will probably still have an NPV of over $1.2 billion. Many shorter life projects after 10 years have an NPV which is a fraction of what it was in year 1.

NPV valuations are much more useful for valuing a 4 or 8 or even 15 year mine life projects, however when it comes to a monster like Thunderbird you can't stick to that model and just add and subtract increases in capex.

So, when you say that you note the point that NPV is not everything, I would hope that people start to realise it’s actually not very much at all when it comes to the sort of sale process which is happening at the moment.

HOW A DEAL WILL BE DONE

Obviously each player will want to get the best deal they can, meaning paying the lowest price possible. However this is a real asset and at the end of the day there is real investment merit in buying the project or at least becoming a cornerstone partner which enables the project to become a foundational asset in a growing resource company. And the real likelihood is that there is a diverse group of international and national investors looking at this investment, entities ranging from sovereign funds, specialty funds, industry majors, and possibly even financing companies. There will be those who want it lock stock and barrel to add to existing operations, those who see the value in buying into a strong cash flow positive asset, and those simply looking to get a return on idle money which needs to be invested. There will be groups redesigning the models, redesigning the plant just to extract what is most valuable to them.

All of them will know what the asset is worth to them and they will need to be competitive if they are going to win the prize. The fact is that if you offer someone $1 for 50c its very attractive, so much so that someone else will probably jump in and offer 60c in order to get it, and then a counter of 70c and so on until a line is drawn.

These companies will not be relying on the companies NPV valuation, they will be remodelling the project in order for them to suit their requirements, to get whatever components are most valuable for them, some want the zircon, some want feedstock, some want LTR others just want to maintain their market control, and others just want a cash return on dollars invested.

SFX is one of the few companies where you’ll find management with such significant skin in the game. They know what the project is worth, their consultants who have put the project models together and have done all the metallurgy and design know what the project is worth, and in the end I believe we will see some serious action over who ends up owning this asset and the result will be based on the real value of the asset - an asset with strong positive cash flows and 42 year + life.

What I’ve written above is in part why I think a $200mil+ placement at sub 60c is in practical terms, off the table.

I simply can’t comprehend that those who actually know what a project of this size and quality represents can for more than a moment consider not being able to hand it over in an alternate form which would see existing shareholders better off than having to resort to a $200mil raising at @ 50c.

Don’t lose track of the likelihood that someone like ILU would acquire the project using scrip, they wouldn’t even have to fork out cash for the acquisition, and the additional capex requirement would be debt funded using their existing balance sheet.

SFX management have a lot to gain by selling to a buyer without the need to dilute the existing capital structure.

So given that’s the case contemplate, and let’s be brutal, Iluka being offered the company for 90c a share through a scrip bid, can you see that getting passed up? that’s less than $250mil for the asset, an asset that will underpin their business for the next 20+ years and will have a project NPV of circa $1billion+ for the foreseeable future after the capex is repaid. I can see a major paying twice that figure if they found themselves in a competitive bid scenario, maybe more, and frankly I don’t think 90c is at all realistic, it just wouldn’t fly, I think low end would be $1.20 (and that would surprise me) if it came to a takeover scenario. But even if it turned out to be 90c which in my opinion would be too much of a steal to walk away from, that’s still a 50% return from current levels.

SO IS A CAPITAL RAISING CURRENTLY CONTEMPLATED OR HAPPENING?
You wouldn’t see 50,000 shares sitting on the bid at 61c for any extended period of time as we saw on Friday, if it was.

SO HAVE NEGOTIATIONS FAILED?
I don’t even think they’ve begun. We’re talking about a big project and a serious commitment, a lot of the investors that UBS will be pitching to will need to do their due diligence, will need to re-model the numbers and maybe even the plant, even though the data room has been open for a year or more, many wouldn’t have really got serious until this process was commenced. I’m sure that SFX external consultants will be having meetings with any party who is really interested, it would be part of the due diligence, and from what I gather once the various party’s speak with the consultants there will be no denying the robustness of the project. All these things take time, and in many cases I suspect will have to be fairly tailored negotiations, that’s why we haven’t been given a time frame.

SO WHY IS IT ALL SO QUIET?
I feel it’s because there is a process to this sort of thing, there is protocol.
The appointment was made on the 14th of January, that’s just over two months ago, I’d be surprised if any formal figures have even emerged yet. Many interested parties will be staying as silent as possible, they would have needed to take a seat at the table, it’s almost certain that by now all parties who have any interest would have needed to sign up to the process. Even if simply to tick off that they have done their job for shareholders any company in the industry would have been compelled to sign up, so I suspect that cards haven’t even started being put on the table, and SFX management and the corporate advisers themselves still don’t have any meaningful indications.

We all know how things work, once something even mildly concrete presents, then the share price will move accordingly, and having said that we may be surprised to find that an announcement hits us out of left field.

I really don’t think that its all that sensible to read a lack of news as well as a lack of share price movement as bad news. After all SFX are probably just as bound to non-disclosure as those parties who sign up to the process. I wouldn’t imagine that they couldn’t really put out an announcement saying that 18 parties have signed up to the formal process and so on.

Based on what I’ve written above it’s fair to say that I don’t suspect that the share price will determine at what price a deal gets done, but rather it will be determined by the assets real value and hopefully in a competitive tension environment, which I think is realistic. Having said this the share price is not entirely irrelevant, it will be looked at as a benchmark of what the shareholders have as an exit option, and therefore thinly traded is good and a rising price is also not going to hurt.

The most dangerous thing about a low share price (which doesn’t represent value) is that it leaves the door open for a party to circumvent the formal process and launch a hostile takeover or bear hug, and then if no other suitors emerge the bid will in part be benchmarked against the last 30 days trading price.

So, in closing, I believe the shares are trading at 60c because of the remnants of sellers who had had enough and were afraid of being hit with a large capital raising, as I’ve explained above I just can’t see a $200+mil raising eventuating because it will dilute existing holders down far too much to make it the optimal route.

I’m just a very long term share holder and my view on this asset remains strong, I recently looked at the price as a great opportunity and still do, even if the stock very gradually drifted up to 90c on very thin volume and it was clear that a corporate transaction was still unknown I personally wouldn’t think of selling given the upside under certain scenarios coupled with the limited downside in my opinion.

I hope that what I write gives people a perspective that becomes part of their mix of assessing how to play the game.

Thanks for hearing me out. I don’t intend any of the above to be considered as investment advice, I am just highlighting how I see things at the moment. I don’t know anything with certainty, so please take everything here as just a relative opinion, however, having said that I can assure you that everything I write is for no other purpose than sharing my honest opinions of how I currently see things.


Out for now