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Skardon River takes another bite
27/04/05
The two great hazards of Skardon River are crocodiles and convertible notes, and Pierpont is by no means sure which are the more dangerous. After all, the local crocodile (affectionately nicknamed Pierpont by Vic Alexander) has never yet bitten anybody, but there must be a few punters limping after their last encounter with Minerals Corporation convertible notes.

For the benefit of readers lucky enough to have never heard of the place, Skardon River is on the west coast of Cape York, about 130 kilometres down from the cape's tip. This remote location has been a great hindrance to the plans by Vic's Minerals Corporation to develop Skardon River as a kaolin mine.

Most Australians may never have heard of Skardon River but a few investors have, because their money is at the bottom of it. The first company to have a crack at Skardon River was Australian Kaolin, which reckoned it would be producing 175,000 tonnes a year by 1998. Australian Kaolin spent some $120 million including $80 million on a plant before collapsing in 1999. Shareholders were wiped out.

Minerals Corporation scooped up the project from the receivers in 2000 for $6.5 million. In the five years since, Minerals Corporation has poured several million dollars more into Skardon River but still hasn't got the project up and running. Vic, as managing director of Minerals Corporation, keeps promising that the end of the tunnel is in sight, but there always seems to be more tunnel and more money needed from the punters before they reach the daylight.

Since acquiring Skardon River in 2000, Minerals Corporation has raised more than $50 million in equity and net borrowings. Some of this would have been spent on Minerals Corporation's other ventures in Western Australia and China, but probably half of it would have gone into Skardon River.

Nevertheless, Minerals Corporation still needs money and now has a prospectus out to raise $10 million in convertible notes. Pierpont sees this as a real test of the market's faith in the minerals boom, because subscribers to the last one had a bumpy ride.

Back in 2001, Minerals Corporation offered the punters 10 million $1 notes. The notes bore 11.5 per cent interest and would convert into shares in three years. The conversion was at a maximum rate of four shares per note, which meant that if Minerals Corporation shares went below 25c, the punters would take a loss.

The purpose of the issue, Vic said, was "to fully develop the Skardon River kaolin project to regular successful operation". And "to recapitalise the group companies with a three-year note to pay off short-term debts".

Somewhat to Pierpont's surprise, the issue was oversubscribed. Minerals Corporation flogged $11.3 million of the notes, helped greatly by the enthusiasm of the Chinese community from the northern Sydney suburb of Chatswood, who took up half the issue. Everyone who subscribed received a ripper yield on the notes, but by 2003 the shares were down to 12c and it was plain the note holders were going to take a bath when they converted.

In October 2003, Minerals Corporation offered holders an escape chute. The note holders were given the option of converting their note into a debenture with a coupon of 10.5 per cent. These mature in September 2007, secured by a charge over everything that isn't secured by lease charges already.


More than 9 million of the 2001 note holders swung into debentures. They're still receiving a rich yield, so Pierpont can't say they've lost money yet, but the thinly traded $1 debentures are around 90c on the market and have been as low as 69c.

Those note holders who hung on and converted have been heavily bitten. Their notes converted into shares at 25c and are now quoted at 8c. So the 11.5 per cent yield was nice, but they've lost two-thirds of their capital.

Now Minerals Corporation is offering another issue of convertible notes for up to $10 million. These notes bear interest at 9 per cent, which means the interest rate on Minerals Corporation stock is falling while official interest rates are rising.

The 2005 notes will be redeemed at face value of $1 in March 2008. Alternatively, holders can convert them into shares in Minerals Corporation or its partly owned subsidiary Australian China Clays at a 15 per cent discount to market price in 2007.

The $10 million from the issue will fund Minerals Corporation's quarrying projects in China, its WA kaolin venture and, of course, Skardon River. The prospectus says interest on the notes is expected to be paid from "the emerging cash flows of the Skardon River kaolin project".

The trouble with this expectation is that it's been around a long time. Investors have been waiting for emerging cash flows from Skardon River ever since North Melbourne won its last premiership.

Kaolin is a type of clay that is used to add whiteness and body to a range of products, including paper, paint, plastics and ceramics. (A thin sheet of paper would be transparent without kaolin.)

The plan at Skardon River was to first dig up the kaolin and then put it through a wet plant that would remove grit. The kaolin would then be slurried 16 kilometres to a dry plant where it would be dried in a calciner (kiln), bagged and shipped overseas to buyers.

By the standards of the mineral-processing industry, this is not an overly complex plant, but it has suffered endless delays.

In the 2001 prospectus, Minerals Corporation reckoned Skardon River would be the company's major cash generator and profit earner by 2003. Indeed, in November 2001, Minerals Corporation even announced that kaolin production had begun. That announcement was made a fortnight after the 2001 note prospectus was launched. Production must have stopped soon after the prospectus filled, because kaolin has been produced in only small parcels from Skardon River ever since.

One major cause of delay was the calciner. Another big handicap is shipping. The Skardon River is shallow, with a sandbar at the mouth. That meant the bagged kaolin would have to shipped out by barge and loaded onto ships somewhere else around the Gulf of Carpentaria a double handling that would raise transport costs.

The 2005 prospectus says the plant, including the calciner, has now been commissioned. If it has been, then it was switched off again, because the March report from Minerals Corporation said that only 900 tonnes were produced during the quarter because shipments were delayed by cyclones. That's barely enough kaolin to coat all the paper the company has issued to its investors.

The plant could have had only very short production runs to date. Nevertheless, Minerals Corporation must be confident it will work well when it turns the switch on again because it's predicting output of more than 80,000 tonnes in 2005-06. That's a very fast ramp-up for a mineral-processing plant and one that strains Pierpont's credulity when he thinks of all the past delays.

If the plant doesn't fire up on cue, subscribers to the 2005 note issue may wonder how they're going to be repaid. One way will be through the Cornell Equity Credit Facility provided by a US investor.

Under this facility, Cornell buys Minerals Corporation shares at a small discount to market whenever Minerals Corporation needs extra dosh. The company still has $8 million left in this facility, which it proposed to use to repay the notes.

The flip side is that the use of this facility will dilute the equity of existing holders by triggering a further 100 million shares onto the market, depending on the share price.

Another $2 million will be provided by the release of a St George Bank facility, but the bank will make this cash available only if regular production is achieved at Skardon River.

For a company that has not yet achieved positive cash flow, Minerals Corporation is getting well geared. Assuming Minerals Corporation raises its $10 million in convertible notes, it will have total debt of $107 million, including $95 million in plant leasing liabilities that stretch out to 2017.

Total assets will be $140 million, but half of that is the value of the plant, which has yet to really do a big production run.

Further, Minerals Corporation is now planning to load some of the wet, degritted kaolin onto barges and ship the wet clay to Port Moresby so that it can be dried and bagged there before being exported to China or wherever.

Minerals Corporation says it is doing this to take advantage of lower energy costs in PNG, where it can buy cheaply the gas that would otherwise be flared from Port Moresby's new oil refinery. The gas might be cheaper, but Pierpont would hope they could establish a new dry plant and bagging operation at Port Moresby for a bit less than $120 million. Otherwise Skardon River won't be into positive cash flow until some time next century.

You can contact Pierpont at www.pierpont.com.au