consolidation considerations

This is a long post – you have been warned...

(and when I previewed this post the second half persisted in remaining in BOLD - apologies for that...)


CONSOLIDATION CONSIDERATIONS

Is consolidation an action the company is able to take? In my view the company is incapable of undertaking that action presently, due to our continuously increasing share register, and uncertainty surrounding the intentions of seriously vested interests.

Currently I would be happy to see a 1 to 1,000 consolidation, but the whole question of a consolidation really doesn’t solve or adequately deal with the ongoing dilutionary threat posed by the Secured and Unsecured Interest Bearing Notes.

Of the Secured and Unsecured notes both are convertible to ordinary shares -- nearly 204 million Unsecured notes were issued in 2006, raising just over $27 million --- by 2009 there were some 143 million of these notes remaining unconverted – by the end of 2009, 77% or approximately 110 million were converted to Secured non-interest bearing notes.

The 2009 conversion event was the biggest sweet heart deal in Australian corporate history, in my opinion.

SECURED & UNSECURED NOTES

Since first being issued as an Unsecured notes in 2006, we now have approx 139,366,674 Secured and Unsecured Convertible Notes remain.

Each type of note has a Face Value of $0.135 - each is convertible to shares by dividing the Face Value by the lesser of either $0.0105 or 90% of the VWAP of the SP.

Clearly conversion benefits a note holder when the SP is sub $0.135 – like when the SP is 0.1 of a cent, like now.

ASOF SECURITY

At the end of 2011 the company appears to have breached its agreement with ASOF, resulting in a settlement that saw the company returning $230K to ASOF of a $700K loan, and then converting the balance owed, $470K, into an unsecured convertible security valued at $700K – in other words, the company received $470K and in return provided ASOF with a $700K convertible security, where conversions occur basically at 90% of the SP. Remember, this is a convertible ‘security’ not a ‘note’, so it isn’t redeemable so it can only convert to shares.

Between 5 January and 20 February ASOF has converted $525K of its security – before doing this the share register recorded 2,782,478,264 shares – ASOF up to 20 February added 513,888,889 shares to the register, effectively diluting pre-existing share holders’ interests by over a nominal 18% -- thank you MST Board, you really know how to add value for existing shareholders...

ASOF still have $175K of their convertible security to go, which WILL see another 194 odd MILLION shares being added to the register, representing a further nominal dilution of 5%, and moving the register above 4 BILLION shares...

DOYLE SECURITY

Back on 2 December the company announced and issued to Andrew Doyle 20 MILLION convertible securities with a Face Value of 0.01, and a 90% of VWAP divvy. Remember, Andrew was part of the 17 October ASOF group announcement, but later struck on his own a little to grab this bundle. Again, they are not redeemable and can ONLY convert to common shares.

Of these 20 MILLION, he converted 5 MILLION to 55,555,555 common shares on 29 February, leaving 15 MILLION still to convert. Strange thing is, both the subsequent 2 and 4 April 3B announcements fail to show the remaining 15 MILLION he holds, so I believe there has been an error in those 3Bs.

Nonetheless, and assuming Andrew converts while the SP is on the mat, (which he really must do), then he will add another 166,666,666 shares to the register.

OTHER SWELLINGS TO THE REGISTER

There are four (4) other major increases to the share register in 2012 that I can’t account for – 27 January, 31 January, 2 February and 6 February – each is said to be in respect of a ‘Subscription Agreement’ I can’t find evidence of, though I suspect it has something to do with ASOF again.

In total this Subscription Agreement has on these 4 dates resulted in a further 344,444,443 common shares being issued at $0.0009 – once again, thank you MST Board for safeguard the value of my investment...

ASOF, DOYLE & SUBSCRIPTION AGREEMENT

Adding together the Subscription Agreement and what will be further conversions from ASOF and Doyle, and in total these three sources of dilution will total an additional 1,274,999,997

Remember now, before ASOF came onto the scene, the share register before options and other Secured & Unsecured Notes, held 2,782,478,264 shares – with the MST Board making deals with under the Subscription Agreement, Andrew Doyle and ASOF, it WILL swell to 4,057,478,261.

Yes, that’s right - 4,057,478,261 shares – where for comparison sake, as of 1 January 2010, the register showed ONLY 791,858,986 shares – therefore this MST Board has done an effective job of destroying shareholder value over the intervening period, diluting your 1 January 2010 interest by over 85%... do you still think the men on this Board are worth the money they’re paid?

Since late 2011 when the MST Board began giving away convertible securities to ASOF and Doyle, pre-existing shareholders have had their equity diluted by more than (nominally) 45% - and this nominal dilution will be further increased with option exercises and the actions of those who still hold the original 2006 convertible notes – the now Secured and Unsecured holders, where Harmony is a substantial holder of the Secured notes.

SOME QUICK NUMBERS

Currently, our capital structure is as follows (plus or minus a few million):

Ordinary Shares:>/b> 3,921,252,117

Secured Notes: 107,098,880
(Face Value $0.135 - convert at 0.0105 or 90% VWAP)

Unsecured Notes: 32,267,798
(Face Value $0.135 - convert at 0.0105 or 90% VWAP)

Unlisted Options: Sep 2012 @ $0.001 – 35,215,403; Sep 2013 @ $0.015 – 1,351,116,999
(I have purposefully excluded many other options that are way out of the money)


It remains questionable whether the Sep 2012 options will be exercised. No matter who is holding them, at $0.001 they remain very relevant and in my view, necessary to convert, which will add a whopping $35K to the MST coffers.

The company and market is waiting to hear what successes transpire with respect to Colt, the MPM-NLWS contract, and the degree of MST involvement in the US Military Force Protection Program. One or more positive announcements about each should easily see the SP rise off the mat a few points of a cent, so easily placing the Sep 2012 options into the extraordinary profits category.

Similarly the Sep 2013 options should get exercised – but that’s a SHOULD only at this time. From $0.001 to $0.015 represents a massive 1400% rise in the SP from its current ‘level’.

The 2013 options represent approx $20.3 million in funds for the company. But they require the SP to be above $0.015, (possible with several favourable contract announcements per above), AND for the substantial holders of those options to NOT be note holders.

Fortunately some 722 MILLION odd of those options were spread amongst all shareholders following the 2010 capital raising, with another 170 MILLION of the same options going to two private placements at the same time.

However there are another 460 MILLION of these 2013 options that I do not know who holds – I can’t see them as being held by employees of the company, and searching through the many of the Doyle related announcements hasn’t shown anything – (any help here would be appreciated) – so trying to fathom the likelihood that these 460 MILLION options will be exercised is impossible, except to say that if the SP is at or above $0.015, they’ll probably get exercised.

SECURED AND UNSECURED NOTE HOLDERS – THE REMAINING CONCERN

If all notes were exercised today, they would increase the common stock by 20,905,001,700 – that’s right, by over 20 BILLION shares – that’s called a DILUTION event.

If first the SP rose above 1.2 cents, and then all current notes were exercised, the common stock would increase by 1,791,857,288 shares.

The above scenarios do not take into consideration the further impacts from option exercises.

Finally, if the company was able to redeem all notes today, it would cost approx $18,814,501.

GENERAL OBSERVATIONS

From a reading of the Trust Deed governing how the company can act in respect of Secured and Unsecured note holders, it is APPEARS that a consolidation CANNOT occur without the prior consent of the Trustee for the note holders -- so any idea of consolidating now by say, 1 common share for every 1,000 common shares held, which would bring the SP up to about a $1 a share, would not necessarily be rejected by the Trustee, as the conversion price for all note holders would still be an attractive be 0.135 (divided by) 0.0105, so giving each note holder 12.86 ordinary share for each note – sure, any current conversions deliver 150 common shares with an SP of $0.001, but it must be kept in mind that these notes were originally issued back in 2006 with some expectation of the SP possibly being above $0.135 before they matured, in which case note holders who didn’t want to redeem where the SP was above $0.135, they would have had to accept 1 common share for each note under the old conversion formula – so still getting 12.86 common shares after a consolidation where a note holder didn’t want to redeem is pretty good business.

This isn’t a small issue – the Trust Deed effectively prevents any actions by the company that would adversely affect the interests of note holders – so a very important question requiring legal clarification by the company, is whether in fact a consolidation of say 1,000 to 1 does adversely affect the interests of the note holders – in my opinion it would not be viewed as an adverse outcome.

Under such a consolidation what would be the detriment to note holders? As far as I can see, none. Why? Because such a consolidation would make every resultant common share worth $1.00. If you are a note holder, you are entitled to convert at the conversion rate, to receive a certain number of shares. As the conversion equation allows for a Face Value (divided by) 0.0105, then each note would receive 12.86 common shares, valued at approximately $12.86 – so a note holder who bought each note for $0.135, would end up with 12.86 common share for each note, valued at $12.86 – a profit of over $12.73, plus previous interest payments already made (approximately $7.5+ million odd), and factor in all the unlisted options these note holders possess, then we start to arrive at an outcome from consolidation that is in fact to the detriment of all non-note holding shareholders...

In other words the company would be handing note holders profits rarely seen before in corporate history, which many could and probably would argue are in fact capital gains better left with the company, and by a similar reasoning, monies that should be shared with all common stock holders, not just note holders.

So what to do then?

The issue of seeking to redeem the note holders is similarly vexed. The company CANNOT easily accelerate and force redemption of the notes. The Trustee for the note holders would have to agree to this, and it would have to be on favourable terms to avoid note holders bringing an Extraordinary Resolution against the Trustee barring the Trustee from taking any action to complete redemption.

But if the redemption terms sought by the company are favourable, say paying Face Value (divided by) a an Amount close to 0.135, the Trust Deed does allow the company the opportunity to seek accelerated redemption, but it CANNOT force all note holders to accept accelerated redemption – it would only be an offer capable of acceptance by those note holders who want to take the cash. Bear in mind, note holders who do accept would still be able to retain the many free options they have already been given, and those same note holders have also received earlier interest payments under the Unsecured notes before most of the remaining notes were converted to Secure notes in 2009.

In other words, an offer by the company NOW to redeem notes at or very close to Face Value would be an extremely favourable outcome for most note holders, chief amongst them being Harmony who hold the lion’s share.

Of course any such offer of redemption would require funds the company presently does not have, thus the talk that has seemingly been going on forever, of the need for a Cornerstone Investor, someone prepared to make the redemption funds available, but at what price?

And here lies our next eat sticking point – at what price does a Cornerstone Investor provide these funds – or stated differently, how much equity does the company give to the next White Knight that gallops in the door?

Consider this then – it’s not just a conversation between the company and the Cornerstone Investor, but one that very much involves the note holders, particularly Harmony who hold most of the majority Secured notes.

Currently Harmony hold most of the Secured Notes of which there are about 107,098,880 -- now try converting these to ordinary shares today --- 107,098,880 (times) face value @ 0.135 (divided by 90% VWAP) @ $0.0009 = 16,064,832,000

That's right -- Harmony could, for no cost whatsoever, convert tomorrow and receive over 16 BILLION SHARES.

Therefore the status quo is this - Harmony could easily seize control of the company, and in the process dilute many shareholders out of any meaningful existence --- with the current SP sitting on the floor at $0.001, then your common shares would be worth less than $0.0002 – as such, Harmony appear to be holding all the cards at the moment.

So the rest of us non-Harmony punters find ourselves between a Rock (potential Cornerstone Investor) and a Hard Place (Harmony holding a strong deck), with an abundance of ‘known unknowns, and unknown unknowns’ swirling in and through the whole mix...

The ‘known unknowns, and unknown unknowns’ are all about impending contracts we hope to receive, (in ‘the pipeline’ interests), and the number of interests who could at any time submit a large order from out of left of field, or who may commit to partnering with us, like Colt for instance.

First thing to note though, is that Harmony CANNOT afford to currently convert all of its notes at this time, as to do so would place their entire interest at real risk while no company making contracts have been signed.

Sure converting and owning 80% odd of the company looks cool, but a company with no contracts, that needs money to ramp up production when contracts come in, means it’s a company that would still need a substantial Cornerstone Investor, meaning Harmony’s 80%+ interest could or would be quickly diluted down as well, in order to satisfy an incoming Cornerstone Investor with sufficient shares – but of course, Harmony may be prepared to wear a substantial dilution, especially if it still ended up owning a substantial portion of the company, because with real contracts coming in, (from the US military and Colt products for instance), the future value of any real substantial share holding would be worth a fortune when measured against any current share holding values today.

But the above paragraph is fantastical it must be said, especially in the context of a consolidation having occurred, which would mean the nominal market cap of the company was all of a sudden in the billions – a pure fiction and back of the envelope exercise at the moment...

SOME CONCLUSIONS

It seems pretty clear that the likes of ASOF, Doyle and to a lesser degree Harmony, have been treating the first half of 2012 as a period for converting to shares – no doubt each is eyeing the other, wondering how this whole dilutionary event will end in terms of substantial holdings.

In my view the clear out-and-out favourites are the Secured and Unsecured note holders, who count Harmony as a major player amongst their ranks – they just hold so many of the damn things (thanks again MST Board!) – but Harmony have to tread carefully, as converting too much could seriously skew the on-paper economics and value of the company, leaving them with many capital short-falls when the time for true production arrives...

For what it’s worth, I believe the onus is upon all remaining ordinary shareholders to lobby this Board hard, and repeatedly, to NOT contemplate a capital consolidation before the SP is made to rise well above $0.015 and well before September 2013, so to ensure the 2013 options get exercised fully – and THEN the company must be told to work very hard to use that money to redeem all Secured and Unsecured note holders – this optimal scenario would take the threat of further substantial conversions from the note holders away, while it would mean the company only needed a Cornerstone investor to assist with production costs for real contracts.

If the 2013 options are not fully exercised, making it well nigh impossible to come up with the necessary cash to make early redemption for note holders attractive enough, then the company will be in a situation of having to sell all other shareholders down the river again, by seeking a Cornerstone investor who will not only help with production costs, but also for paying out the note holders, inwhich case the Cornerstone investor will become our major shareholders and controlling interest, in my opinion.

LESSONS

I really think there is only one to be learnt here – you simply CANNOT accept what your Board says as always being in the best interests of the company, especially when they utter “shareholder value” in the same breath, because to me this MST Board has only delivered that value for a select few now, after so disastrously bungling earlier capital raising events – being just so bad at raising capital is the true weakness of this Board, despite how often they manage to do it – that just can’t do it a few times, but multiple times, and with each new raising more and more of the company is GIVEN away to Johnny Come LateLIES...

Anyway, the future fortunes of most remaining ordinary share holders, (and I mean ordinary in terms of all those unassociated with Conertible notes or securities), remains grim, and a massive uphill battle...

It's when you do the numbers like above, you start to see why this Board doesn't bother buying shares in this company, or worry about asking for performance options, because of the simple fact they will be diluted to the point of being worthless in due course -- thus why they opt to take obscenely high salaries instead.

And why are they obscene salaries?

Well just look at what these highly paid men have delivered - no truly commercial contracts, and only truly incredible prospects for the state and value of the share register, one in which over 80% of the company seems assured to go into the hands of just a few, for an obscenely small price (think around $20 million in the absence of any great contracts), thereby showing a history of years of hollow words, all in an effort to get your money...

Will a visionary new manager or group of managers save this company from being given away?

... unlikely, but no one really knows right now.

I look forward to your comments and pointing out any necessary corrections to the above.


good luck