Bargain Bin Special

I was going to title this post "Fire-sale" but that's cuts a little close to the bone and I've probably already niggled management enough recently. I'm not just referring the the SFX share price, let's look at how well have Yansteel (YS) have done with this deal. There was some confusion about what they paid to buy 50% but there shouldn't be, it's pretty clear.

There are a number of paths this final JV deal could have followed to arrive at the same outcome. For example, SFX could have sold 50% of TB to YS for $65M on the agreement that both parties then contributed their 50% TB ownership and $65M cash into a JV company to develop the TB deposit. Same outcome as both parties making their asset contributions straight into the 50:50 JV company, in what was described as "Yansteel to invest A$130.1M to acquire 50% of the project". The word "invest" does not mean "paid" which is why the word "paid" was not used.


However you structure it, the outcome is a JV company with enough equity required to meet debt requirements and develop TB. The point about YS investing $130M to acquire 50% is pertinent. Unless YS agreed to also fund JVCo for $65M as their share of development equity SFX would never have sold them 50% for $65M. There would be no deeal. Sale was conditional on providing enough funding to develop. We wait for the new BFS figures but using a round $1B post-tax NPV8% for TB value, YS just bought 50% of TB ($500M value) for 13% of it's value ($65M). SFX sold them 50% of TB at an 87% discount to value, hardly sale of the century...

Keep in mind that all development capital equity is added back onto NPV value because the NPV already includes repaying all the capital from free cashflow. For example, if all $400M of capex was paid for with equity instead of debt then the value of TB would be $1B NPV + $400M capital add-back = $1.4B. Using all debt capex to develop then value = NPV, but unfortunately no lender will lend 100% of the capex and working capital etc. Point is, the $65M cash each partner has contributed into the JV is not an expense but a start-up investment that will be returned over time in addition to the project's other free cashflow returns. YS paid $65M to SFX benefit to buy 50% of TB, a bargain indeed.

Another way to look at what a bargain is on how much capital SFX have raised and spent over the last decade to explore, discover, complete feasibility studies, fully permit and spend on early works for this great project. From the Dec 2019 HY report we can see SFX have raised $117M to date, a figure that excludes much of Carrawine and those assets were spun off a few years ago. For half of TB, YS haven't paid much more than half what SFX have raised and spent to successfully bring TB to the point of development. Makes junior exploration and development look a mugs game when investors can come in at the end and grab half of the few successful deposits discovered at cost, but that's reality for junior resource explorers.

On one hand it's a pity YS didn;t come along during the last structured sale process in 2019 when there was at least some competitive tension with potential PE investors. On the other it's just as well they came along at all because nobody else seemed interested, and by definition only interested at lower prices than SFX just agreed to. So SFX have done the best deal they could under the circumstances, good luck to YS. The deal also included a placement for 10% of SFX, so in reality YS beneficially own of 55% of TB (50% in JV and 5% through SFX holdings). By definition pre-existing Old SFX holders now only own 45% of TB given the YS share placement dilution. The price to pay for funding was selling 55% of the project.

That YS placement at 37.6c was calculated by dividing the $130.1M equity investment by 346M total shares on issue after YS was placed 9.9% of current shares. It's interesting this 37.6c is also the share price SFX would needed to raise at in a market placement capital raising for the same $130.1M equity funding and $12.9M working capital. That is, 37.6c is the placement price and dilution equivalent funding alternative leaving pre-existing "Old SFX" shareholders with the same 45% ownership in TB as they end up with under this YS JV deal. As per the table below, SFX could have raised $143M TB development equity/working capital the traditional way by issuing 380M new shares at 37.6c (except when the share price was 10c they could have got anywhere near that price for a CR, a CR funding option was impossible). It's instructive though because it makes very clear what this complex deal is equivalent to in terms investors might better understand.... issue 55% of the company to new shareholders at 37.6c and move forward to development.



The other two JV Options tabled show what the theoretical value of SFX is depending on whether capex ends up costing $130.1M or $143M. If capex ends up costing $143M then SFX shareholders have to pay 100% of the capex increase beyond $130.1M (ie $12.9M). Half of that $12.9M invested into the JVco will be for the benefit of YS and thus only half the value accrues to SFX. Either way it's not material to SFX value unless we don't have the money spare and then do another diluting CR to raise it. If management could have got an extra $13M into the JVCo from YS and left SFX with $13M outside the JV for working capital and corporate costs it would have significantly reduced the risk of a future CR. No competitive tension, beggars can't be choosers, we got the deal we got.

YS must be laughing, they secured security of a 40 year off-take for their new pigment business and bought 50% of the project to vertically integrate their business at a 87% discount to post-tax NPV8%. If TB is valued at $1B discounted back to today, then 50% is valued at $500M which represents an instant 770% profit on their $65M purchase price investment. Bargain! So much for strategic premiums lol. Multi-bagger returns are common enough in junior explorers but usually at the beginning by early investors, not at the end by off-take investment partners. The upside is that YS now stands as a very firm off-take buyer likely to honour take-or pay contracts, maybe even on generous pricing terms. TB represents a very valuable and profitable investment for YS's private owners held safely outside of China, a lot more valuable than the $130.1M investment price. Great partners to have and unlike a market placement funding option, they will not be selling down SFX every 5c move north over time like broker clients.

Note the $12.9M investment into SFX shares is quite a separate asset in it's own right, just as SFX shares I bought are an asset to me. If SFX tips that $12.9M into the JV for extra capex, YS still own their 34M SFX shares worth $12.9M at 37.6c, worth $26M @ 75c etc. Please don't tell me YS have contributed that $12.9M into the project, they have just bought SFX shares to provide working capital like everyone else in other CR's. It's all SFX shareholders together that will tip in another $12.9M in the JV if required, not YS, and we will all feel the pain if it comes with another CR.

Hopefully that clears up what the deal actually means for all parties. Even if it' was too cheap, SFX still come out of this with a good, value-adding deal that get's us developing TB. That theoretical SFX value table should be rounded down to $1.50/share after taking account of LOM corporate costs etc but it's a good rough value. Upon FIRB approval SFX will be sitting on 23c/share cash ready for development as their share of the JV, cash raised at the equivalent of 37.6c/share. Show me any other developer who raises the equivalent of $143M at a 37.6c placement price on a $1B post-tax NPV8 project, leaving them 23c/share cash backed, but the market prices them 10c below the CR price and only 5c above cash backing? Talk about Bargain Bin Specials all around this deal, crazy stuff.

Either the market is heavily discounting the chances of FIRB approval, the company/project/industry is more hated than I imagined, or we just have to wait longer for stale holders and profit takers to wash out. I expect results of the new BFS are announced sometime soon, other off-take deals etc, but FIRB approval is obviously the real price driver which although 2-3 months away should see SFX up into the 50's. I think FIRB approval's almost certain for multiple and compelling reasons, so I see today's price has 100% upside over 2-3 months is my bottom line.

Good luck