building a case for a conti play -2

Thanks to all those who are still with me.

This post that I am writing now is very important to explain how I see things.

I have been reading some of the posts on the this site for sometime and it saddens me to see so many people have lost so much money on Continental Coal. There is an air of deep anger, bitterness and despondency about the prospects of the company under this management. Not having known the company for very long, I have found some of the posts very useful (like the ones by bigbillbrown)to understand the background of the company/management. I have my deep sympathies with the Aussie crowd but I do think they are missing one important point.

In the resource bull cycle, if your company hasn't already made it big (and there are great success stories like Fortescue or Linc Energy and many others) by the time the credit cycle peaks (2007-2008), life for a small explorer/developer is likely going to be much harder on the other side of the peak. Until 2007-2008, most small miners had blue sky valuations. Reality dawned when credit conditions worsened and the challenge was to bring the assets to production. You see, mining is very expensive for a small firm even in normal circumstances: high capital costs, possibly high acquisitions costs, high regulatory and environmental costs, long lead time to projects, gut wrenching commodity price movements, dealing with labour problems and safety issues, thinking about logistical complications in selling resources, and if you add to this the difficulties in accessing finance (lifeblood for small miners) on the other side of the credit cycle peak, it is true that most small miners will lose you money beyond 2008. The trouble with Conti Coal is that they came to the coal business around 2008 - very late in the cycle. And once you saw the European crisis and the inevitable China slowdown (from lower European and world demand), investors should have been careful in putting too much money into Conti.

What has the management achieved positively so far? The positives would include the identification of unlisted Mashala with attractive resources and assets (coal washeries, rail sidings, rail allocations, RBCT port allocations) in the Witbank-Mpumalanga area. I think it was Turvey who identified Mashala during his BHP days. Mashala was unlisted and hence did not have easy access to capital. The wheeling dealing ways of the rest of the managemnent allowed them to access capital to buy out Mashala, raise additional capital to start Penumbra and Vlakvarks. Ferreira was already producing with Mashala but Conti has extended the project life of Ferreira by buying additions around it. Technically, all this is no mean achievement at all in this short span of time (although a lot of the success has got to do with the attractiveness of the Witbank area to bring a new project to production once you have the money). If only they did not promise so much more within this timeframe (which clearly was unachievable in a finance starved world) and they did not dilute the shareholders to very little, the management would have looked much smarter. They have also replaced the Mashala
as a BEE (Black Economic Empowerment) partner with a much more financially stronger Sishen. Mashala was very weak and unable to pay their share of financial costs on most occasions. At least we have three producing mines and several very good assets - most junior miners have very little productive assets - Conti can at least grind on unlike so many others. Higher coal prices will help as the coal cycle turns and their cash flow will increase with additional Penumbra production.


This is an important paragraph. Where to from here? I think if the current management tries to push the other assets to production, grind on is all they will get. It will take a decade or more to raise finance and carry the lengthy production work on the various assets (leaving aside Botswana). Meanwhile shareholders will forever be scared of dilution. Debt financing will always be very expensive. It really is an end of the road for the current management seeking any kind of growth unless financing conditions dramatically improve, a possibility I discount with a high probability.

Another important paragraph. Is all lost? Far from it. At current low share prices, it opens us to extraordinary possibilities of making money in the short/medium term even if you do not trust the current management's skills in the long run. To see this, realize that the current low share price is some market estimation of NPV from the assets with high discount rates (because of high financing costs) and long slow returns over the further side of a decade or more. Just for once now mentally calculate the NPV of the same assets in the hands of a deep pocketed player. Financing costs could drop by a half or possibly more. In a liquidity trapped world where finances only go to the big deep pockets easily, the finance costs differences could be huge depending on whether you have deep pockets or not. So discount rates would drop for a stronger holder. A deep pocketed player will also be able to bring these assets
to production potentially in as little as two or three years. Remember, this is Witbank and if you have the money, there are very few easier places in the world to bring thermal coal assets to production. Also, we know that there is huge demand for South African coal. The bringing forward of the return stream and the reduction of the discount rate makes the new NPV for the deep pocket player to be many many times higher than that with Conti coal's management. Economically, the assets need to change hands to deeper pocketed players to realize this higher NPV. And a properly organized and played bidding process on the assets will do just that. If there are many such strong bidders, we can extract a lot of this difference in the sale price of the assets. There are many such deep pocketed players available like Glencore, Anglo Coal, Exxaro, BHP, Tata power, Jindal, Coal India,
NTPC, Reliance power, RP Goenka who fit the bill. It is bringing as many of these firms to the bidding table as possible which ought to be the management strategy.

Is there anywhere else that Continental Coal's management is indispensable? I doubt very much. Witbank Coal mining is no big mystery- whatever this management can do, a deeper pocketed company's management should be able to do it easier. This is not an intellectual property right play or a play on special ministerial/political connection. If there is somebody who will be more important from current Conti's management, they will probably be from the production side like Turvey. Many of these production people will probably retain their jobs under a new owner.

I do think that Conti is in play.