financing and credit crisis 101

Not very happy about the share price however I am a passive long term investor so these aberrations, whilst painful, don’t dictate my investment philosophy. What I do find interesting, however, is the financing aspects of this project and finding an extra USD 56 Million and the manner in which some posters (who quite frankly have shown their ignorance of the ‘credit crisis’ and it’s implications in their rather scattered posts) read the update last week and promptly threw the baby out with the bathwater.

Credit Crisis – what does this actually mean? Contrary to popular belief, financial institutions are not shutting up shop and halting lending (okay perhaps Bear Stearns have). All that is happening is that risk is simply being repriced. A couple of years ago an emerging company (gold coast property developer, Peruvian miner or Mongolian Yak herder etc) could have sourced funding at a fairly tight margin over the bank’s cost of funds due to (1) the intense competition between institutions globally and (2) the rosy economic outlook which suggested that the risk of delinquency was fairly minimal.

What we have now is risk being priced far more realistically (so, for example instead of a margin of say 1% over cost of funds maybe corporates are starting to see 2 or 3% over cost of funds). What does this mean from a lending perspective? Well, institutions are becoming risk averse but only so far that they are increasing their credit risk margins – if the emerging company are prepared to (1) pay the additional margin and (2) submit to whatever loan covenants the institutions stipulate then the funding will be secured.

What does this mean from AIM’s perspective (focusing on financing and ignoring the other management and accountability and performance issues)? I think that we all can acknowledge that the management exhibited incredible levels of arrogance in sourcing and securing finance during 2006 - 2007. If the truth be told, any muppet can act this way when the economic environment is such that the borrower can set the rules of engagement however the tide has changed and I suspect that AIM will pay dearly for the arrogance that the previous MD has shown. Does this mean that AIM will be unable to secure debt finance if it chose to do so? The short answer on this in my opinion is no. Assuming no further substantial cost blowouts occur (I know Elly … big assumption but work with me here) we have a USD 165 Million project. At present USD 109 Million has been raised in equity (67% equity). A 2:1 gearing ratio is actually a fairly conservative ratio (FYI the ratio usually is the other way around) and I believe would be sufficient to secure debt financing from an institution if funding was secured in conjunction with AIM agreeing to submit to a number of covenants (such as partial hedging of zinc price exposures for the debt repayment period). The only things that that would derail the company’s bid for debt is (1) the legal action going on with NS and (2) the risk that previous MD has stuffed relationships with financiers such as Standard Chartered (who I think were mandated to do some debt for us at some stage).

Other alternatives to equity raising would be (1) offtaker financial arrangements (although I think that the stuffing around with securing offtake sales agreements would strongly suggest that we could be waiting until 2013 for offtake financing to materialise – I would like to think otherwise but logic prevails on this one) or (2) proving up and sale of Mokopane to further reduce the dilution of AIM though another equity issue.

I would suggest that the company has a number of alternatives available, the key thing will be whether they have the courage and foresight to pursue debt or limited equity instead of handing out equity in a rapidly shrinking pie. Although, more critical than this is the ability for the management to add some value to the company without crucifying it.