Sirius Minerals (SXX) shares: is this the beginning of the end?

What has happened to Sirius Minerals?

'Due to the ongoing poor bond market conditions for an issuer like Sirius we have not been able to deliver our stage 2 financing plan. As a result, we have taken the decision to reduce the rate of development across the project in order to preserve funding to allow more time to develop alternatives and preserve the significant amount of inherent value in this world-class project.' – Chris Fraser, chief executive of Sirius.

Sirius Minerals has cancelled its plans to raise $500 million of loan notes, without which it can’t access a $2.5 billion credit facility from JPMorgan that formed the backbone of the financing it needs to build its polyhalite mine in North Yorkshire.

Read more: Sirius Minerals share price plunges after pulling bond issuance

The company originally postponed the issuance of the loan notes in early August and said the market conditions have not improved since then, stating no company with a similar credit rating (of B/B- range) has tried to raise debt through the bond market recently.

What’s at risk?

Ultimately, with a $3 billion-plus funding gap to fill, the entire company and project is at stake. The company has £180 million in cash, of which £117 million isn’t already accounted for. It says this will last for the next six months but that it will need more funding by the end of March 2020 if it is to survive. Plus, if it wants to secure such a large and complex funding package it will have to have something in place much sooner, preferably before the end of 2019.

Although Sirius is confident it can find the funding it needs, the situation is precarious enough to raise doubts about its survival. 'The board of directors believes that additional financing will be secured in the coming months, however there is a risk that a successful outcome may not be reached. This therefore represents a material uncertainty that may cast significant doubt upon the group's ability to continue as a going concern,' the company said in its recently released interim report.

If no solution is found, then over 1000 jobs could be lost in a neglected area where jobs have already been lost. There could be further job losses if it spills over to any local contractors or suppliers.

The story is a local one even when it comes to investors, with many of the company’s 85,000-plus retail investors thought to be from the surrounding area.

What now for the SXX share price?

The company has had to halt major development of the project and slow down the pace of work in order to hoard cash to survive over the next six months. Sirius intends to conduct a full strategic review during that time in the hope of finding the funding it needs.

Option 1: secure government support

As far as Sirius is concerned, its project is not only integral for the local area but for the country as a whole. It therefore hoped that it would secure support from the UK government, but this has proven to be an incorrect presumption. The company’s original funding plans for the project were based on the 'anticipated participation' of the Infrastructure and Projects Authority, part of the Treasury. But it abandoned those plans when JPMorgan stepped up and offered the credit facility.

Sirius went back and pleaded for the government to reconsider when it decided to postpone the bond issuance last month. It asked the government to guarantee $1 billion worth of the debt to get the wider financing plan over the line but was unsuccessful. This would have provided more confidence to those considering lending money to Sirius, because the government would act as a guarantor for a substantial portion of it.

'The government has reviewed the case for the provision of the support requested to facilitate the financing of the project and has decided not to provide the support requested. The company believed this commitment would have enabled the company's financing to be delivered as planned,' Sirius said.

There may still be hope for Sirius. There is still some political pressure being applied, mainly by local politicians. The Labour MP for Redcar, Anna Turley, for example, has said the project is 'as important for Teesside in terms of jobs created as Crossrail is for the South' and warned it threatened the country’s reputation as a sound place to invest in major infrastructure projects.

It seems very unlikely that Sirius will secure the support of the government. However, there is widespread expectation that a general election will be held sooner rather than later. The government’s tune toward the project could change depending on the result.

Option 2: an alternative financing arrangement

Sirius is also looking for other lenders and considering alternative forms of funding to get the project back on track. It has said that 'a number of different investors and advisers have indicated the potential for a range of alternative approaches'.

This opens up the risk that any new financing package could be materially different to the previous one, or possibly more expensive if lenders decide to charge more to account for the added risk now attached to the company.

Debt will have to remain the main source of any new funding package because issuing equity now would be ineffective considering how much shares have slumped. But the main reason Sirius decided not to issue the bonds is because the poor market conditions meant it may have had to offer a yield of over 15%. That would have been regarded as too high to satisfy the conditions to access the larger pool of debt from JPMorgan. This initially casts doubt over the ability to raise money through debt or equity.

However, Sirius said it has received feedback that issuing loan notes 'could potentially be successful should the offering include warrants', but said this would also would have failed to meet the conditions needed to secure the support of JPMorgan. Sirius asked JPMorgan to waive the condition, but was rejected by the bank. This suggests that any new financing arrangement could cause further dilution to existing investors, which is clearly a concern to existing investors.

There is good reason to doubt Sirius will find an alternative lender, or that JPMorgan will change its tune. It already stepped up to save Sirius when its original funding plan fell through and seems unwilling to budge, and if JPMorgan, which is already invested in the project, considers it too risky then there is little reason to think another major lender will think otherwise.

Option 3: cut the risk to make the debt more attractive

A more likely option is that Sirius can restructure the financing to reduce the risk for potential lenders. The company has said that one shared concern amongst most potential lenders, it has spoken to over the last three years, is the perceived risks with sinking the deep shafts of the mine.

'During the strategic review the company will explore how the development of the shafts and the other major aspects of the construction programme can be rescheduled in a way that reduces this perceived risk and delivers better cost and scheduling certainty for debt providers across the project,' Sirius said.

It also says it will also look to lower costs by optimising the project, such as possibly removing one of the tunnel boring machines, or try to bring forward commercial production (which is not currently expected until 2024) to make it more appealing

Option 4: find a strategic investor or buyer

The fourth option somewhat ties into option three. If Sirius believes lenders will bite if the riskier parts of the project are removed, then it has to find another way to fund the likes of the shafts. The company has said it has drawn up a list of potential partners that could invest in the project. This would raise funds to construct the shafts and other riskier elements of the project and make it easier to raise debt to fund the rest.

Any company that did decide to help Sirius is likely to demand a large chunk of the project, possibly a controlling share. But the project’s survival will be materially enhanced if Sirius can find a partner. It could completely change the finances of the project if it can self-fund the most expensive and riskiest part of construction, and a new experienced partner could also find new ways to develop the project going forward, and bring the overall risk of the project down.

There is also the possibility that Sirius could be acquired outright or that the project is sold altogether, allowing a larger, more experienced and financially stable business to takeover. Either way, the valuation that Sirius earns as part of any investment or takeover bid will be interesting. Sirius is right to boast about the unique nature and huge potential of the project, but the market was also right to punish the share price when it failed to deliver. Any potential investor or bidder will have to judge a valuation along that scale, and Sirius’s weak position suggests it could be at the lower end.

Option 5: collapse and enter administration

If Sirius fails to find the funding it needs by the end of March 2020 then the company is at risk of collapsing and entering administration. This could see administrators try to sell the project at a much lower valuation and it would be highly unlikely that investors would receive anything, as lenders take precedent over shareholders in such a situation.

Read more: is the Sirius Minerals share price a zero?

Who could be the saviour of Sirius?

A string of big names have already been touted to rescue Sirius. It has already secured significant support from wealthy investors – with Australian mining billionaire Gina Rinehart and the sovereign wealth fund of Qatar among its largest shareholders. Those that have an interest in the project are more likely to come to the company’s aide if their investment is at risk. However, Rinehart has already contributed to previous funding rounds and, like other investors right now, could be considering cutting her losses.

Other potentially interested parties include one of the handful of mining companies that produce fertiliser, such as ICL or K+S. ICL currently operates 'the world’s only polyhalite mine' not far from Sirius’s project, while K+S is a large European firm already interested in fertiliser.

BHP Group or Rio Tinto have also been touted by Sirius’s house broker, Shore Capital. Shore has also said Archer-Daniels Midland could be interested because it has already signed offtake deals for Sirius’s product and agreed to supply the binding agent used in Sirius’s granulation process.

Fortescue Metals Group could be another contender. The current chairman of Sirius, Russell Scrimshaw, used to be an executive of the Australian mining firm and Fraser’s relationship with the company stretches back to his days as an investment banker.

What should investors do now?

This is not the first hiccup that Sirius had had, but it is the biggest. Even if Sirius survives, the entire investment case and valuation of the company will have to be reset, and it is the early investors that could be punished. The threat of more equity being issued as part of a new financing deal means existing investors could be significantly diluted, while the possibility that a partner will buy a chunk of the project means existing investors will ultimately own less of the asset that gives the company value.

If the project does go ahead then it could be dramatically different to the one currently planned. A new financing package or major investment could severely effect the economics of the project and investors should prepare for the numbers to change, everything from when commercial production will start, to the operating costs, to the volume produced each year.

For existing investors, the question is whether to take a bullish or bearish view. Those that remain confident can take advantage of the plunge in Sirius shares and build-up their position while those that have lost faith can cut their losses and redeploy what they have left somewhere else. The Times quoted Fraser following the news as saying: 'I read stories where people seem to have over-invested or probably not taken the right advice. I feel very bad for those situations, but we have been clear about the opportunities and also the risks.'

For those looking at Sirius as a fresh opportunity, the investment opportunity remains risky but potentially rewarding. Liberum had a price target of 40p on Sirius before the financing fell through, nearly ten times the current share price, suggesting shares could rocket if it finds a solution to its funding woes. Still, Liberum sees upside even in the current situation after striking a 9p price target on the stock after the bond issue was cancelled.

Read more: how to buy, sell and short Sirius Minerals shares