Sirius Minerals: digging in deep pockets

There is light at the end of the tunnel for Sirius Minerals – and no, we are not talking about the 37 kilometre tunnel the company has started to dig under the North Yorks Moor National Park.

Instead, we are talking about the miner’s tough task of securing the billions it needs to build its ambitious project.

Sirius Minerals, the company developing the vast Woodsmith mine in North Yorkshire with ambitions of supplying polyhalite to the world’s farmers as a superior fertiliser, has attracted tens of thousands of investors looking to buy into this unique development on their doorstep. The firm has raised over $1.4 billion to-date but needs billions more to build the mine. And, after telling investors it had abandoned prolonged talks with one lender to begin discussions with another last month, shareholders have breathed a sigh of relief it has managed to announce a financing plan in time - especially as its current funds are only enough to last a matter of weeks rather than months.

We have a look at the four elements of the stage 2 financing and explain what happens next, including what risks will remain even if Sirius secures the funding it needs. If you want an in-depth look at Sirius Minerals and the story so far, including a timeline of events, click here.

Sirius Minerals stage 2 financing: what you need to know

Sirius Minerals has unveiled its plan to raise the $3.8 billion it needs to complete development of the Woodsmith mine. The package is made up of four elements with $425 million in equity, $400 million in convertible debt, $500 million in senior bonds and, forming the backbone of the entire thing, a $2.5 billion revolving credit facility from JPMorgan.

The $3.8 billion is considerably more than what Sirius originally budgeted for. Under its previous plan the company was looking to raise between $800 million-$900 million of UK government-backed debt, $500 million-$700 million of bonds and $1.5 billion of bank debt. But, after failing to win round ministers and being hit by around $600 million of cost-overruns, the company had to rely more on its shareholders and the banks.

Sirius Minerals chief executive officer (CEO) Chris Fraser described the stage 2 financing was ‘capital markets led’ rather than securing project financing through the banks, which he said was one of the reasons why they were able to formulate the plan so quickly.

The four elements of stage 2 financing are:

1. Placing and open offer
2. Issuing $400 million convertible bonds
3. Issuing $500 million worth of bonds
4. JPMorgan revolving credit facility

Placing and open offer

At the start of May, Sirius raised £327 million ($425 million) through a placing and open offer of 2.18 billion new shares priced at 15p per share, which was the very bottom of its targeted price range. The new shares were priced at a 32% discount to the closing share price the day before the shares were issued, and the fundraise significantly watered down existing shareholders.

Although existing shareholders were given an opportunity to minimise the dilution spawning from the placing by subscribing under the open offer they were only entitled to buy one new share for every 22 they already held. Ultimately, the placing and open offer took the number of Sirius shares in issue to 6.98 billion, with the new shares accounting for over 31% of its issued share capital (with the placing shares accounting for 28% and the shares taken up by existing investors through the open offer representing just 3%).

Issuing $400 million convertible bonds

Sirius also raised $400 million by issuing convertible bonds around the same time it raised the equity portion of its financing plan. The bonds carry a cash coupon of 5% per annum (but paid quarterly) and will mature on 23 May 2027, when they will be converted into new shares in the business. The conversion price of the bonds will be ‘a premium in the range of 20%-25% above the clearing price’ of the shares issued under the placing and open offer, implying a price of around 18.00p to 18.75p. However, Sirius intends to review the conversion price in May 2020, which could remove the premium from the conversion price.

Importantly, the $400 million raised through the new bonds is not immediately available to the business and will be held in an escrow account until Sirius secures the other elements of debt needed to complete the stage 2 financing; namely, issuing the $500 million of bonds and securing the revolving credit facility from JPMorgan.

Sirius also took the opportunity to extend the maturity on some existing convertible bonds in issue, replacing $244.2 million worth of bonds that were due to mature in 2023 with ones that will now mature in 2027. Sirius intends to consolidate the new bonds and the reissued bonds under a single series in January 2020.

Issuing $500 million worth of bonds

Sirius intends to issue $500 million of senior secured bonds (meaning they will take priority over other debts and financial commitments the company has) before the end of September 2018. Completing this step is crucial if Sirius is to bring the stage 2 financing together as it will not only unlock the $400 million raised by issuing the convertible bonds but the $2.5 billion revolving credit facility from JPMorgan that forms the backbone of the entire plan.

The main reason there is doubt over whether the senior secured bonds will be issued comes down to demand. While JPMorgan is assisting the company in finding buyers for the bonds, it is not willing to purchase them itself if there aren’t any takers. In a nutshell, there is no guarantee that lenders will bite, and JPMorgan is not willing to take on all the risk itself, especially as it already intends to lead the biggest proportion of financing.

Considering the placing was predominantly targeted at bringing institutional investors on board, something the company had lacked beforehand, and that it was oversubscribed suggests there are companies willing to put money into Sirius and that the warning it may fail to borrow the $500 million it needs is superficial. Fraser has, as always, been extremely bullish on the company’s prospects and has told investors that he believes the company will be able to get a single B rating on its debt.

JPMorgan revolving credit facility

Once, or if, Sirius manages to raise the $500 million through the senior secured bonds, JPMorgan will supply a revolving credit facility of up to $2.5 billion. Although Sirius has said it intends to issue the bonds before the end of September, it technically has until the end of October under the agreement with JPMorgan.

JPMorgan, understandably wary of lending such a vast amount under such risky circumstances, intends to syndicate the $2.5 billion of debt to other lenders, meaning the funds will come from a variety of sources with JPMorgan acting as the lead. Once again, there are no guarantees that there will be enough appetite to lend the company such sums and Sirius admits availability is subject to other conditions, ‘not all of which are under the control of the company’.

Although Sirius needs to secure the revolving credit facility sooner rather than later, the company does not intend to drawdown from it straight away. Sirius intends to issue more senior secured bonds in the future as a way to replace the sums borrowed under the facility over the longer term.

Sirius Minerals stage 2 financing: what happens next?

Sirius shareholders will have to approve the placing and open offer, and the issuance of the convertible bonds, at a general meeting on 21 May 2019. It is highly likely that this will be approved by investors considering there is so much at stake. Excluding the sums raised in equity, Sirius only has enough cash to keep going until the end of May.

Sirius has said the sums raised through the placing and the convertible bonds is enough to get the project up and running, and to achieve its initial production capacity target of 10 million tonnes per year. It will then begin to utilise the sums raised through the senior secured bonds and that available through the revolving credit facility to expand the project to 20 million tonnes per year and get the mine to positive cashflow.

If successful, then Sirius aims to start producing polyhalite from its mine in 2021 and hit 10 million tonnes per year by 2024.

What happens if Sirius fails to raise the debt it needs?

Sirius has warned that if it fails to secure the lenders it needs for its $500 million of senior secured bonds, and therefore the larger $2.5 billion credit facility, then it will not be able to access to the $425 million raised through the convertible bonds that is held in escrow. This would mean the business would have ‘no available cash to deploy into the project, beyond September 2018 and force it to ‘cease all discretionary spending’ while it raced to find an alternative financing option.

‘Unless the company was able to secure alternative funding (if any such alternative funding were available to the company, which it may not be) or a merger or acquisition transaction involving the company by the end of September 2019, the company would cease to operate as a going concern and the board would be required to place the company into administration or liquidation, which could result in shareholders losing part of or all of their investment in the company,’ Sirius stated as it launched its stage 2 financing.

Sirius Minerals: what are the risks going forward?

While securing the stage 2 financing will be a landmark moment for the business and give it the resources it needs, there remains a number of potential risks going forward that shareholders should consider. These include:

1. Keeping the project funded, on-budget and on-schedule
2. Shareholder dilution and pressure on the share price
3. Managing a heavy debt burden
4. Proving the benefits of the product and the size of the market

Keeping the project funded, on-budget and on-schedule

Sirius has already had to push deadlines back and experienced cost-overruns even during the early phases of the project. Although this is common for a new mining project, it is not ideal and the sheer size of the project heightens the risk of budgets being blown. The main reason Sirius had to raise equity (which was not part of its original plan) as part of the stage 2 financing was to plug a shortfall in its budgets.

However, the company has said it has learnt from the mistake of underestimating its funding requirements. Sirius said the $3.8 billion sum 'was made on the basis of much more reliable cost information' and that the risk of cost-overruns has been reduced since the end of 2017.

With the bulk of the work still left to do the risk of being hit by a setback or delay is still high. While Sirius has ensured the stage 2 financing is designed to provide it with a cushion to fall back on any delays will ultimately prolong the journey to production and, more importantly, the vital cashflow it will need to begin paying down the vast amount of debt it is taking on. Keeping the project on track is a priority.

Shareholder dilution and pressure on the share price

Sirius Minerals shares are mostly in the hands of retail investors, with reports suggesting there are as many as 85,000 individual investors in the business, many of whom are based in the North Yorkshire region where the mine is based. Prior to the placing and open offer shares being issued the largest single shareholder in the business owned 6.8% of the business. The fact that the stage 2 financing is bringing on more institutional investors suggests the company is getting the backing it needs to convince the market it is onto a winner.

However, shareholders are rightly concerned about dilution. They have already been penalised for the latest cost overruns and seen their stakes watered down. It will have just shy of 7 billion shares in issue once the latest placing and open offer is formally completed – compared to just 4.8 billion at the end of 2018, 4.5 billion at the end of 2017 and 2.5 billion at the end of 2016.

In addition, the latest placing and open offer was priced at 15p, which was a large discount to the market price at the time and at the bottom end of its targeted range. In fact, Sirius shares were trading at around that level after it secured planning permission in 2015, demonstrating the pressure that continued dilution has had on the share price. This is significant as appreciation in the share price is the only way investors will be able to reap a reward on their investment over the shorter term. The value of Sirius shares has been cut in half over the last 12 months, even after announcing the stage 2 financing.

If the stage 2 financing is successful, the company should comfortably avoid having to raise any further equity for the foreseeable future, giving shareholders some stability. However, there is always the threat of further cost overruns or budget pitfalls that could require more cash. Plus, existing shareholders face further dilution even if it does avoid raising any further equity because of the amount of convertible debt it has issued.

Sirius has had to raise more equity than it planned, and shareholders have had to pay for the company’s mistakes so far but, ultimately, it forms a vital part of the stage 2 financing and helps to significantly de-risk the project.

Managing a heavy debt burden

Sirius is having to take-on an almighty amount of debt to develop the project, enough to cripple even the biggest of businesses. If the stage 2 financing is successful then it will have around $1 billion worth of debt (some of which is convertible, which returns to the problem of dilution) in addition to the $2.5 billion revolving credit facility from JPMorgan. That is huge considering Sirius has a market cap equal to just over $1 billion (£826 million as of 16 May) and is yet to pull a commercial product out of the ground or generate a single pound in revenue.

This level of debt also limits any wiggle room in the future should its budget overrun again and considering it has already tapped up investors more than it wanted to it is unclear where Sirius could turn if it ever needs more money. It also exacerbates the pressure to keep the project on schedule to ensure it generates the cash it needs to repay lenders on time.

Proving the benefits of the product and the size of the market

Although attention has been on the company’s finances there are still operational risks to consider. Polyhalite, which contains four of the six macro-nutrients needed for fertiliser, is not a mainstream product and is currently regarded as niche. The company believes it is a superior product that can revolutionise the agriculture industry, but it is still conducting hundreds of trials and tests to cement its point.

Bearing in mind that this makes polyhalite a new market, some believe Sirius has been a bit over-zealous with its predictions. Consultancy firm CRU said the global polyhalite market last year was around 30 times smaller than Sirius’ planned production, suggesting the job at hand is just as much about creating the market for polyhalite as it is producing it. Analysts at Berenberg have added that while the market is big enough to be economical it is likely to be smaller than what Sirius has estimated.

Sirius will rightly point to the huge amount of offtake agreements it has secured for its product to quash any of those concerns. It has deals in place for over 10 million tonnes of its product, which exceeds its initial production capacity. Plus, many have welcomed its latest client, BayWa, the German agricultural and fertiliser group that generated over €16 billion in revenue in 2018. Although Sirius had signed-up distributors across most continents, it had been lacking a partner in Europe - the second largest fertiliser market behind China, where it has already signed deals.

Sirius Minerals: will the short-term volatility be worth the long-term gains?

The stage 2 financing is by far the biggest hurdle for Sirius to clear, so the company and its shareholders have every right to feel confident. If it secures the package then the project will be significantly de-risked and, after years of share price volatility driven by funding concerns, shareholders could finally see a couple of years of stability while the project is built – barring any development delays, of course.

Still, the money is not in the bank and although Sirius has laid out the pathway to its future there is no guarantee, it will get to the end of it. Issuing the $500 million senior secured bond will be the critical step it needs to complete to secure the credit facility from JPMorgan and keep construction going. With the end of September set as a deadline by the company, the next few months will be nerve-racking for shareholders and share price volatility is likely to continue. The financing package may not be ideal, but it is necessary.

The volatility will be welcomed by short-term traders but not investors. However, anyone looking to put their money behind Sirius must take a long-term approach and try to look through the uncertainty in the meantime.

Read more on whether mining in the UK and Ireland is well and truly alive

Fraser has openly addressed the criticism of Sirius and its chances of turning its ambitions into a reality. ‘Only once this thing is a $20 billion FTSE 100 company will the sceptics be satisfied… and even then I am sure they will find some reason not to invest in the company,’ he told the Financial Times.