Kopane - a rough diamond?

Are you looking for massive potential upside but, to get to it, you're willing to retain confidence in distant operations that take much longer and absorb much more cash than initially expected? Are you willing to live with the price of your shares fluctuating, over a twelve month period, from 1.38p to 18p? If so, then diamond group, Kopane Diamond Developments, currently mining in Lesotho, Africa may be one for you...

The current price (02 November 2009) is 14p which capitalizes the company at £31.3m, a mere fraction of its potential $2.6bn value if remaining exploration yields hit the spot within the main pipe development. [ref] http://www.stockopedia.com/news/announcement/KDD/091005kdd000260.htm/Kopane+Diamond+Trading+Update [/ref] , But there's that little word ‘if’ - as with so many mining and exploration companies.

The shares hit 18p last month following a press release relating to a favourable mineral survey and a potential agreement with an unnamed mining group  with the ‘technical, operational and financial ability to take the project to full scale production’. [ref] http://www.kopanediamonds.com/s/NewsReleases.asp?ReportID=369328&_Type=News-Releases&_Title=Proposed-placing-and-issue-of-27942857-New-Ordinary-Shares [/ref] This announcement made no mention of the possible terms of this agreement. Given KDD’s need for cash, it may be that the conditions extracted by the potential partner will not be all that favourable to KDD. As apparent confirmation, the shares fell back to their present level on news, in the past week, of the latest rights issue [ref] www.mining-technology.com/news/news66211 [/ref] – see below.

The Company

Formed in 2001, the Company’s diamond mine operations are centred on Liqhobong at the northern most edge of Lesotho, 120 kilometres north of the country’s capital Maseru and, usefully, probably the nearest point in Lesotho to Johannesburg which is 350 miles to the north of Liqhoborg and the acknowledged centre of the African diamond industry. [ref] www.kopanediamonds.com [/ref]

The mineral rights and resources in Lesotho are actually owned by the Liqhobong Mining Development Company, in which KDD has 75% of the equity and the remaining 25% is held by the Government of Lesotho.

Extraction and consequent product revenue did not come through until the year ended 30 June 2006 and then in the nominal amount of £630,000 with not much more following during the next two years. Operating losses borne to 30 June 2008 were over £20m.

What does not appear to have helped KDD’s overall position has been the prospective mining for diamonds in Lahtojoki, Finland. The initial attractions of this becoming the first commercial diamond mine in Western Europe seem to be fading fast. In January 2008, seemingly having insufficient funds themselves to progress matters further at the required rate, KDD entered into a Joint Venture Agreement with Mantle Diamonds plc (unquoted) which allowed Mantle to earn 70% of KDD’s Finnish assets by spending $5m on the Definitive Feasibility Study at Lahtojoki.  To add to the mix at 30 November 2008, Mantle Diamonds plc held nearly 6% of KDD’s quoted shares.

The DFS at Lahtojoki seems to be sputtering on and to 31 December 2008, KDD have spent  £2.1m on their Finnish project but Mantle, having contributed an initial £700,000, are stalling on their next payment of £667,000 [ref] http://www.kopanediamonds.com/s/NewsReleases.asp?ReportID=369328&_Type=News-Releases&_Title=Proposed-placing-and-issue-of-27942857-New-Ordinary-Shares [/ref] and a legal shoot-out looms.

Lesotho

Entirely surrounded by the Republic of South Africa Lesotho is a constitutional monarchy extending to 30,000 sq. kms and has a population of just 1,800,000. For comparison the area of the UK is 245,000 sq.kms, it has a population of 61m[5]. The 2008 per capita GDP of Lesotho was  $825 placing it 159^th in the world in comparison to the UK’s 13^th place with $38,850. [ref] http://www.nationmaster.com/graph/eco_gdp_percap-economy-gdp-per-capita [/ref]

Now a bicameral democracy, the National Assembly (lower house) has 62 elected seats and the upper house a total of 33 hereditary/monarch appointees. The country has had its share of coups but has been politically stable for the past ten years and likely to remain so in the foreseeable future.

Almost totally dependent on South Africa for trading links, and therefore vulnerable to economic and political developments there, it is the most southerly landlocked country in the world and the other remarkable physical characteristic is Lesotho’s altitude with the lowest point of the country being 4593 ft above sea level. [ref] www.worldatlas.com/aatlas/populations/ctyareal.htm [/ref] This contributes to Lesotho’s climate and other (in addition to diamonds) main export, water to RSA, which clearly assists with the overall international relationship.

Interim Report six months to 31 December 2008 [ref] www.kopanediamonds.com [/ref]

Announced on 30 March 2009 and showing sales for the six months of £1.6m and an operating loss for the period of £3.1m, this period coincided with the worst of the world wide economic recession and in KDD’s case, the temporary cessation of mining operations following the collapse of the international diamond market.

These uncontrollable events could not have come at a worse time and even with a harsh cost cutting programme KDD was drained of cash. It was left with just £200,000 in March 2009 and this, for a company still with significant day to day operating losses, was a desperate position.

As a salvage operation, the company placed 50m new shares with Obtala Resources plc at the near giveaway price of 3.5p each, raising £1.7m after expenses, enabling KDD to progress work on the Definitive Feasibility Study and to come through to a period when diamond prices are now recovering. Indeed, such was the pace of diamond price recovery in the first part of 2009 that these funds were diverted back to mining and items of a more immediate revenue earning potential.

As an incidental note, this astute deal gave Obtala Resources, another AIM-listed African mining company, 23% of KDD. OBT have subsequently undertaken considerable trade in KDD shares and at the time of their interim statement in July 2009  held 14.75% of KDD which OBT’s chairman Francesco Scolaro, also now on the board of KDD,  stated as  ‘held as available for sale short term investments’. [ref] http://www.obtalaresources.co.uk [/ref]

The directors also state that, even with the adequate cash provided by this rights issue, they are not going to complete the DFS at this time but rather progress with ‘items of a more immediate …’  Shareholders may be disorientated by this as completion of the DFS has formed the backbone of the company’s objectives almost since inception.

As support for the new rights issue, there are reams of evidence from recent surveys of  better than expected ‘Indicated’ and ‘Inferred’ resources and higher quality diamond ore, this was of course the source of the recent share price bounce as commented elsewhere.

Rights Issue announced 28 October 2009 [ref] http://www.kopanediamonds.com/s/NewsReleases.asp?ReportID=369328&_Type=News-Releases&_Title=Proposed-placing-and-issue-of-27942857-New-Ordinary-Shares [/ref]

The latest in the long list of fundraisings in order to finance the lengthening period prior to expected operating profits is the placing of nearly 28m shares at 14p per share to realise £3.5m after expenses. The way that the Company puts this is ‘to assess potential strategic opportunities and for general working capital requirements’. This issue will increase the number of issued shares by 12.5% and although at present market price there is no immediate dilution to existing shareholders the placing does spread the eventual ’jam’ that bit thinner.

It seems that the Company’s advisers have had to work hard to get this rights issue away. 22.5m shares at 14p per share are being taken by Lanstead Capital under an equity swap agreement with KDD. The sum due to KDD is  payable in 24 monthly instalments and if, during the next 24 months, the share price exceeds 18.67p then KDD will receive more than 100% of the instalment due. If the share price is below 18.67p then KDD will receive less than 100% of the instalment due and there is no lower limit. The price of this agreement to KDD is an immediate payment of £35,000 to Lanstead  and 2,250,000 free shares.

The board of KDD is ‘pleased to have secured these funds on these terms which allow the Company and its shareholders to further benefit  from the potential positive near term news flow’. Umm....

Conclusion

There appear to be no financial profitability or balance sheet forecasts available (understandable, would you?) . However, the recent surveys in Lesotho, showing more mineral available and of better quality than previously thought, give grounds for cautious optimism. 

Nonetheless, it is now eight years and many unplanned fundraisings on from formation and, as can be seen from the terms of the current rights issue, KDD is arguably stretching the support of shareholders. Unless KDD rapidly eliminate operating losses, then the funds now being raised will not see them through the next twelve months and given the close call this time, another rights before the emergence of operating profitability seems unlikely.

The Finnish Project may be aptly named and could involve a sizable write off. However, unless KDD try to continue to finance this themselves (unrealistic) or get sucked into a costly legal fight with Mantle (neither party will presumably want this), then the future cash flow effect should be minimal.

Nearly all mining and exploration shares are speculative to differing degrees. The underlying institutional support for KDD, as evidenced by the placing of the latest of many rights issues despite the onerous terms, and the subsequent agreement to finance exploration could be an indicator that there is something worth backing here and that  events should not conspire to result in investors losing all their money.

At 14p, they are reasonably priced and for those not of a nervous disposition, prepared to sit through another probable two/three years of falls on scares/wider economic gloom and some sharp rises on favourable rumours/official press releases, KDD could provide a useful return – but don’t count on it!

I welcome comments from any holders out there...