Small Cap Value Report (15 Aug 2014) - ZIOC, SRG, TUNG
Good morning! This is my last report from Paxos, as I'll be back in sunny England on Sunday. Even first thing in the morning it's too hot to sit in direct sunlight, so I've parked myself on the verandah in the shade of one of the vast number of olive trees on the island. It's a quiet day for news, with only a few things catching my eye today, as follows.
Zanaga Iron Ore (LON:ZIOC)
Share price: 18.5p
No. shares: 278.78
Market Cap: £51.6m
The announcements from this company are always a model of clarity, as well as giving a useful background summary on the company. It's been mentioned here a lot before. The company is developing a joint venture (with mining giant Glencore) iron ore mining project in the Republic of Congo (the smaller & politically stable of the two Congos).
Despite the iron ore price being under pressure, this project appears to be going ahead, because it has a number of key advantages - the most important being that it will be a very low cost iron ore mine, hence is economically viable even at the depressed iron ore prices pertaining at the moment. Secondly, the iron ore is high grade, and low in impurities, which means it will command a price premium, and be sought after by China in particular, where pollution from low grade iron ore processing is a big issue.
The main risk with the project is that financing for the $2.6bn initial capex has not yet been secured, so until that happens this share must be seen as high risk. However it's also potentially high reward, with the economics of the project being compelling. The company believes that most of the funding for capex can be secured through debt packages, and of course having Glencore as your JV partner makes this project entirely credible - i.e. if Glencore wants it to go ahead, it will go ahead.
Today's announcement from ZIOC concerns the granting of the mining licence, and mining convention (I'm not sure what the difference is, perhaps a reader could explain in the comments below). It details the terms agreed with the RoC Govt, which look favourable to me, although I'm not a sector expert.
So that ticks one remaining box, with the only other one being project financing. My understanding is that representatives from Glencore and Zanaga have formed a project financing team, and are looking at various options. So we'll have to see what happens on that front in due course. Although so far so good, the project seems to be progressing as hoped for.
I'm not sure whether today's news will trigger much of a price movement, because it was largely a formality - there was never any doubt about ZIOC being granted a mining licence, as the project is so important to the economic development of the RoC. However, the terms of the deal (taxes, etc) look good to me, so that might trigger a rally in the share price, who knows?
I've attended several meetings with this company to discuss developments, over the last year, and what has impressed me is that the company does what it says it's going to do - i.e. expectations are kept grounded, there's no hype, just facts & figures. Announcements (so far) have been in line with the company's stated aims. I like that, it's reassuring particularly for someone like me who never normally goes near resource sector shares.
Security Research (LON:SRG)
Share price: 55p
No. shares: 19.3m
Market Cap: £10.6m
This is a potentially interesting micro cap. It has a peculiar mix of activities, in electronics, packaging, and legal services for property transactions. The company secured a remarkably lucrative contract to make devices for detecting hidden bombs (IEDs) in Afghanistan, but that has come to an end now I think, and some of the one-off profits were returned to shareholders.
The company has today announced the result of a strategic review, to decide whether to keep its property legal services company;
In light of the strong trading in PSG and across its franchise network, the Board has concluded that it is in the best interests of SRG and itshareholders for PSG to continue focussing on the development of its businessas a wholly owned subsidiary of SRG.
So that sounds positive. I'm flagging up the share as one that might be worthy of further research. I don't hold any personally, and am not intending to buy any, as it's too illiquid and I don't have time to do the thorough research ncessary to be certain that the shares are good value or not. However what I can say is that it's been on my radar for some time, and looked potentially interesting last time I looked at it. As usual, this is not a recommendation, I'm just throwing the idea out there to anyone who has the time & inclination to research it properly.
Tungsten (LON:TUNG)
Share price: 293p
No. shares: 100m
Market Cap: £293m
In my view this company is guilty of over-announcing - i.e. putting out anything & everything as an RNS. The trouble with that is that it dilutes the impact of important announcements, and it makes some investors worry that management are ramping the share price ahead of a fundraising (which is sometimes the case).
Today's announcement is a good example of that. It is entitled "update on debt financing", but doesn't really say anything much, other than that they are continuing to seek debt financing! If anything I think this announcement is negative, as it makes the company sound a bit desperate, and maybe struggling to raise debt financing?
I hold shares in the company, but am not impressed at all with today's announcement.
There's nothing else of interest today, so I shall sign off. Also t'internet is being unreliable here, cutting out & back in again randomly, so better quit whilst I'm ahead!
Have a smashing weekend, and see you back in Blighty on Monday!
Regards, Paul.
(of the companies mentioned today, Paul has long positions in ZIOC and TUNG, and no short positions)
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28 comments
Some nice TUNG buys today
11:05:01 339p 33,000 £111,870 338.5p 338.75p Buy
11:03:43 339p 33,000 £111,870 338.5p 338.75p Buy
11:03:16 339p 100,000 £339,000 338.5p 338.75p Buy
"if say China comes with a bypass deal," - Probably the single biggest risk to shareholders.
"I also on balance do not trust the ZIOC management" - Agreed.
" the necessary licence in now in place"
Subject to the Congolese Parliament to approve the Convention as a law. Having said that I would expect this to proceed and the clock is then ticking.
It has to be said that mining companies have displayed a remarkable lack of judgement over the last few years in creating a massive over-supply of iron ore. Hopefully investors are not placing to much faith in their expertise.
"1. This is a major project for Congo the importance of which is emphasised by the speed of the approval - could add 30% to GNP. Also with Glencore involved there is, imho, no risk of the licence being withdrawn."
Glencore, how many divisions? If someone makes a better offer to the government (current lot or successors) that involves shafting Glencore why should they refuse? The very size of the cake makes it more tempting to nick an extra slice from legacy players. Someone may even start a new country in the region, Katanga style: 1% of billions buys an awful lot of AK47s and mercenaries in a country where the average income is less than $2/day, and a civil war situation, whatever its outcome, would suspend the project for a long while.
"So far they have shown no interest in adding to their holdings. Not too surprising given the magnitutde of the potential returns."
So the theory is they don't care about money because they have enough? Maybe. I prefer the idea that they plan to flog the thing at the point where they get enough over-optimistic buyers willing to pay more than what they think it's worth in risk-adjusted terms (arguably somewhere above current price), hence the utility of a listing and of spending quality time with random punters.
The idea that an AIM(!) listing adds credibility also seem implausible at that sort of scale, if not an outright negative (disclosure requirements, guilt by association, etc).
cig,
re £ZIOC I accept there are risks, of course there are, but I think you're probably overstating them considerably. Have you seen the project economics? The upside on this project is multiple billions, and it's not pie in the sky - the FS alone cost Xstrata/Glencore over $300m, is done & dusted, and the necessary licence in now in place. So it looks like the project is going ahead, subject to financing - most of which can be debt financed, according to Zanaga.
So as with everything, it's risk:reward. The upside is potential major multi-bagger, and so far things are moving in that direction. The downside is something goes horribly wrong & Zanaga shareholders end up being heavily diluted, but probably end up with a smaller slice of something very valuable. The disaster scenario you outline is of course a possibility, but most people who've looked at this consider that a low % probability.
So one just estimates the probabilities of the different outcomes, combined with the upside/downside potential, and that leads me to a risk weighted value that's attractive. However if you think the downside risks are a very high probability of actually happening, then you will arrive at a much lower valuation, and would probably treat it as a bargepole job. That's what makes a market!
The clincher for me is that JV partner Glencore are progressing it. They've very smart & experienced, and if they think the project is good, then their judgement is probably better than yours, mine, and everyone else on Stockopedia put together!!! So being a JV with Glencore makes ZIOC very much better than most junior resource stocks.
Regards, Paul.
Someone may even start a new country in the region, Katanga style: 1% of billions buys an awful lot of AK47s and mercenaries in a country where the average income is less than $2/day, and a civil war situation, whatever its outcome, would suspend the project for a long while.
I think you are confusing Congo (Brazzaville) with Congo (Kinshasa).
Average income is $6.30 per day and the risk of civil war is modest, relative to many of its neighbours!
I think you are confusing Congo (Brazzaville) with Congo (Kinshasa).
I know full well about the two Congos, I got my number from a google of GDP/capita trying to find the one for the right Congo but it seems I did get the wrong one. I stand corrected. Still doesn't make mercenaries that onerous. Yes, it's much better run than it's larger neighbour, not a big challenge given that it's one of the worst failed states on Earth. As far as I can tell the RoC is a Putin-style regime, which while corrupt is relatively orderly, but this is subject to change when the strong man dies (he's old) or if people get finally bored of him. It also makes the risk more discrete: the exit from an authoritarian regime is a step event. Also while he's still in charge, he could change his mind in how he treats the Glencore JV if say China comes with a bypass deal, and then phone his parliament to pass any law to cancel their property, or less drastically simply increase taxes/his cut beyond the currently agreed deal. Bulls seem to use the relative stability to imply the governance standards are like the Isle of Wight's.
(Paul:) So one just estimates the probabilities of the different outcomes, combined with the upside/downside potential,
Totally agree on methodology here, it's just we're estimating different probability coefficients for the various risks. What is a couple of billions 10-20 years from now with high chances of partial or total confiscation worth today?
The clincher for me is that JV partner Glencore are progressing it. They've very smart & experienced, and if they think the project is good, then their judgement is probably better than yours, mine, and everyone else on Stockopedia put together!!!
Yes, it's clearly a positive, but in my view they price political failure using a portfolio approach. They know some of their projects in emerging countries will get partially or totally confiscated due to political trouble, but that not all of them will fail at the same time. It does not mean any single project they're involved with is super safe as such.
I also on balance do not trust the ZIOC management, which mean that to me the chance that AIM punters get their fair share of the venture is further reduced, thus needing to discount further from the "partner level" value of the JV. It's actually a big one: between (legit) funding dilution and management risk, I'll be surprised if the shell ends up with more than 10% of the gross JV value.
Some very good points in there, though I think the age of the President is over-played in an African context. He is 71, so there seems a reasonable chance that he'd seek relection in 2016 for another 7 years.
I'm not sure that the Isle of Wight is an appropriate paragon of democratic virtue either, since it has the worst voter:MP ratio in the UK......
I'm agnostic on the question of management - and I still don't have a position (mainly due to worries about the macro market, in which a sudden move to "risk off" could have a big impact on long-term projects - and I've got enough exposure there for now, with rather better downside protection).
So - Zanaga Iron Ore (LON:ZIOC) is an interesting one to watch. The upside looks extremely interesting over the long term but there are material short term risks. I suspect that timing of any entry will be very important.
1. This is a major project for Congo the importance of which is emphasised by the speed of the approval - could add 30% to GNP. Also with Glencore involved there is, imho, no risk of the licence being withdrawn.
2. The current iron ore price is entirely acceptable for this project; smaller uneconomic mines particularly in China may close.
3. The economics of the project are compelling.
4. If the major shareholders had ambitions to take the company private they would probably have done so when the shares were much lower. So far they have shown no interest in adding to their holdings. Not too surprising given the magnitutde of the potential returns.
Re Zanaga Iron Ore (LON:ZIOC), I think it's worth considering that about 73% of the shares are already owned by the Chairman (Clifford Elphick) and one of the Non-Execs (Michael Haworth). Therefore there's little incentive for them to buy more, and they would need authority from the Takeover Panel before they could buy more.
When working with Glencore to raise the $2.6bn project financing, I imagine that being a UK Listed plc is a major benefit to ZIOC in terms of status in the eyes of potential financial backers for the project. So taking the company private would be a crazy thing to do, as it would undermine their own credibility. As kinkell says in his point 4 above, if they were going to take it private, they would have done it by now, since the shares bottomed out at around 9p last year.
Regards, Paul.
Not sure I understand why Zioc and Glencore should be going into a country like RoC and negotiating a 5 year tax holiday.
I guess #TUNG will have been liaising with the British Business Bank to get a feel for the level of success they will have with this application. They said the same about the banking licence from memory
I didn't read the RNS from Tungsten in quite the same way as JakNife, What struck me was that it did not say that they had got any commitment from the BBB, only that they had made an application. This is rather underlined by the closing: "There can be no guarantee that Tungsten will be able to secure such debt financing.". I hope I'm wrong but it all sounded rather precarious to me.
TUNG will have had to make this announcement this morning because it's potentially market sensitive. They've got the commitment from the British Business Bank and are now out there marketing a 10-year bond with Cannacord as bookrunner. They need to make sure that there is equivalent information in the public domain as is being given to the bond holders.
Given all that though, Paul is spot on that TUNG have probably been guilty of over-announcing of late. There is a fine line between keeping the market informed versus frenetic RNS publishing, it was a topic discussed at the Mello event and it's one where different people will have very different views on. Personally I'd side with Paul that they've RNS'd too much but I could understand if others felt differently.
Morning Paul, you have slightly mangled the quote from the SRG RNS. It should read as given below. Regards, Chris.
"In light of the strong trading in PSG and across its franchise network, the Board has concluded that it is in the best interests of SRG and its shareholders for PSG to continue focussing on the development of its business
as a wholly owned subsidiary of SRG."
It's important to recognise that ZIO is a speculative investment with a real risk of a -100% return. Its 3% of my overal equity portfolio, so any serious losses won't cause any problems but the upside is attractive, thank you for the update Paul.
I would suggest that you would be very unlucky to see a -100% return.
The directors hold a majority stake so they could theoretically squeeze the small shareholders out on unfavourable terms if they wished. There would be some return however.
Also if the licence is revoked I would imagine a bit of a legal bun fight so there would probably be some opportunity to get out.
The ZIOC admission to AIM document (all 354 pages of it) lists some 14 pages of risk warnings which every ZIOC shareholder should probably be aware of. There are many risks but in my view a zero return is not that likely.
Its also worth noting that ZIOC floated at 156 in 2010 and I think form memory raised 30 odd million. The small shareholder derserves a break with this share.
I would suggest a little caution with ZIOC.
The biggest risk is that the RoC government might withdraw the licence at some stage if they feel that the licence holder is not getting on with the project and producing ore.
This puts ZIOC in a bit of a difficult situation as they have to look as if they are doing something. Unfortunately the price of iron ore is moribund with over production and a possible slow-down in China. Against this background it’s difficult to justify spending 2.6 billion or indeed raising that kind of money.
I would guess that ZIOC will be making comforting noises for quite a while hoping to keep their options open for as long as possible without losing the licence. Ore production is a long way off in my view.
Regarding Security Research (LON:SRG) , this is a field I have some experience in. I would be reluctant to put any real money here as the field tends to be very fast moving. What is cutting edge one minute is old hat the next. Also new technologies are often replaced with cheaper manpower. (Why employ equipment costing millions when you can employ black Zimbabweans to do the same job for a fraction of the price? I experienced that on the ground. It was also interesting that those guys were eventually replaced by Alsatian dogs! And the dogs were generally treated better than the de-miners!!) Also Chemring (LON:CHG) was consolidating parts of the field, but they have now had their fingers burned, so a takeover is very unlikely. Finally several of the big spenders in this area were actually European charities. By and large they have pulled their involvement and are putting their money into more effective works. G4S (LON:GFS) have the current US and GB contracts in Afghanistan. That says it all really! But then again I have got everything else wrong over the last two years, so it is probably a definite buy!!!
I sold my shares in Zanaga Iron Ore (LON:ZIOC) when I read that >9,000,000 options had been granted to management (in addition to the existing LTIP) - see the RNS on 31 July this year. I concluded that the management were running the business for themselves and not for ordinary shareholders.
A bit harsh Paul re TUNG. I think they just want to demonstrate that things are happening but agree, there is a fine line to tread re RNS overload. I found this on the net and it gives some views following their results announcement last month:
While TUNG is just a £275mn mkt cap stock, trading just over £2mn a day, with just one (non-banks) analyst (TUNG is a type of bank) and little invoice-financing execution to date, huge progress is being made behind the scenes. It seems a matter of when, not if, it will be a success in our view. It is simply taking what already happens in the world today (invoice processing, factoring, spend analytics) and making it very low cost via a cloud-based network. No-one has more blue-chip clients in more countries.
We spoke with CEO Edi Truell this morning, here are the key findings on how things are progressing.
1.$1tn invoice flow target?: from the earnings call last week, this seemed less of a stretech target from the $190bn flow today, simply taking existing buyers on the network and getting 100% spend e-invoiced would reach that. Interestingly, some buyers like GSK and Tesco have now reached 90%+, so close to 100% is not unreasonable in a few years it would seem.
2.Elephant hunting – the Germany government: this ‘pilot’ is progressing well. TUNG was chosen from three suppliers to pilot, the other two were locals (interesting, not SAP’s Ariba – seen as the key competitor – or Basware). This is a $1tn invoicing opportunity by itself. Having the German govt confirmed would be a huge positive for the business, also EU govts will mandate e-invoicing from Jan 2016, so having the German govt signed up would clearly be positive going into 2016. Clearly this is going to be a focus short term, TUNG has several people full time on it.
3.Other elephants: target c.20 big buyers at any one time, want to sign 2-3 per year to be a success, the current run-rate is great, just signed GE for example and German govt pilot in just a few months.
4.Competition? It’s really paper invoicing and perhaps Ariba. It seems as though Ariba is not changing its extremely expensive pricing structure, basis points on the invoice capped at over $10k (TUNG charges £1 on average) so plenty of scope to win customers. This pricing doesn’t appear to be changing, clearly SAP is making a lot of money from it so it’s hard to change (TUNG CEO estimates over $300mn pa) but SAP is bundling it more with existing SAP products.
5.Factoring pricing: CEO is confident about pricing that can be achieved, since 12-13% APR is the going rate from a bank. It is going to be tailored according to the customer credit quality and demand, a Siemens-type supplier would demand lower rates than 12% but an SME may be willing to pay above 12%. The price elasticity is still to be established, it’s early days after all. Nevertheless, 12-13% is the going rate in the real world, so there’s a benchmark here.
6.Factoring volumes: this is a bigger unknown. Again, in the real world, the percentage of invoices factored is c.10%, but the figure will vary by country and customer. What actually gets factored on the Tungsten network of e-invoices remains to be seen. It may take some time for suppliers to get comfortable with it, but then even doing just 5% of invoices on the network (assume $1tn invoices in a few years, that’s $50bn (£30bn), at a spread of even say 500bps (hoping for more to start with), for 45 days that’s £185mn of gross income on a very low cost/income ratio when scaled (who knows how low) and virtually no bad loans (factoring only occurs after invoices are approved to be paid bu the buyer; even on 10x this figure you get a multiple of the stock price. Clearly there can be upside to these assumptions and when TUNG can show success, with more analyst coverage, the multiple is unlikely to be 10x earnings.
7.Supplier uploading: there is more work being done to enable the uploading of suppliers (buyers force this compliance) to be more slick. The CEO wanted the supplier uploading experience project to be completed by July, it’s going to be more like December now. If supplier sign-up rates speed up from here, this process will need to be slick.
So, things are lining up very well from what we can see. The stock has some serious shareholders, but proper analyst coverage and greater visibility on the financing experience is still some way off – hence the £275mn valuation. Given what the group has achieved already with serious MNC clients (120+ and couting), little competition and a financing engine with analytics capability ready to go, the risk reward looks very skewed to the upside at this market cap.
http://www.aviatelive.com/tungsten-key-points-from-call-with-ceo/#sthash.QRxaSOaL.dpuf
Hi Mike -
Re. TUNG. I have learnt far from from your note than recent RNS s put out by TUNG. Today's RNS simply says 'watch this space' and it is precisely the same message they put out a little over a month ago under the heading "Tungsten Explores Debt Funding Opportunities". The information value of both these updates is near zero.
On the bright side, I am a great fan of this share and have a decent holding.
So why doesn't Glencore just buy ZIOC? At 50p to 100p a bid it's pocket money to them.
Hi SevenPillars,
Good question. The answer is that Glencore can't buy Zanaga, because there are substantial blocking shareholdings. That works to our advantage, as it means that nobody can buy ZIOC on the cheap.
There are also complicated legal agreements which mean that ZIOC can't be forced out of the project, even if it is unable to raise its share of the cash required for equity-funded capex.
Regards, Paul.
"The answer is that Glencore can't buy Zanaga, because there are substantial blocking shareholdings. That works to our advantage, as it means that nobody can buy ZIOC on the cheap."
Why are the insiders leaving money on the table, and getting out of their way to give it away, rather than buy (back) the rump and delist though? They could easily raise the few millions required.
"Today's announcement from ZIOC concerns the granting of the mining licence, and mining convention (I'm not sure what the difference is, perhaps a reader could explain in the comments below)."
Paul, as you say the announcement is very clear: The Mining Licence "holder .... has the exclusive right to mine the relevant minerals within the boundaries of the licence area for an initial period of 25 years.". The Mining Convention provides "confirmation of the Project's fiscal regime" and the financial details are then clearly summarised.
Hi Splode,
Thanks for clarifying. I thought it was something along those lines, but good to have it explained.
Regards, Paul.
Hi Paul, Enjoy the last few days in the sun.
I don't hold Zanaga but note your comments on how impressed you are with the management and it doing what it says it will do. I recently bought back into Gem Diamonds which I have known for six years and where the experience has been the same; no coincidence then that the Chief Executive of Gem Diamonds, Clifford Elphick is also Chairman of Zanaga.