Is Sirius Minerals PLC About To Be Taken Over?

Sirius Minerals (LSE: SXX) is up 50% in the last month alone — should you buy or sell it right now?

And, equally important, should you bet on a takeover of this potash developer? 

Consider This

Firstly, you ought to be very careful before considering Sirius to be either a value or a growth play. In fact, at present we have no elements to suggest that Sirius is worth much. It’s all about expectations based on its York Potash project study.

Secondly, as speculation about a change of ownership persists, you’ll likely burn your fingers if that’s the only reason why you are buying into the stock. In fact, the fall could be painful, and the more the stock appreciates, the less likely a takeover will become. 

On The Up…

The market cap of this potash development company has risen to £225 from about £150m since 11 March, when Sirius announced it would raise new equity — aside from that, nothing relevant has happened since, aside from certain potato trial results.

“By carrying out these trials in these important markets like the United States and UK, where potatoes are a key crop, we continue to validate the effectiveness and value of polyhalite,” chief executive Chris Fraser said on 2 April. 

You may well argue that such an update is not worth £75m of incremental value!

Well, its sales are zero and its operating cash flow profile hasn’t improved, as Sirius is still burning between £1.5m and £3m a month, according to my calculations. On that basis, its recent cash call of £15m is small change, really, particularly taking into account that its potash mine project is still pending planning permission.

How Much Are You Paying For Sirius? 

One caveat is that is virtually impossible to make any reliable assumptions at this stage of maturity for the business, but let’s say that Sirius will start generating revenue at some point in future. This could be a highly lucrative business with hefty margins, and I can see why some investors are willing to take risks. 

Based on the valuation of similar businesses I have studied over the years, the current market value of Sirius implies that investors believe the company will be able to generate £40m of forward revenues, which should produce net income of £10m — current net losses stand at about £8m on a yearly basis — and adjusted operating cash flow of £14m. Such high margins — 25% and 35%, respectively — are not out whack with reality, and they could determine a valuation premium of between 40% and 60% versus more mature potash players.

Many other factors such as the value of its assets, growth and capital invested should be considered, of course, but what this scenario implies is that, assuming the current market cap of Sirius remains constant over time, its shares would trade on forward earnings and core cash flow multiples of 16x and 22x, respectively. Under this scenario, gross cash and gross debt on the balance sheet equal zero. Its implied revenue multiple would be 5.6x.  

In truth, investors are snapping up the shares of a business that won’t generate any revenues and income for a very long time, and whose fair value, based on its assets base, is merely speculative right now. These numbers are essentially for illustrative purposes only, given that there’s no hard evidence upon which to base a proper judgment. In fact, Sirius is a business that will need billions of investment to generate several hundred millions of earnings, at least theoretically.

To put my numbers into context, consider that, according to Sirius, the “project study was completed to a level of accuracy of +/- 25%” and that, as part of the study, the expansion of NPK (which is part 2 of the study) “could deliver incremental annual Ebitda in the range of $374 – $617m from approximately 2.5mtpa of polyhalite”.

To me, that’s stuff for a behemoth in the chemicals space…