Whenever I’ve covered Sirius Minerals (LSE: SXX) in the past, I’ve always concluded that it’s a highly speculative business, but one that could produce fantastic returns for investors.
However, the company’s future hinges on management’s ability to lock in funding for the second stage of construction, which was supposed to be in place by now. But it seems the process has hit a snag, and Sirius has had to change plans in orders to get backers on board.
A new plan
While the company is confident it can still agree on a funding package, I’m starting to be concerned Sirius has bitten off more than it can chew.
Last week, the business informed investors that it had changed the $4.2bn financing plan for its potash project in North Yorkshire following talks with prospective lenders. Initially, the funding for the mine was supposed to arrive in two tranches, the first of which has already been agreed, signed and paid — a lengthy but ultimately successful process.
The second more substantial tranche is proving to be much harder to lock down. To help reassure prospective creditors, management has decided to split this final funding requirement in two. The company now is pursuing up to $700m from high yield bonds and $1.5bn of bank debt for the first round, and then $800m-$900m of loans guaranteed by the UK government’s Infrastructure Project Authority (IPA). That’s excluding $600m from an equity issue.
According to management, the new structure is designed to reduce risk to the taxpayer because the IPA debt will only be drawn on once sales have started and the main construction risks had passed.
Risks are growing
Several things concern me about the new plan. Firstly, only just last year the company was telling investors that it was “essential” to secure $2bn in debt guarantees from the Treasury to push ahead with the next phase of the project. The new plan suggests these guarantees are no longer “essential.” The question is, does this mean the company doesn’t need them, or does it mean the Treasury didn’t want to offer them?
Secondly, high-yield debt is a costly way of borrowing money, especially for early-stage mining companies. What’s more, by borrowing from banks and capital markets, Sirius exposes itself to the risk that creditors could try to seize control of the business if it misses specific payment or construction milestones.
Time running out?
Higher debt costs and the chances of a possible creditor take over both dramatically increase the risk of failure for the company, in my opinion. Plus, the business only has £230m of cash in the bank, just enough to last until the end of the second quarter. That’s why I think time could be running out for the Sirius Minerals share price.
So far, construction is progressing to plan and the risk/reward ratio for investors is still attractive. However, small mistakes in the mining business can quickly escalate into big, expensive problems and this has always been the biggest risk for the company.
By taking on more debt, even a small hiccup in construction could lead to significant repercussions. And if the company starts to struggle to meet obligations, shareholders could be wiped out.
