Over the past two weeks, shares in Sirius Minerals (LSE: SXX) have crumbled. At one point, the stock was trading 33% below its 52-week high of 39.8p, which was only printed at the beginning of August.
The shares have since staged a modest recovery, but the big question is, could there be further pain ahead for investors?
Storm brewing
As I’ve written before, it’s rare that early stage mining companies can move from the exploration to the production phase without any hiccups. Building a mine’s infrastructure is a risky and complex process. No matter how many calculations engineers complete to try to ensure costs don’t spiral out of control until the diggers start digging, no one has any idea how much the project will ultimately cost — especially when it includes the construction of a 23-mile tunnel underneath the English countryside.
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Cost overruns and delays were always going to be a threat to Sirius’s success. In fact, I would’ve been astonished if the company didn’t encounter any speed bumps during the construction phase. So, when the firm announced that it would need an additional £463m (at the top end of estimates) for the project last week, it didn’t surprise me.
The extra funding requirement means total project costs have now risen to just under £3.7bn, from around £3.2bn, previously. The company has already raised £1.1bn and management has stated that it’s well on the way to raising the additional £2.3bn to complete the rest of the project before the end of 2018 (I wouldn’t rule out these figures changing again before completion). If creditors are happy to commit an extra £2.3bn, they’re also likely to help the firm raise a further £463m, rather than lose their investment.
Risk of dilution
The bigger concern for investors is the risk of dilution. Management has admitted that fresh equity will be needed to meet the total funding requirement. So shareholders will be footing some of the bill.
In my opinion, the prospect of equity issuance, and possibly even a rights issue, is a more significant threat to the Sirius share price than anything else today.
With a market capitalisation of just under £1.3bn at the time of writing, according to my figures a three-for-one rights issue would allow the company to raise around £430m, enough to fund the projected project shortfall. I should, however, caution this is just a back-of-the-envelope type calculation, and is only designed to be an illustration of one possible fundraising scenario. A placing with large institutional investors is another option.
If the company does decide to raise cash by selling shares, based on the current market value I estimate existing shareholders could be diluted by around a third. Depending on market sentiment, this could result in a 30%-plus decline in the Sirius share price.
Once again, these are just estimates. Nevertheless, these estimates show that if the company does raise equity to finance the mine’s next stage of development, the path of least resistance for the shares is down.
