I am starting to become worried about Sirius Minerals (LSE: SXX). 2018 was supposed to be the year the company locked in the second stage of financing for its flagship potash mine in North Yorkshire. That was meant to clear the way for production to begin in the early 2020s, and remove the uncertainty that has surrounded the business since its IPO back in 2005.
However, as the year has progressed, it’s become increasingly clear the company won’t be able to make the progress everyone hoped it could.
In my opinion, the delay isn’t good news and could signal that the company’s creditors are starting to doubt the viability of the project.
Further declines
Before I continue, I want to make it clear that I still believe Sirius has tremendous potential, over the long term. What I’m concerned about is how much value will be left for current shareholders five years from now.
As I have covered before, I believe the company’s creditors will continue to support it because if they don’t, they stand to lose the money they have already committed. For Australian mining magnate Gina Rinehart, this could mean a loss of as much as $300m.
But the outlook for ordinary shareholders is less clear. Management has already admitted that cost overruns on the construction of its potash mine will be funded with an “equity component,” implying the company will be issuing more shares to raise capital.
Dilution
Issuing more shares will keep the lights on, but it will also dilute existing shareholders. Ultimately, this means that each share in the company has a smaller percentage claim on assets and earnings and is therefore worth less.
For example, over the five years between 2013 and 2017, book value per share jumped from £135m to £505m, a compound annual growth rate of 41%. Meanwhile, the number of shares in issue climbed from 1.5bn to 4.3bn, a compound annual growth rate of 26%.
Book value per share, a measure of a company’s net asset value per share, or the amount each shareholder could be entitled to in the event of bankruptcy, increased from 7p to 11.3p over this period. If the number of shares in issue had stayed constant between 2013 and 2017, book value per share would be around 34p today, approximately 200% higher.
My fear is that the firm will continue to issue more shares to keep the lights on, diluting existing shareholders and effectively neutralising any earnings or book value growth. As the company’s market capitalisation is only £1bn, compared to the necessary funding commitment of £2.7bn, if management does decide to raise a portion of the funds via an equity issue, shareholders could be diluted by more than 50%. That may have the effect of cutting the share price in half.
I should point out this is the worst-case scenario, and may never happen. But I believe it’s always important to consider the risks to any prospective investment.
