Searching for new opportunities

Monday, 23rd April 2018 10:29 - by David Harbage

From time to time this writer is asked to review new businesses in search of potential corporate stars of the future. Understandably, the majority of these are technology-biased, which is logical given the way that life is being changed by the increasing application of the internet and the prospective use of all sorts of other clever hardware such as drone devices or software-enabled manipulators of big data.

Investigating the product or service and carrying out due diligence on the business model can be fun, but the prime problem surrounding an investment case invariably comes down to procuring confidence in their longer term success. In particular, maintaining high barriers to the inevitable competitive threat – given the global spend on research and development in technology. Other risks and concerns, most recently of digital databases’ security (per the Facebook example), are secondary by contrast.

As regular readers will know, this blog has a preference for assets which offer the prospect of growth but can be seen, touched or better understood. In addition, for investment purposes, those that already proved themselves by generating revenue and sharing profits with their owners (in the form of dividends). So, this blog is going somewhat ‘off-piste in looking at, as yet, unprofitable businesses.

Last week’s request was to take a look at Sirius Minerals which plans to exploit a huge potential underground seam of potash fertiliser in north Yorkshire. This exploration project has been backed by a number of financial institutions, but sinking a shaft 1mile deep and a subsequent 22 mile tunnel of 5 metres diameter will require further funding in excess of £2bn to enable the polyhalite product to be transported to the coast to be purified and shipped. Management expect extraction to begin in 2021 and reach full production (of 20m tons worth £5bn+ per annum on current potash prices) in 2026. With operating costs of circa 15% the current US$280 a ton selling price, this business could prove to be highly profitable.

However, the market worth of the equity of Sirius Minerals is already valued at almost £1.4bn and, with the business unlikely to break even in the next four years, all depends on the board’s ability to raise additional monies to build the tunnel and a manufacturing plant. Beyond recourse to bank lending, the FTSE250 constituent’s shareholder register provides limited encouragement: besides 5% director ownership and a 9% stake by fund manager Capital Group, retail shareholders feature at an unusually high level. Having said that, one quarter of a US$1.2m cash raising exercise last year was provided by one of Australia’s wealthiest individuals, mining magnate Gina Rinehart.

This blog never makes recommendations, but this company is clearly not an investment for ‘widows or orphans’. The same could be said for Bluejay Mining, which today announced a four-fold increase in the prospective size of its sand ilmenite (which is a source of titanium dioxide, used in a raft of products including paint) resource in Greenland, as compared to that first announced a year ago. Representing another exploration project of a potentially globally significant, widely used raw material, it has clear similarities with Sirius Mining. Having said that, these businesses clearly have very different properties and elements of risk - when considered from an operational and a stock market investment perspective.

Bluejay is listed on the Alternative Investment Market (AIM, which has less rigorous disclosure requirements than a full or premium listing on the London stock exchange) and, following a £17m cash raising exercise in February 2018, is currently worth £210m. Directors own a little over 10% and the shareholder register shows six major institutional stakeholders including Prudential 12%, Sand Grove Capital, HSBC, Capital Group and ING. The extraction process - of removing and conveying material from 30 miles of beach (albeit in a more hazardous climate) onto a ship – is relatively straightforward and inexpensive by contrast with tunnelling. Profitability is not in immediate sight and further spend on site infrastructure may require additional recourse to shareholders before full production is reached.

The announcement of off-take contracts (the buyers of the raw material), who are likely to be major chemical, energy or mining companies, involving significant upfront payments would encourage shareholders to support the projects. These same companies could, of course, decide that the benefits of vertical integration prompt a more aggressive investment by taking an equity stake or launching a takeover bid.