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Sirius Minerals' fields and dreams: why small cap firms struggle when building projects

"Build it and they will come" ... was basically the theory, but first Sirius needed enough capital to pay for the whole mine development

Hurricane Energy PLC - Sirius Minerals fields and dreams: why small cap firms almost always struggle when forced to build their projects
An expensive hole in the North Yorkshire ground

Small-cap resource companies are notoriously bad at delivering projects in the real world, so is it really that big of a surprise that Sirius Minerals PLC (LON:SXX) has come unstuck?

Sirius hasn’t been a small-cap share for some time (although it may be again soon) and it left AIM more than two years ago, but, its roots are most certainly in the junior market.

Not to do the small caps a disservice, AIM’s hardy and ambitious geologists are very good at getting investors to buy into big ideas.

They are adept at turning whirling drill-bits into vast theoretical resource estimates, and even drawing up blueprints for what these blue-sky projects may eventually become.

In the script of an AIM stock’s biopic, the third act would invariably feature celebratory fireworks and fanfare as the senior management team inks a takeover or asset sale.

Such deals would deliver risk-free rewards to the small-cap firm’s cavalier punters, unmissable opportunities to cash-out profitably and move on. Unfortunately, these deals are thin on the ground. This is rarely how the story goes in the real world.

Management, in the real world, often find themselves presented with dilemma even after their exploration successes - what do they do with all these resources amassed on spreadsheets and geology models?

Once they have hundreds of millions or billions of dollars’ worth of natural resources, enough to justify development, a pre-revenue company can’t justify their existence with endless drill programmes.

They can’t simply keep stacking up reserves for the future. They must at some point build the damned thing! So, without any immediate helping hands, the only real remaining option is to be brave, believe and go it alone.

This, it turns out, is much easier said than done.

Hurricane and Xcite - case studies of success and failure

Those troubled Yorkshire shareholders – Sirius has some 85,000 shareholders, a very large proportion of which are private investors from the areas closest to the proposed mine – may look northwards, offshore for a glimpse at two very different potential outcomes.

Sirius arguably shares similarities with both Hurricane Energy Plc (LON:HUR) and failed North Sea oiler Xcite Energy.

Like Sirius, both propositions hinge on a specialised variation on a core commodity story. For Hurricane, it is about pioneering basement oil pools whereas Xcite had a heavy, waxy crude that required extra work to extract and process.

Sirius’s polyhalite fertiliser is essentially an alternative to typical ‘potash’ minerals. Whilst the London-listed firm has pre-sale client list an arm-long there has been open scepticism from some stock market experts and (perhaps naturally) industry rivals.

What they all have in common is that industry ‘big boys’ evidently passed up opportunities to snap up ‘world-class’ scale project early, instead, they required more de-risking work to be done.

Parallels could also be drawn with fast-rising drug stocks, as top tier pharma-cos will happily forego the first phases of rapid value growth through clinical trials as they instead wait to acquire fully proven and approved drugs with certainty in their route to market.

What’s a few hundred million dollars more if you’ve got the cash flow of a GlaxoSmithKline, BP or Rio Tinto?

Ultimately, the companies with the most operational capacity to deliver new large-scale resource projects rarely have the need or desire to get their hands dirty with riskier non-standard assets – instead, they’ll happily accept paying more for them in time once the risks are removed.

Project financing a perennial stumbling block for ‘world-class’ small caps

For the likes of Sirius, Hurricane and previously Xcite it presents the daunting task of taking ‘world-class’ assets entirely on their shoulders to fund and take projects to fruition by themselves.

Hurricane, heavily back by private equity even before its 2014 AIM float, has navigated this challenge particularly well. It executed a series of important funding rounds with the help of its cornerstone investors - largely using only-partially dilutive convertible debt.

The West of Shetland oiler has enjoyed comparative comfort as it had the wherewithal to drill several wells and earlier this year it successfully delivered an ‘early production system’ at the Lancaster field which gives it revenue-generating production in the order of around 14,000 barrels of oil per day.

A number of years ago, however, things fell apart for Xcite. The company’s management failed to secure partnership-based financing for the proposed development of the Bentley heavy oil field in the North Sea.

Stumbling from one missed funding opportunity to another, the company eventually collapsed amid worsening oil prices, as crude fell from its US$100-plus per barrel highs.

Certainly, the commodity pricing was a major factor, as was the economic burden of the project’s non-standard resource, but, there was certainly a sense at the time that better deal-making or greater compromise could potentially have created some room to optimise the project.

Indeed, Bentley’s privately owned current owner Whalsay Energy claims to have ‘developed a technically credible and conventional Bentley field development ‘ which apparently comes with a lifecycle cost below US$33 per barrel crude.

Xcite’s private investor heavy shareholder register was ultimately left to rue what might have been as the company disappeared into liquidation back in 2016.

Turning back to the present, Providence Resources PLC (LON:PVR) is yet another example to underline the point that finding a large deposit is the easy part.

The Irish oiler, like Sirius, is ailing through problematic financing arrangements whilst hoping it can come out the other side with a revenue-generating project.

Providence last year inked a deal with Chinese partners which envisaged quick-fire funding followed by an active drill programme and production as soon as 2021.

Instead, the very first payment of around US$9mln has yet to be received and the company was last week forced into emergency US$3.76mln equity funding. Chief executive Tony O’Reilly now has financial breathing room until February – what happens to the company and/or the Barryroe oil field beyond that date remains unknown.

So what happens to Sirius now?

Tuesday’s news effectively wipes out a US$3.4bn project financing plan laid out in April - the smallest of mercies for Sirius’s battered shareholders is that the other US$400mln of the original US$3.8bn package was equity raise, and the company is currently holding around US$180mln of cash.

Sirius is left deep in a literal and figurative hole. It has a partially complete mine construction, which to the untrained eye appears simply as a cement-lined chasm. 

The company has enough cash to cover six months’ of reduced running costs in which time it must come up with a new plan to finance what will now be a delayed delivery of the mine.

There will be disappointment that the government refused to step-in with a requested US$1bn commitment that, according to Sirius, would’ve safeguarded the larger US$2.5bn project financing and would’ve enabled the completion of the project.

It will be a particularly bitter pill given that Theresa May’s government previously supporting the project, with US$1bn worth of guarantees factored into a previously envisaged financing package (albeit negotiations started with an expectation that Sirius could get as much as US$2bn guaranteed).

Theoretically, government support may not be off the table for future consideration, but, the current government’s future probably looks even less certain than Sirius’s mine project.

Sirius still has pre-sale agreements with future customers accounting for some 10.7mln tonnes worth of contracted sales per year, spread across multiple customer deals.

The miner’s house broker Shore Capital, in a note on Tuesday morning, emphasised that Sirius “still has options”.

Specifically, Shore Cap reckons Sirius could turn to the industry for salvation - but, evidently its bargaining position is weak.

Alternative solutions could potentially include teaming up with a strategic partner. A new strategic investor could theoretically provide cash upfront in exchange for a stake in the business but due to the company’s need was likely to be on unfavourable terms.

Sirius’s own guidance of its pending strategic review stated that it would consider ‘all options’.

Even the most optimistic appraisal of possibilities - that a large mining firm with sacks of disposable cash swoops in to save the project - comes with an unlikely tone and would certainly be in the context of bargain hunting rather than the kind of premium-priced exit London (or York’s) speculators had hoped for.

In the meantime, the question for investors ought to be: if your aspirational resource stock wants to take its ‘world-class’ resource into production alone, do you really want to follow?

Quick facts: Sirius Minerals PLC

Price: 3.558 GBX

LSE:SXX
Market: LSE
Market Cap: £249.78 m
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